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Written and copyright © 2009-2010 by Thomas N. Bulkowski. All rights reserved.
Here are a few trading tips that could make your trading life easier, and more profitable, if you follow them.
Tip 1: Don’t Invest. Wait for the Best.
Imagine that you are contemplating a trade, but the chart pattern doesn’t look quite right. You have doubts. Is the left shoulder too far below the right for a proper
head-and-shoulders top? Are the two bottoms of an
Adam & Eve double bottom too far apart in time or price or is it another combination of Adam and Eve?
Such questions are good to have, but they also highlight a problem area. If you have to ask me for
help with a trade then you should look elsewhere for a more promising setup. If you have doubts about a pattern then others may share similar feelings.
Sometimes, chart patterns and
technical analysis in general are self-fulfilling prophesies. For example, you can mathematically show that round numbers are no more likely to act as support or resistance than other
numbers, but if traders believe that they do, then the technique works.
Here is another example, taken from my
Encyclopedia of Chart Patterns  book, first edition (the second edition is pictured on the right).
Double bottoms spaced a few months apart work better than do those spaced a year apart. I show a chart of price rise after the breakout
versus bottom separation. The rise is lower for those bottoms spaced farther apart.
In the second edition of my book, Eve & Eve double bottoms with
narrowly spaced bottoms show rises of 44% in a bull market, but
those spaced wider apart show post breakout rises averaging just 37%. Traders see the narrower double bottom and trade it, overlooking the wider one.
Do your wallet or purse a favor and wait for a setup in which you are confident that other traders will see it the same way that you do.
If you are a novice at picking chart patterns, so was I once. I remember looking at a triple top chart pattern. Was it a triple top or a head-and-shoulders top?
The middle peak was below the surrounding two, so it was clearly not a head-and-shoulders. But was the middle peak too far below the others? The answer came with experience and the
recognition that other traders probably had the same doubts. A search for more triple tops revealed that it is common for the middle peak to be slightly below the other two.
A bit of research eased my mind and I was able to trade the pattern with confidence.
Tip 2: Avoid Overconfidence
My worst trades are those in which I know that I am right. I am so confident in my position that when price drops, I average down (buy more at a lower price, dropping the
average purchase price). That technique works well for buy-and-hold providing that price recovers, but it is often a disaster for more frequent trades.
What happens is that the price
drops enough so that the pain of losing
gets so hurtful that you sell just before the stock begins recovering. Not only do you take a huge loss, but feel additional pain as price rises while you watch from the sidelines.
You kick yourself for not holding on a few days longer. That belief creates a bad habit. The next time a loss happens, you will hold longer, suffering an even larger loss.
Overconfidence leads to failure.
The next time you feel that the trade is a no-brainer, that it can’t lose, recognize that you’re about to lose big. Skip the trade. Sometimes the best
trade you can make is none at all.
Tip 3: Chart Patterns Work only in Trends
If price is in a trading range, meaning that it is bouncing up and down, but not really moving anywhere except sideways, then the breakout from a chart pattern could signal the
start of a new trend. However, the breakout may be fake with price returning to moving sideways, or worse -- zipping downward.
In these turbulent markets (2008, mostly), I see many chart patterns with breakouts showing price rising, but not enough to justify raising a stop to break even.
This type of choppy movement causes loss after loss, but I know that if I don’t play the market, a trend will start and I will miss it.
Waiting for the chart pattern indicator to signal green helps with trend determination, so I have added that to my toolbox to help pick successful trades.
The most reliable signals occur when three diamonds accompany the signal. I show a screen capture of the diamonds circled, and you can find them near the top of most pages on this
website. Only two diamonds appear in this picture, so the bearish signal may or may not be accurate.
If I could reliably tell when a market was trending, I would be retired. OK, so I did retire at 36, but you know what I mean.
I want all of my picks to work.
I want every chart pattern breakout to lead to a long, straight-line move up. That is the stuff I dream about, but sometimes a woman is involved...
-- Thomas Bulkowski
Written and copyright © 2009-2010 by Thomas N. Bulkowski. All rights reserved. Copying machine: A device that shreds paper, flashes mysterious codes, and makes duplicates for everyone in the office that isn't interested in reading them.
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