Chart Pattern..

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Bullish Flag

Definition:

A bullish flag forms in the context of a bullish trend. Like the name implies, the pattern appears as a flag, complete with a flagpole. The flagpole of the pattern is formed when a stock stages a sharp upward move in a short period of time.

The flag of a bullish flag can unfold in one of two ways. First, the flag can be defined by very precise horizontal support and resistance levels. This variation of the pattern reveals strong opinions on the parts of buyers and sellers. Second, the bullish flag might format with downward sloping support and resistance levels. This second variation is the most common.

Nuance:

Bullish flags are typically short-term in nature and are quite common within the context of strong bullish trends. In fact, bullish flag after bullish flag will form during strong bullish trends. They may form and play out in a matter of days or weeks. Rarely will a flag form over the course of years.

Application:

A bullish flag is confirmed once the stock closes above the upper-end of the flag, whether the flag is horizontal or downward sloping. A stock might break above horizontal or diagonal resistance and retest the level several times, using it as support. This price action is consistent with that of most bullish continuation patterns such as the bullish wedge.

A bullish flag is rejected if the stock breaks down below support, either horizontal or downward sloping. The stock will typically languish if it violates its bullish flag.

Example:

The two variations of bullish flags are shown in Figure 5.3 in the United States Oil Fund (USO), which is an exchange traded fund that tracks the price of crude oil. Notice how two of the bullish flags are slanted, with downward sloping support and resistance levels. The flag in the middle is horizontal, with well-defined support and resistance levels.

This example illustrates how bullish flags can repeatedly form within a bullish trend. It also shows the different time periods over which flags can form, from relatively longer periods to incredibly short periods. The third flag in the USO formed in a matter of days, yet it led to an explosive move higher.

 

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Bullish Pennant

Definition:

A bullish pennant is very similar to a bullish flag. Like the bullish flag, the bullish pennant starts when a stock stages a big upward move in a short period of time.

The difference between a flag and a pennant is that the pennant forms with converging support and resistance levels. The support and resistance levels are coming to a head as buyers and sellers becoming increasingly aggressive. Eventually the tension reaches the apex of the bullish pennant, at which point the stock usually breaks higher.

Nuance:

Bullish pennants are typically short-term patterns that recur within the context of strong bullish trends. Bullish pennants offer quicker entry points than bullish flags. That’s because of the convergence of support and resistance. This convergence also offers a tighter stop loss with which to manage risk.

Application:

A bullish pennant is confirmed once the stock crosses above the upper-end of the pennant, which is defined by the downward sloping resistance line. A bullish pennant is rejected if the stock breaks down below the upward sloping support line.

Example:

Shares of Chipotle Mexican Grill (CMG) traced a bullish pennant by starting with a big burst higher in a short period of time as shown in Figure 5.4. The stock surged from $80 to $105 in a matter of a few weeks. In the following weeks, the stock bounced back and forth between converging support and resistance levels.

Notice how once the stock broke the bullish pennant it never looked back. A stock is unlikely to retest the downward sloping resistance line of a bullish pennant. Once the stock breaks above diagonal resistance, it generally trends higher.

 

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Cup and Handle

Definition:

The cup and handle is a unique bullish continuation pattern. It starts after a stock stages a lengthy rally. The stock then pulls back and starts to level off. The stock then rallies back up to the point at which the previous run ended. The stock reverses once more from the same level, creating horizontal resistance. The stock levels off after pulling back, attracting buyers, but this time at a relatively higher price. It returns to the horizontal resistance once more and breaks out, continuing its bullish trend.

Nuance:

The cup and handle is an extremely strong bullish continuation pattern. But unfortunately the pattern is rare. The strongest cup and handle patterns are usually long-term in nature, taking months or even years to form. Generally the longer the pattern takes to form, the strong it is once broken.

Application:

A cup and handle is confirmed when the stock breaks above horizontal resistance. Like other bullish continuation patterns with horizontal resistance, the cup and handle horizontal resistance often acts as support after it’s broken.

