Lesson 5 - Patterns
- 1. Lesson 5 - Patterns Mark Putrino, CMT 1
- 2. Charts ▪ Chart patterns are not mysterious, mystical, or magical. They are illustrations of the supply and demand dynamics that are occurring in a given market ▪ All charts should be viewed through the prism of supply and demand dynamics ▪ If you understand what the pattern illustrates, it isn’t important to memorize the names of them. This is especially the case with candlestick patterns ▪ Patterns are combinations of trends and levels ▪ Only certain patterns are valid ▪ Reversal patterns only occur after uptrends or downtrends. If the market has been trading sideways the reversal pattern that analysts have been talking about isn't a reversal pattern 2
- 3. Head & Shoulders Pattern ▪ We’ve all had seller’s remorse. You sell a stock. It trends lower. But then it rallies and trades higher than your selling price. ▪ You decide to buy your stock back. But you also decide that you will only do so if you can get it for the same price you sold it at. This way you can erase your mistake. So ou place your buy order at the same level. ▪ This is a common occurrence in the financial markets. You can see it on almost any chart. Understanding this dynamic can lead to great profits. It is the key to understanding the head and shoulders and other reversal patterns. ▪ When markets are rallying, there are so many remorseful sellers placing buy orders at their prior selling prices that it causes support to form. If there are enough of these buy orders, the levels that had previously been resistance turn into support. ▪ In bull markets levels that were resistance convert into support. ▪ The first sign that the bull market is coming to an end is when this conversion dynamic ends. When the peak or resistance level that formed the left shoulder of a head & shoulders pattern does not convert into support, it is a bearish signal. ▪ If you understand the fundamentals you don’t need to memorize the patterns. ▪ The essence of the Head & Shoulders pattern is that it shows the bullish dynamic of former resistance levels converting into support levels has ended or is about to end. 3
- 4. Uranium Energy (UEC) Between December 2020 and March 2021 each important resistance level for UEC converted into support. But in April the $3.05 level did not turn into a support level. This was a signal that the rally was over. 4
- 5. Clearsign Technologies (CLIR) – April 12, 2020 Resistance at the $5 level caused two distinct left shoulders to form. After the stock broke through, it formed a peak or head around $6. After trending lower it reached the $5 again. But as you can see on the following chart, there was little if any support. CLIR is now trading below $5. This could be a sign that the downtrend will continue. 5
- 6. Opko Health (OPK) – April 12, 2020 On the following chart, you can see how the resistance that caused the left shoulder to form didn’t convert into support when OPK fell back to it. This is warning sign number one. There is a second warning sign shown here that is also part of the traditional H&S pattern. The right shoulder is a lower high than the head. Lower highs are bearish. They show that as time has passed, buyers have become less aggressive. They aren’t willing to pay prices as high as they previously did. In this example, some buyers were willing to pay up to $6 a share for OPK in February. This was the head of the pattern. But in March the highest investors were willing to pay was $5 a share. This is the right shoulder of the pattern. It’s a lower high. 6
- 7. Inverse Head & Shoulders Pattern ▪ They opposite dynamic occurs in bear markets ▪ During bear markets there is buyer's remorse. Investors buy stocks and then watch them move lower ▪ They decide they want out. But they don’t want to lose money. This makes them place their sell orders at the same price they bought their stock for ▪ When markets are heading lower, there are so many remorseful buyers placing sell orders at their prior buying price that it causes resistance to form. If there are enough of these sell orders, the levels that had previously been support turn into resistance. ▪ If there are enough of these sell orders it will cause resistance to form ▪ The essence of the Inverse Head & Shoulders pattern is that it shows the bearish dynamic of former support levels converting into resistance levels has ended or is about to end 7
- 8. AT&T Inc (T) Between July and November 2020 shares of AT&T Inc (T) trended lower. Important support levels converted into resistance twice. But then in November, the $27.85 level which had been support did not convert into resistance. This was a sign that the selloff was over. 8
- 9. Electronic Arts Inc (EA) In July 2020, shares of Electronic Arts (EA) found support around the $134 level. In September and October $134 became a resistance level. Then in September and October, there was support at the $124 level. But in late November there was little if any resistance Shares were able to rally right through $124. This was a sign that a new rally was forming. 9
- 10. Peloton Interactive (PTON) The $100 was important support for Peloton in March and April 2021. When the stock cleared this level in May it was a sign that a new uptrend was forming. 10
