The Top 10 Best Candlestick Patterns

There are many candlestick patterns but only a few are actually worth knowing. Here are 10 candlestick patterns worth looking for. Remember that these patterns are only useful when you understand what is happening in each pattern.

They must be combined with other forms of to really be useful. For example, when you see one of these patterns on the daily chart, move down to the hourly chart. Does the hourly chart agree with your expectations on the daily chart? If so, then the odds of a reversal increase.

The following patterns are divided into two parts: Bullish patterns and bearish patterns. These are reversal patterns that show up after a pullback (bullish patterns) or a rally (bearish patterns).

Bullish Candlestick Patterns

Engulfing:This is my all timefavorite . This pattern consists of two candles. The first day is a narrow range candle that closes down for the day. The sellers are still in control of the stock but because it is a narrow range candle and is low, the sellers are not very aggressive. The second day is a wide range candle that "engulfs" the body of the first candle and closes near the top of the range. The buyers have overwhelmed the sellers (demand is greater than supply). Buyers are ready to take control of this stock!

Hammer: As discussed on the previous page, the stock opened, then at some point the sellers took control of the stock and pushed it lower. By the end of the day, the buyers won and had enough strength to close the stock at the top of the range. Hammers can develop after a cluster of stop loss orders are hit. That's when professional traders come in to grab shares at a lower price.

Harami: When you see this pattern the first thing that comes to mind is that the preceding it has stopped. On the first day you see a wide range candle that closes near the bottom of the range. The sellers are still in control of this stock. Then on the second day, there is only a narrow range candle that closes up for the day. Note: Do not confuse this pattern with the engulfing pattern. The candles are opposite!

Piercing: This is also a two-candle reversal pattern where on the first day you see a wide range candle that closes near the bottom of the range. The sellers are in control. On the second day you see a wide range candle that has to close at least halfway into the prior candle. Those that shorted the stock on first day are now sitting at a loss on the rally that happens on the second day. This can set up a powerful reversal.

Doji: The is probably the most popular candlestick pattern. The stock opens up and goes nowhere throughout the day and closes right at or near the opening price. Quite simply, it represents indecision and causes traders to question the current trend. This can often trigger reversals in the opposite direction.

Bearish Candlestick Patterns

You'll notice that all of these bearish patterns are the opposite of the bullish patterns. These patterns come after a rally and signify a possible reversal just like the bullish patterns.

Ok, now it's your turn! I'll let you figure out what is happening in each of the patterns above to cause these to be considered bearish. Look at each candle and try to get into the minds of the traders involved in the candle.

Kickers

There is one more pattern worthy of mention. A "kicker" is sometimes referred to as the most powerful candlestick pattern of all.

You can see in the above graphic why this pattern is so explosive. Like most candle patterns there is a bullish and bearish version. In the bullish version, the stock is moving down and the last red candle closes at the bottom of the range.

Then, on the next day, the stock gaps open above the previous days high and close. This "shock event" forces short sellers to cover and brings in new traders on the long side.

This is reversed in the bearish version. Wait For Confirmation?

Most traders are taught to "wait for confirmation" with candlestick patterns. This means that they are supposed to wait until the following day to see if the stock reverses afterward. This is absolutely ridiculous!

I ain'twaitin' for nostinkin' confirmation!

How's that for good grammar! Seriously, think about it for a second. If a stock pulls back to an area of demand (support) and I have a candlestick pattern that is telling me that buyers are taking control of the stock, then that is all the confirmation I need.

As a swing trader I have to get in before the crowd piles in, not when they get in! In other words, I want to be one of the traders that make up the pattern itself! That is the low risk, high odds play.

Just the way I like it.

How to Read Candlestick Charts

Reading candlestick charts is an effective way to study the emotions of other traders and to interpret price. Candles provide a trader with a picture of human emotions that are used to make buy and sell decisions.

On a piece of paper, write down the following statement with a big black marker:

There is nothing on a chart that matters more than price. Everything else is secondary.

Take that piece of paper and tape it to the top of your monitor! I think too often swing traders get caught up in so many other forms of technical analysis that they miss the most important thing on a chart.

You do not need anything else on a chart but candles to be a successful swing trader! There is nothing that can improve your trading more than learning the art of reading candlestick charts.

Buyers And Sellers

There are only two groups of people in the stock market. There are buyers and sellers. We want to find out which group is in control of the price action now. We use candles to figure that out.

The picture above shows how candlesticks are constructed. The highs and lows of the time period are called the "wicks" and the open and close form the "body". The candle itself is the "range". When stocks close at the bottom of the range we conclude that the sellers are in control. When stocks close at the top of the range we conclude that buyers are in control.