A cup and handle is violated if a stock pulls back from horizontal resistance and falls below the second low, creating a relatively lower low.

Example:

Shares of Deere (DE) traced a cup and handle, starting with the termination of a rally at the $44 level as shown in Figure 5.5. The stock then retraced down to near the $34 level, rounded out a bottom, and then headed higher back to $44. The stock pulled back for a second time from horizontal resistance at $44, but to a shallower level at $42. DE then returned to $44 a last time, breaking the resistance in spectacular fashion.

Observe how DE retested the $44 resistance level several weeks after breaking out from the cup and handle pattern. The stock surged higher in a short period of time after the successful retest of previous horizontal resistance at $44.

 

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Bearish Continuation Patterns

Bearish continuation patterns are best to apply in bearish markets, industries, or individual stocks. It sounds simple enough, but too many traders ignore this axiom. Don’t go looking for bearish continuation patterns in bullish markets or sectors.

A bear market is one that is at a minimum ten percent off of its highs. A more conservative definition is a market that is 20 percent off of its highs. Look for bearish continuation patterns in markets, sectors, or stocks that are at least ten percent from their highs and trending lower. Preferably only look for bear markets in sectors or stocks that are 20 percent, or more, off of their highs and trending lower.

Bearish continuation patterns predict the continuation of existing bearish trends. A prerequisite of bearish continuation patterns, therefore, is a historical bearish trend. Put another way, there needs to be a historical bearish trend before the formation of a bearish continuation pattern. As simple as this may sound, it’s often overlooked by traders new to price patterns.

The formation of a bearish continuation pattern doesn’t guarantee a continuation of a bearish trend. The probabilities favor as much, but it’s far from a guarantee. It’s vital to manage risk in the event that a bearish continuation pattern doesn’t play out as planned. Remember that short sellers are a fickle group of traders. They know that stocks can go a lot higher than they can go lower. It’s imperative to manage risk, maybe even erring on the side of being conservative, when trading bearish price patterns.

Bearish continuation patterns oftentimes require a catalyst, a piece of bad news or an event in the economy. The odds of making money when trading bearish continuation patterns greatly increase when there is a catalyst to motivate a move lower.

 

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Bearish Triangle

Description:

A bearish triangle is a symmetrical triangle that forms in the context of a bearish trend. The triangle starts with a big downward move in the stock over a short period of time. The stock then proceeds to bounce higher, reverse lower, and continues to do so along converging support and resistance lines. The lines meet at the apex of the triangle, at which point the stock generally breaks lower.

A stock doesn’t necessarily need to reach the apex of a bearish triangle before breaking down from the pattern. In fact, a breakdown from a bearish triangle before the apex generally reveals aggressive selling, even fear in the marketplace. This can be a good sign that the stock will continue to trend lower.

Nuance:

The triangle itself is symmetrical and, in fact, neutral in terms of directional bias. It’s only a bearish triangle if it occurs in the context of a bearish trend. It’s very important to independently define the trend when coming across situations such as triangles.

Application:

A bearish triangle is confirmed once the stock breaks below the lower-end of the triangle, which is defined by the upward sloping support line. A bearish triangle is rejected if the stock breaks above the downward sloping resistance line. Such a rejection usually leads to sideways trading or occasionally the beginning of a bullish trend.

Example:

A long-term bearish triangle formed in shares of Alcatel-Lucent (ALU) over the course of about 16 months as shown in Chart. The bearish triangle was preceded by a lengthy bearish trend in the stock.

Notice how ALU bounced back and forth, between upward sloping support and downward sloping resistance. The stock broke down below the upward sloping support line at $12. It steadily dropped over the next several months.

 

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Bearish Wedge

Definition:

A bearish wedge starts with a sharp downward move over a short period of time. A bearish wedge forms when a stock reaches and repeatedly retests a horizontal support level within the context of a bearish trend.