- 11. V Bottoms, Tops, and Reversals ▪ These are reversals that happen over the period of a couple of days ▪ There is typically (but not always) high levels of volume traded ▪ The reversal has the appearance of a V or inverted V on a chart 11
- 12. There were V bottoms for Wayfair (W) in May and August of 2021. The large amount of volume that traded was a signal that the trend was going to reverse 12
- 13. There were V bottoms for Ingersoll Rand (IR) in March, May, and June of 2021. Large amounts of volume traded each time. These were signs that the trend was about to reverse 13
- 14. Shares of Twitter (TWTR) capitulated and formed a V bottom in November 2020. Capitulation shows the sellers are done. They have left the market. The dearth of supply forces the shares higher 14
- 15. When shares of HeadHunter Group (HHR) plunged in June 2021 they did not form a V pattern. But the large amount of volume signaled a capitulation. This was a sign that a new uptrend was forming 15
- 16. After gapping up in February 2021, shares of Zillow (Z) formed a V top before reversing 16
- 17. Reversal days are one day patterns that show the leadership of the trend has changed. After a steep downtrend, shares of Zoom Video (ZM) staged a bullish reversal day. This was a signal that the selloff was over 17
- 18. Shares of Standard Lithium (SLI) formed a V top before reversing in August 2021 18
- 19. After a big move higher in April 2021, shares of BIGG formed a one day bearish reversal pattern. This was a sign that the rally was over 19
- 20. Johnson & Johnson (JNJ) had a reversal day at the end of October 2020. This was a sign that the leadership of the market had changed from the bears to the bulls 20
- 21. The reversal pattern that formed on the chart of Kellogg (K) in September 2020 was a sign that the selloff was over 21
- 22. There were three weekly trends in Lumber between March and July 2021. The turning points were all signaled by reversal day patterns 22
- 23. Shares of Trinity Place Holdings (TPHS) formed two classic bearish reversal day patterns between January and August of 2021. The stock opened at a much higher price than the prior days close. But it sold off after the open and trended lower over the course of the day. This was an illustration that the bears had seized control from the bulls 23
- 24. Huge Reversal Could Signal Trouble for Apple (AAPL) – September 3rd, 2020 The tide made have turned for Apple (AAPL)... Like the break of a trendline, a "reversal day" – like the one Apple's stock experienced yesterday -- shows the leadership may be changing from buyers to sellers. After yesterday's open, the bulls jacked AAPL all the way up to $138.97 a share. But by the late morning, the bears took over. They knocked it all the way down to $127 a share. It ultimately inched up to close at $131.40. As you can see from the chart, the closing price was below where it opened on Tuesday. This is a classic reversal-day pattern... This type of action typically comes at the end of an explosive uptrend. AAPL is up 30% since the end of July. That certainly qualifies. It's natural to see some profit-taking... but the reversal-day could signal bigger trouble ahead for the stock. If the bears are in control, AAPL could fall to $125 a share, or even its next major support level at $100 a share. 24
- 25. A Rounded Top shows a slow and steady changing of leadership from the bulls to the bears. One formed on the chart of the iShares Siver ETF in May and June 2021 25
- 26. A Rounded Bottom shows a slow and steady changing of leadership from the bears to the bulls. Sometimes these patterns take a long time to form. This one in General Electric formed over most of 2020 26
- 27. A Rounded Top formed on the chart of Apple (AAPL) between August and December 2018. This was a sign that a new downtrend was forming 27
- 28. A Rounded Bottom formed on the chart of Activision (ATVI) between October 2018 and September 2019. This was a sign that a new uptrend was forming 28
- 29. Ascending & Descending Triangles / Higher Lows and Lower Highs ▪ Ascending and descending triangles are usually reliable patterns ▪ Ascending triangles show that as time as passed the sellers have been content to wait for the buyers to come to them. The sellers have held firm while the buyers have been willing to pay successively higher prices ▪ Descending Triangles show that as time as passed the buyers have been content to wait for the sellers to come to them. The buyers have held steady while the sellers have been willing to accept successively lower prices ▪ Higher lows are bullish ▪ Lower highs are bearish 29