Note: In the stock market, for every buyer there has to be a seller and for every seller there has to be a buyer.

If a stock closes at the top of the range, this means that buyers were more aggressive and were willing to get in at any price. The sellers were only willing to sell at higher prices. This causes the stock to move up. If a stock closes at the bottom of the range, this means that sellers were more aggressive and were willing to get out at any price. The buyers were only willing to buy at lower prices. This causes the stock to move down.

Where a stock closes in relation to the range tells us who is winning the war between buyers and sellers. This is the most important thing to know when reading candlestick charts.

We can classify candles in two categories: wide range candles (WRC) and narrow range candles (NRC). Wide range candles state that there is high volatility (interest in the stock) and narrow range candles state that there is low volatility (little interest in the stock).

Note that stocks tend to move in the direction of wide range candles.

The arrows on the chart below show how stocks move in relation to the range and closing prices:

Wide Range Candles

If we know that stocks tend to move in the direction of wide range candles, we can look to the left of any chart to gauge the interest of either the buyers or sellers and trade in the direction of the trend and the candles.

The importance of this cannot be overstated! You want to know if there is interest in the stock and if it is being accumulated or distributed by institutional traders. Narrow Range Candles

Narrow range candles imply low volatility. This is a period of time when there is very little interest in the stock. Looking at the chart above you can see that these narrow range candles often lead to reversals (up or down) because:

Low volatility leads to high volatility and high volatility leads to low volatility. So, knowing this, doesn't it make sense to enter a stock in periods of low volatility and exit a stock in periods of high volatility? Yes.

Hammers, Doji's and Shooting Stars?

The number one rule when reading candlestick charts is this: You want to buy stocks when nobody wants it and sell stocks when everybody wants it! This is the only way to consistently make money swing trading!

I know what you're thinking. You thought this page was going to be about hammers, doji's, and shooting stars. Sorry to disappoint you, but knowing all of the different types of candlestick patterns is really not at all necessary once you understand why a candle represents the struggle between buyers and sellers.

Consider this:

In this picture we see a classic candlestick pattern called a hammer. What happened to cause this? The stock opened, then at some point the sellers took control of the stock and pushed it lower. Many traders were shorting this stock thinking it was headed lower.

But by the end of the day, the buyers took control, forced those short sellers to cover their positions, and the stock had enough strength to close the stock at the top of the range.

When we are reading candlestick charts, why would we need to know the name of the pattern? What we do need to know is why the candle looks the way that it does rather than spending our time memorizing candlestick patterns!

How to Use Moving Averages

Moving averages help us to first define the trend and second, to recognize changes in the trend. That's it. There is nothing else that they are good for. Many traders will try and get cute using all kinds of various combinations and really it is just a waste of time.

You do not have to keep adjusting the period of a line on a chart hoping to find the Holy Grail. It isn't there!

I won't be getting into the gory details about how they are constructed. There are about a zillion websites that will explain the mathematical make-up of them. I'll let you do that on your own one day when you are extremely bored out of your mind! But all you really have to know is that a line is just the average price of a stock over time. That's it.

The Two Moving Averages

I use two moving averages: the 10 period simple moving average (SMA) and the 30 period exponential moving average (EMA). I like to use a slower one and a faster one. Why? Because when the faster one (10) crosses over the slower one (30), it will often signal a trend change. Let's look at an example:

You can see in the chart above how these lines can help you define trends. On the left side of the chart the 10 SMA is above the 30 EMA and the trend is up. The 10 SMA crosses down below the 30 EMA in mid August and the trend is down. Then, the 10 SMA crosses back up through the 30 EMA in September and the trend is up again - and it stays up for several months thereafter. Here are the rules:

Focus on long positions only when the 10 SMA is above the 30 EMA. Focus on short positions only when the 10 SMA is below the 30 EMA. It doesn't get any simpler than that and it will ALWAYS keep you on the right side of the trend!

Note that moving averages only work well when a stock is trending - not when they are in a trading range. When a stock (or the market itself) becomes "sloppy" then you can ignore moving averages - they won't work!

Here are the important things to remember (for long positions - reverse for short positions.):

1. The 10 SMA must be above the 30 EMA. 2. There must be plenty of space in between the moving averages. 3. Both moving averages must be sloping upward.

The 200 Period Moving Average

The 200 SMA is used to separate bull territory from bear territory. Studies have shown that by focusing on long positions above this line and short positions below this line can give you a slight edge.

You should add this moving averages to all of your charts in all time frames. Yes. weekly charts, daily charts, and intra-day (5 min, 60 min) charts.

