Finding Day Trading Trends in Securities Price Charts
Because markets tend to move in cycles, day traders look for patterns in price charts that give them an indication of how long a particular trend may last. Following are some of the common patterns that day traders look for when they do technical analysis. Alas, some are only obvious in hindsight, but knowing what the patterns mean can help you make better forecasts of where a security price should go.
This is just an introduction to some of the better-known (and cleverly named) patterns. Technical analysts look for many others, and you really need a book on the subject to understand them all.
Head and shoulders formation
The head and shoulders formation is a series of three peaks within a price chart. The peaks on the left and right (the shoulders) should be relatively smaller than the peak in the center (the head). The shoulders connect at a price known as the neckline, and once the right shoulder formation is reached, the price plunges down.
The head and shoulders is one of the most bearish technical patterns; it looks like this:
Gaps are breaks in prices that show up all the time, usually when some news event takes place between trading sessions that causes an adjustment in prices and volume. A gap is a break between two bars:
Gaps are usually great signals. If a security gaps up at the open, that usually means that a strong uptrend is beginning, so it’s time to buy. Likewise, if it gaps down, that’s often the start of a downtrend, so it’s better to sell.
Day traders can get sucked into a gap, a situation known as a gap and crap. When the security goes up in price, many traders view that as a great time to sell, so the day trader who buys on the gap up immediately gets slammed by all the selling pressure. Some day traders prefer to wait at least 30 minutes before trading on an opening gap, while others rely on their knowledge of the buyers and sellers in a given market to decide what to do.
A pitchfork is sometimes called an Andrews pitchfork after Alan Andrews, the technical analyst who popularized it. It identifies long-run support and resistance levels for subtrends by creating a channel around the main trendline. Here’s what it looks like:
The upper fork shows the resistance level for upward subtrends, and the lower fork shows the support level for lower subtrends. The middle line forms a support and a resistance line, depending on which side of it trading takes place. If the price crosses above the mid-line, it can be expected to go no higher than the highest line. Likewise, if it crosses below the mid-line, it can be expected to go no lower than the lowest line.