TRADING Strategies
Multiple patterns,
BY CHRISTOPHER TERRY
MULTIPLE TIME FRAMES
Converging patterns on different time
frames can help pinpoint trade
opportunities. This approach shows
FIGURE 1 MULTIPLE TIME FRAMES
Finding a shorter-term reversal pattern within a
longer-term pullback or continuation pattern can improve
the odds of a successful trade.
you how to set up these trades
and take profits when opportunity
arises.
number of classic chart patterns provide the
two components necessary for profitable trading: an entry point and an exit point (either a
stop-loss point or, hopefully, a profit target).
You can raise the reliability of your trading using patterns by
applying a multiple time-frame approach.
Such an approach uses two time frames, e.g., one-minute
and five-minute, 15-minute and 60-minute, or daily and weekly. The longer time frame defines the direction of the trend. The
shorter time frame establishes the pattern and trigger for the
trade. The key is to look for a continuation or countertrend pattern on the longer time frame and then drop to the shorter time
frame to find a reversal chart pattern for trade management.
Consequently, this approach trades in the direction of the
longer time frame trend but against the shorter time frame
trend, as shown in Figure 1 (above). The longer time frame
(blue line) first trends down, retraces the first decline, and then
retests the low. During the retracement a reversal pattern a
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Longer time frame trend
Shorter time frame trend
H
S
First objective:
Retest
of pattern lows
head-and-shoulders top develops on the shorter time frame.
This is the pattern we use for entry and risk management.
There are a number of patterns you could look for on the
longer time frame; the best for this scenario is a flag or a countertrend channel. Dropping to a shorter time frame (red line), a
reversal pattern, such as a head-and-shoulders top, often
appears at the end of the retracement.
continued on p. x
www.activetradermag.com February 2002 ACTIVE TRADER
FIGURE 2 ADDITIONAL CONFIRMATION
Entering on a breakdown through the shorter-term trendline of the right shoulder of the H&S pattern provided a second
confirming indication of downward momentum.
111.00
S&P (SPY), one-minute
110.80
S&P (SPY), five-minute
110.80
H
110.60
110.60
110.40
110.20
110.40
Sell short
110.20
Neckline
110.00
110.00
109.80
109.80
109.70
109.60
109.70
109.60
H & S target
S
50-percent
retracement
target
109.40
109.40
109.20
Major support
109.20
Major support
109.00
109.00
108.80
108.80
10:00 10:13 10:26 10:39 10:52 11:05 11:18 11:31 11:44 11:57 12:10 12:23 12:36 12:49
10:20 10:45 11:10 11:35 12:00 12:25 12:50 13:15
Source: TradeStation by TradeStation Group Inc.
Figure 2 (above) shows an example using one-minute and fiveminute charts of the Standard & Poors tracking stock (SPY).
The five-minute chart on the right has formed a rising channel
pattern, and the one-minute bars on the left traced out a headand-shoulders top pattern (a reversal formation). Together,
they offer a strong combination for entering a trade.
If you were just following the five-minute chart, you would
have most likely gone short as prices fell through the lower
trendline of the upward channel at 11:20 a.m., which was not a
bad entry. However, the H&S pattern provides confirmation
the market is most likely done rising and the downtrend will
reassert itself, which reinforces the trades reliability. You can
enter the trade after the development of the right shoulder at
11:36 a.m. In this case, you look to go short
as price breaks the up trendline drawn
along the lows of the right shoulder. A
break of the neckline (the trendline connecting the lows of the patterns shoulders) is
confirmation the pattern is complete and a
harbinger of lower prices.
If you pay attention to support and resistance levels, you can see how you would
look for the right shoulder to develop. First,
before the right shoulder forms, its possible
to identify the resistance level for the left
shoulder (110.30) and the head (just below
110.60). Once the market breaks the up
trendline of the channel on the five-minute
Look for continuation or countertrend
patterns on the longer time frame
and then drop to the shorter time frame
to find a reversal pattern to manage
the trade.
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www.activetradermag.com February 2002 ACTIVE TRADER
FIGURE 3 TAKING PROFITS
Here, a downside penetration of the shorter-term H&S necklines signals a short entry. The H&S pattern also can be used to
set basic profit targets.
Veritas Software (VRTS), daily
Veritas Software (VRTS), weekly
90.00
100.00
H
80.00
90.00
Neckline
70.00
80.00
S
50-percent
retracement
target
70.00
60.00
60.00
50.00
H & S target
50.00
40.00
40.00
Major support
Major support
29.92
29.92
20.00
20.00
Mar.
Apr.
May
June
July
Aug.
Sept.
Oct.
Feb. Mar.
Apr. May June
July Aug.
Sept. Oct. Nov.
Source: TradeStation by TradeStation Group Inc.
chart, watch for a support level for the right shoulder to form
(which occurs just above 110.00 here). We would expect the
right shoulder to peak in the vicinity of the resistance level of
the left shoulder (110.30), which is exactly what happens in this
case. By drawing an up trendline along the lows of the right
shoulder, you go short when price breaks below this line; set
your stop-loss just above the top of the right shoulder. (We will
cover where to take profits shortly.)
Figure 3 (above) consists of daily and weekly charts of
Veritas Software Corp. (VRTS). We follow the same criteria.
The daily time frame (left) has an H&S pattern (reversal pattern) and the weekly time frame (right) has a rising channel
pattern. Here, the daily chart shows the right shoulder is higher than the left shoulder and the neckline is rising as well. We
can go short on a penetration of the neckline with a stop-loss
just above the top of the right shoulder.
Three basic profit-taking targets can be used with this
approach, giving you different levels to work with as a trade
progresses. These profit targets are for short sales. The same
approach, in reverse, can be used for long trades.
ACTIVE TRADER February 2002 www.activetradermag.com
The first target for the pattern is a 50-percent retracement of
the distance between the major low and the top of the H&S
pattern. Because a 50-percent retracement would be a typical
decline of the previous price move, we take partial profits at
this level.
The H&S pattern also has a profit objective we can use as a
target: the difference between the head and the neckline, subtracted from the neckline. The final profit target is the major
low.
Use a trailing stop placed at the declining resistance levels
once the trade moves in your favor.
As popular as technical indicators have become, a solid
understanding of classic chart patterns analyzed on multiple
time frames can provide the entry, exit and risk control structure of a solid trading strategy. Here, we have shown that the
combined confirmation of two chart patterns over two time
frames can signal trading opportunities near the completion
of a countertrend price move. This approach offers a low riskto-reward ratio and keeps you trading with the longer-term
trend.
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