Patterns and Trend Channels
One day before the election, and everyone seems to be waiting. However today was a good example of the relationship between trendlines, channels, and chart patterns. The early gap held for less than three minutes, and although I could make a case for an entry about 6:50 (Pacific), the Russell was lagging badly, so I just watched.
By the end of the first hour we had set up a trading range, and I drew the yellow horizontal lines. As I’ve mentioned before, when I can’t find an entry I like in the first hour I’ll often wait for a breakout before considering a trade. And those early pushes through the top line are not breakouts.
Notice the lower blue line that can be drawn shortly after 7:30 from point #1 to #2. This and the parallel drawn from point #3 are created long before we know if the day’s high will create a level of strong resistance. But when it does, you have the shape of a well-known chart pattern — the upside triangle.
So which line do you use — the top yellow line creating the triangle or the blue parallel? The correct answer is to use both. When a triangle breakout occurs, the first target is the parallel of the side opposite the breakout. That’s just another way of saying that price channels make natural targets. If I hadn’t already drawn the upper blue line, I would put it on the chart as soon as I recognized the triangle pattern.
I can already hear a voice saying “But it didn’t reach the parallel.” That doesn’t prevent a profitable trade. My procedure is to move a trailing stop very close to price when we approach a parallel, so the fact that we didn’t quite get there doesn’t mean I give back much of the accumulated profits.
But in this case, there were none to give back. I didn’t like the “upside” triangle because of the irregular top, and the breakout had very little volume. Low volume upside breakouts are prone to failure. Some low probability setups work out just fine, but I’d rather have more odds on my side.
