Lesson 9: How to Trade Using Failure Patterns We are taught that if we have failed at trading, we are losing money, but if we watch a stock for a few days or weeks, we can see how failing patterns can be used to one’s benefits, and how some traders use those failure patterns make big money being failure patterns traders. Let’s take a closer look. The optimum trade might be in the opposing direction when a traditional price pattern doesn’t act according to textbook rules outlined in trendy books and web sites. Actually, familiar patterns such as the bull flag and head and shoulders have distinctly defined levels which can activate trade entry signals which are opposing to the direction to that they're logically leaning. We're informed and educated early in our trading careers to buy breakouts and sell breakdowns, but numerous traders endeavor to make a living doing the precise opposite. Basically, the traders wait for a selloff to fail and other traders are selling the breakout. Oppositional strategies don't stop there because tacticians employing these non-fundamental methods take the hypothesis one step further and buy when the failure fails. We are going to back up and examine this reversed thinking method one move at a time. In trading we generally follow a shared path -- we pile into stocks, futures or forex pairs when they break out beyond easily examined opposition, but modern procedures have been programmed to predict precisely how human traders will respond when a breakout neglects to interest momentum and rolls over. Using this knowledge, they intrude and steer price action down to levels where breakout traders are caught and implement rapid fire short sales to produce added downside drive that concludes the failure swing. Now turn your brain and think about this opposing analysis to the next level. You’re confused by this diabolical expense action plenty of times that you learn from your understanding and sit on your hands when a favorite play breaks out. The assembly hesitates, and it trades off but you still pause, observe and do nothing. Then, once marketing pressure has dissipated and it closes back exceeding the breakout level, you jump in and buy, recognizing that weak-handed players are no longer situated. Make sense? Let’s critique what just happened. The original breakout appeals the typical momentum crowd, hurrying the stock, commodities contract or forex pair to higher ground without too much contemplation or plan. The upside dissolves out and price turns lower, cornering those who haven’t sheltered situations with stops or profit-taking strategies. Distress takes grasp when the decay cuts through the level that first indicated the breakout, compelling additional downside that sets off more bearish signals. The falling apparatus eventually finds its balance and bounces in a fresh attack that pierces the broken level. New buy signals go off, drawing our opposing traders into a long position. How do algorithms know where human traders will act sensitively? Basically identified, most of us take shop experience employing common strategies that have been critiqued by smart money and their software code. As a result, stock, futures and forex prices therefore go through support and resistance levels more effortlessly
in the present than in the past. Fortunately, when contemporary markets find the latest ways to take your money, they also offer new ways to make it. Let’s look at three pattern failure setups and find contrary ways to profit from them. A. A-B-C Failed Breakout Walt Disney (DIS) topped out at 84 in March after a powerful rally. It assembled a trading range in May and broke out; however, the uptrend paused at just two points higher, making way to a failure swing which broke additional support (blue line). The decline ended on the 50th-day EMA, with the Dow element testing new resistance for two weeks and then rolling higher. The second buying instinct off the low activated a failure of a failure buy signal that heralded a new rally high. It helps to see the breakout process as A-B-C wave patterns in which “A” marks the initial breakout surge, “B” the failure swing and “C” the resolution wave that lifts the price to a new rally high or completes the failure with a decline that breaks the “B” low and releases all sorts of short sale indications. B. The 50-day EMA Flush
Apple (AAPL) completed a momentous rally near 101 in September 2012 and appeared in a long adjustment. It resumed to resistance in August 2014 and occupied two months filing sideward on top of the 50-day EMA (exponential moving average), previous to breaking down on October 15th. The stock lingered under new resistance for three phases and shot higher, closing back above the 50-day EMA and then breaking out in a vast uptrend just one session later. This pattern failure occurs frequently, but frequent traders fail to detect the enormous opportunity it sets into motion, especially when price engagements unfold in a widely held issue like Apple. This pattern failure also demonstrates how failure swings can interact with other charting characteristics, generating positive feedback loops that spark long-term trends. This is specifically true when the 50-day EMA comes into action because it signifies the most familiar intermediate support level, with positive tests having the power to pull numerous sidelined players into latest long positions. C. The 62-78 Fibonacci Whipsaw
Small cap biotech Esperion Therapeutics (ESPR) struck into a source of momentum traders when it first broke out of a long base in September 2014. The upright rally almost doubled the stock’s price in only two weeks, generating a short-term top at 30.38 trailed by a sharp retracement that quickened mid-month; there, it broke down into the upper teens on weighty volume. A Fibonacci grid positioned over the boundaries of the uptrend manages the chaos, with the decline breaking normally with solid backing at the 62% retracement and coming to respite at the 78.6% retracement. This 62-78 failure combo happens often and frequently continues with a large buying change in a small amount of price bars. The trade entry strategy is easy: you wait for price to close when it is back above the 62% level and enter a long position as close to that price as possible. Intraday traders should realize this pattern failure technique is extremely useful because it appears frequently on 15-minute and 60-minute charts. Relatively tight stop losses are essential regardless of holding period because price action inclines to be unpredictable near these significant inflection points. The Bottom Line The investor who is prepared to act against what may seem instinctive has thus figured other complexities into his/her calculations. This trader can see how innumerable stock trends intermingle with other chart characteristics; thus, he/she is not startled by alternatives in, or divergences from, textbook patterns. Such an investor is also aware of how these deviations can become more pronounced due to the emotional reaction of investors, which is a factor in itself that must be embedded in an assessment of market movements. These various factors, in combination, create unique scenarios which the investor anticipates, and which present an opportunity for him or her to make bold market moves, and even take long positions -- which could, against all odds, bring great profits.