- 30. SPY Insights: Classic Pattern in Energy Sector: June 4th, 2020 The rally in energy stocks looks to continue. Since finding lows around $24 a share in March, the Energy Select Sector SPDR Fund (XLE) has rallied to $40 a share. Now the chart is forming a classic bullish pattern that suggests that XLE will continue to move higher. We wrote about the "stealth rally" in energy last month. "The mid-April collapse in oil prices generated a rush of panicked headlines. But the rally in energy stocks has gone virtually unnoticed," we said on May 15. "But as long as oil trends higher, this will continue..." Since then, XLE is up nearly 15%. And its chart is showing no signs that the uptrend will stop soon. Chart patterns illustrate the supply-and-demand dynamics occurring in a market. As you can see in the following chart, the "ascending triangle" pattern that has formed in XLE shows April buyers have become more aggressive. Meanwhile, the sellers who formed resistance around $39.50 a share didn't become more aggressive. They were content to stay at their price level. This combination of aggressive buyers and content sellers has bullish implications… Now resistance at the top of the pattern has been broken. This means the sellers who had been offering shares around $39.50 have completed their orders. 30
- 31. Shares of Johnson & Johnson (JNJ) formed a series of four higher lows between March and July of 2021. This showed that buyers were becoming increasingly aggressive. Meanwhile the sellers were content to stay at $171. The dynamics of aggressive buyers and complacent sellers was a signal that the resistance at $171 would break 31
- 32. Shares of Morgan Stanley (MS) formed a series of four higher lows between January and July of 2021. This was a signal that the resistance at the $94.50 level would be broken 32
- 33. Shares of Ryder System formed and ascending triangle in March and April of 2021. The series of lower highs was a signal that the resistance that formed the top of the pattern would break 33
- 34. The six higher lows that formed on the chart of Hyatt Hotels Corporation (H) was a sign that the support around $75 would break and the stock would head lower 34
- 35. A perfect descending triangle formed on the chart of Ford Motor (F) in June 2021. It shows that as the month passed, buyers were content to stay at $14.60 and wait for the sellers to come to them. Over the same time period sellers became more aggressive. They were willing to accept successively lower prices 35
- 36. The lower highs that formed on the chart of Giib Holdings (GIIB) were a sign that the support which was the lower part of the triangle would ultimately break 36
- 37. The lower highs and descending triangle pattern that formed in the SPDR Gold ETF (GLD) was a signal that a new downtrend was forming 37
- 38. Gaps • Gaps refill • Stocks that gap up refill the gap during selloffs • Stocks that gap down refill the gap during rallies • Resistance forms when remorseful buyers try to sell their stocks at the same price that they bought them at • Support forms when remorseful sellers try to buy their stocks back at the same price they sold them at • When a stock spends little or no time trading through certain price levels it appears on a chart as a gap • Because little if any volume trades at the levels the stock gapped through there isn’t enough time for meaningful amounts of vested interest and buyer’s/seller’s remorse to form 38
- 39. Inovalon Holdings (INOV) gapped down from $26 to $20 per share in October 2020. The gap was refilled in January 2021 39
- 40. Amazon (AMZN) gapped down at the end of July 2021. The gap was refilled at the end of August 2021 40
- 41. The gap that formed on the chart of American International Group (AIG) in June 2021 was refilled in August 2021 41
- 42. Shares of Abbott Laboratories (ABT) gapped down in early June 2021. The gap was refilled at the end of the month 42
- 43. Pennants & Flags / Continuation Patterns ▪ Continuation patterns illustrate a period of sideways trading after an uptrend or a downtrend ▪ They show that the buyers and sellers who created the trends have decided to take a break ▪ They think if they stay out of the market the price may reverse a little and they can finish their orders at a better price ▪ There are usually lower amounts of volume traded while these patterns are forming 43
- 44. In March, investors ripped IBM higher. But then in early April the buyers decided to temporarily leave the market. They thought this would cause the stock to give back a little so they could finish their buy orders at a lower price. After they realized this wouldn’t happen, they jumped back into the market and finished buying. This caused the rally to resume 44
- 45. A classic bullish flag formed on the chart of Bitcoin at the end of July into early August. It was a sign that the buyers decided to take a break and leave the market. But once they came back in, the uptrend resumed 45
- 46. Zomedica (ZOM) formed two bearish flag patterns while it was trending lower from June through August 2021. These were signals that the bears were trying to take some pressure of of the stock. It didn’t work, so the jumped back in and kept driving it lower. A classic rounded bottom pattern showed a new uptrend was forming 46
- 47. Summary ▪ All chart patterns need to be viewed in the context of the supply and demand dynamics that they illustrate ▪ If you understand the fundamentals, you don’t need to memorize the patterns ▪ Some classic patterns have validity. Most don’t ▪ Understanding chart patterns will give you low-risk entry points and logical sell targets 47