As the stock bounces up from horizontal support, it repeatedly rolls over at increasingly lower resistance levels. The price action forms a diagonal resistance level, which eventually converges with horizontal support.

Nuance:

The bearish wedge is extremely bearish in nature because the sellers are growing increasingly aggressive over time. This aggressive selling usually overcomes the horizontal support, which generally forms at psychologically or technically significant levels in the stock. A psychologically significant level in a stock might include $20, $50, or $100. Examples of technically significant levels include 52-week lows and multi-year lows.

The bearish wedge can break before the confluence of horizontal support and diagonal resistance. A breakdown before the apex of the wedge is usually an extremely strong signal that the stock is going to trend lower.

Application:

A bearish wedge is confirmed once the stock breaks below horizontal support. Once broken horizontal support is broken, the level can act as resistance on subsequent rallies. Although, in the case of a bearish wedge, a stock usually drops rather precipitously once the pattern is confirmed.

Example:

Shares of Office Depot (ODP) traced a bearish wedge with horizontal support at the $18 level as shown in Figure 6.2. Observe how the stock rebounded from the $18 level on several separate occasions. The sellers grew increasingly aggressive, however, pressuring the stock lower and lower. The sellers eventually overpowered the buyers at the $18 level, and the stock plummeted lower.

The ODP bearish wedge was one in which the stock didn’t immediately drop. In fact, ODP hesitated after initially attempting to breakdown from the bearish wedge. The horizontal support at $18 morphed into resistance and capped each brief rally attempt after the stock fell below $18.

 

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Bearish Flag

Definition:

A bearish flag forms in the context of a bearish trend. The inverted flagpole of the pattern is formed when a stock stages a sharp downward move in a short period of time. Like the bullish flag, there are two types of bearish flags. One type has horizontal support and resistance. The other type of bearish flag has upward sloping support and resistance levels.

Bearish flags with precise horizontal support and resistance levels are rare, but generally strong indications that the bearish trend will continue. These types of bearish flags usually require a long time horizon to unfold.

Trader Tip

Bearish flags with upward sloping support and resistance are common. These bearish flags occur regularly within the context of a bearish trend. Bearish flags with upward sloping support and resistance tend to be shorter-term and very actionable.

Nuance:

Bearish flags with horizontal support and resistance are rare. When they do form, they are typically long-term in nature and driven by a significant news event or other fundamental development.

Bearish flags with upward sloping support and resistance are common. These bearish flags are relatively easier to trade because action points are precise.

Rarely will you see a either type of bearish form over the course of years.

Application:

A bearish flag is confirmed once the stock closes below the lower-end of the flag, whether the flag is horizontal or upward sloping. A stock might initially breakdown from a bearish flag, below support, but then retest previous support before ultimately trending lower.

A bearish flag is rejected if the stock breaks out and above the upper-end of the flag. This rejection of the bearish flag may mark the beginning of a short-term bullish trend.

Example:

Shares of Group 1 Automotive (GPI) traced a bearish flag in Figure 6.3 with horizontal support and resistance. Notice how the stock traded sideways, between $39 and $43 for several months after a sharp drop. The stock took its time consolidating such a steep drop before ultimately continuing lower.

Observe how previous support at the lower-end of the bearish flag at $39 served as resistance after the stock broke down. In fact, there were two separate occasions when GPI traded up to $39 and subsequently rolled over, after it broke down from the bearish flag.

Example:

The bearish flag with upward sloping support and resistance is show in shares of Brunswick (BC) in Figure 6.4. The stock steadily trended lower for several months before staging a short-term rebound, during which it formed a bullish channel. In the context of the overall bearish trend, the short-term bullish channel helped to define the bearish flag.

The stock broke down in a decisive way from the bearish flag, offering a precise entry point into new bearish positions. Following the breakdown from the bearish flag at $23, BC continued lower over the next several months, falling as low as $17.

 

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Bearish Pennant

Definition:

The bearish pennant starts when a stock stages a sharp downward move in a short period of time. The support and resistance converge towards an apex as buyers and sellers becoming increasingly aggressive. Eventually the tension reaches the apex of the bearish pennant, at which point the stock breaks lower.

The difference between a bearish flag and a bearish pennant is that the pennant has converging support and resistance levels. The bearish flag, meanwhile, always has parallel support and resistance levels.

Nuance:

Bearish pennants are typically short-term patterns that recur within the context of strong downward trends. Bearish pennants offer quicker entry points than bearish flags. That’s because of the convergence of support and resistance. This convergence also offers a tighter stop loss with which you can manage risk.

Application:

A bearish pennant is confirmed once the stock closes below the lower-end of the pennant, which is defined by the upward sloping support line. A bearish pennant is rejected if the stock breaks above the downward sloping resistance line.

Example:

Shares of Applied Materials (AMAT) traced a bearish pennant over several weeks as shown in Figure 6.5. Notice how highs were repeatedly capped at sequentially lower levels. Also, look at how the lows inched up to higher and higher levels. These two patterns in the highs and lows helped to form the converging resistance and support.

Once AMAT broke down from the bearish pennant, it moved lower. The breakdown below the upward sloping support line was easy to identify with the drop below $18

 

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Double Distribution (Inverted Cup and Handle)

Definition:

The double distribution, or inverted cup and handle, is a somewhat rate bearish continuation pattern. It starts when a stock a stages a steady bearish trend. The stock then starts to rebound over several weeks or months, but then loses upward momentum and levels off. The stock then slides lower, back down to the point from which it first rebounded. The stock rebounds once more from the same level, creating horizontal support. The stock starts to level off again, after rebounding for a second time from support, but during this rebound the stock levels off at a relatively lower level. This creates a series of lower lows. The stock returns to the horizontal support once more and breaks down, continuing its bearish trend.

Nuance:

The double distribution is an extremely strong bearish continuation pattern. But unfortunately the pattern is rare. The strongest double distribution patterns are usually long-term in nature, taking months or even years to form. Generally the longer the pattern takes to form, the more convincing it is once broken.

Application:

A double distribution is confirmed when the stock breaks below horizontal support. Like other bearish continuation patterns with horizontal support, the double distribution horizontal support often acts as resistance after it’s broken.

A double distribution is violated if a stock rebounds from horizontal support and advances above the second high, creating a relatively higher high.

Example:

Shares of AirTran (AAI) traced a double distribution, starting with the termination of a strong bearish trend at $9 as shown in Figure 6.6. The stock then rebounded from several quarters, reaching as high as $13 before leveling off. The stock retested $9 about one year after first falling to that level. It then rebounded once more, but leveled off at the $11 level, which was $2 below the first high. The pattern of lower highs is a requirement for the double distribution.

AAI dropped lower after breaking below the $9 horizontal support level. There was no hesitation once support was broken. Observe how a clear action point was offered at the $9 horizontal support level.

 

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Bullish Reversal Patterns

Bullish reversal patterns predict the reversal of an existing bearish trend and the beginning of a new bullish trend. Nevertheless, bullish reversal patterns go against the grain of an existing bearish trend. This makes bullish reversal patterns a little more nuanced and delicate in their application.

Bullish reversal patterns emerge when existing bearish trends grow old, when the fundamental drivers of the trends have run their course. The bullish reversal patterns reveal equaling levels of demand for or supply of a stock; sellers complete all of their selling and buyers begin to see value.

The bullish reversal patterns point to an end of a bearish trend and the beginning of an opposite bullish trend. The reversal patterns provide entry points, offer price targets, and even suggest the time horizon in which the price target might be achieved.

The probabilities of bullish reversal patterns playing out as expected are less than the probabilities associated with trading bullish continuation patterns. The lower probabilities associated with trading bullish reversal patterns stem from the fact that the patterns go against the existing bearish trends. It’s vital, therefore, to manage risk in the event that a bullish reversal pattern doesn’t play out as planned.