The 200 SMA is the most important moving average to have on a stock chart. You will be surprised at how many times a stock will reverse in this area (look at the chart above).

Use this to your advantage!

Also, when writing scans for stocks, you can use this as an additional filter to find potential long setups that are above this line and potential short setups that are below this line.

Support and Resistance?

Contrary to popular belief, stocks do not find support or run into resistance on moving averages. Many times you will hear traders say, "Hey, look at this stock! It bounced off of the 50 day moving average!"

Wrong!

Why would a stock suddenly bounce off of a line that some trader put on a stock chart? It wouldn't. A stock will only bounce (if you want to call it that) off of significant price levels that occurred in the past - not a line on a chart.

Stocks will reverse (up or down) at price levels that are in close proximity to popular moving averages but they do not reverse at the line itself.

So, suppose you are looking at a chart and you see the stock pulling back to, let's say, the 200 period moving average. Look at the price levels on the chart that proved to be significant support or resistance areas in the past. Those are the areas where the stock will likely reverse.

How to Find on a Chart

Support and resistance identify areas of supply and demand. But what exactly is supply and demand? Supply is an area on a chart where sellers are likely going to overwhelm buyers causing the stock to go down. On a chart, we call this resistance. Demand is an area on a chart where buyers are likely going to overwhelm sellers causing the stock to go up. On a chart, we call this support.

Knowing this, it only makes sense to buy at support and sell at resistance!

Stocks run into resistance (supply) because those traders that bought too late and saw the price go down now want to get out at break even so they sell. Stocks find support (demand) because those traders that missed the move up now have a second chance to get in so they buy.

Ok, you probably already knew all that but here is something that most traders do not know. There are varying degrees of support and resistance.

On the long side, when a stock falls down to a prior low it is more significant than when a stock falls down to a prior high.

On the short side, when a stock rises up to a prior high it is more significant that when a stocks rises up to a prior low.

Here is an example:

The chart above shows how stocks run into resistance and find support. When this stock reached a prior high (resistance), it fell. When it reached a prior low (support), it rose. Now, look at the next chart...

This stock broke through resistance. When it pulled back, it found support at the prior high. This chart shows how resistance, once broken, can become support.

Look again at the those areas that I highlighted in yellow. What are these traders doing buying stocks that are running up into an area of supply (resistance)? Why are they selling their stocks when it is falling down to an area of demand (support)?

They do that because they are novice traders. They always buy after significant buying has already taken place into areas of resistance, and they always sell after significant selling has already taken place into areas of support. This is the opposite of what you should do! So...

YOUR JOB AS A SWING TRADER IS TO IDENTIFY THE NOVICE TRADERS BECAUSE THOSE TRADERS ARE THE ONES YOU WILL PROFIT FROM.

But wait! There are other forms of support and resistance that are not so common. For example, look for stocks that pull back and find support halfway into a prior wide range candle. Like this:

Or, look for stocks to pull back and find support halfway into a ...

The bottom line is that you want to be buying stocks where buyers will likely come into the stock. You want to be selling stocks where sellers will likely come into the stock. Don't follow the novice traders!

Why You Should Trade Trending Stocks

To consistently make money in the stock market, you only want trade stock trends! But what are the characteristics that make up a trend? I thought you would never ask.

Remember when we talked about stock market stages?

Well Stage 2 is an uptrend that is characterized by a series of higher highs (HH) and higher lows (HL).

Stage 4 is a downtrend that is characterized by a series of lower highs (LH) and lower lows (LL).

This creates a series of peaks and troughs on the chart that you can trade quite successfully.

Below is the beautiful anatomy of stock trends:

Stocks Trends Versus. Trading Ranges

It is estimated that stocks only trend about 30% of the time. The rest of the time they move sideways in trading ranges. This is what a trading range looks like:

Yeah, trading ranges can get that sloppy! There is absolutely no reason to trade stocks that are chopping around like that when you can trade stocks that are in the trending phases. Trying to trade stocks in trading ranges (stage 1 and stage 3) is a great way to chew up your trading capital. Stick with trends!

This is a stock in a nice up trend...

And, this is a stock in a trading range:

Which one would you rather trade?

Case closed! I know all of this may seem pretty basic but I can't tell you how many times I've been in a stock trading forum and Joe Trader says, "I bought XYZ stock yesterday at $32.57".

So I go and look at the chart and the stock is in a steep downtrend! Or someone says that they shorted a stock at $52.03. So of course I look at the chart and the stock is in a parabolic uptrend!

It just doesn't make sense to trade that way.

If you look at any stock on a chart that is in a strong uptrend, you will find that the pullbacks are short lived. This gives you a excellent opportunity to buy the stock before it resumes the uptrend.

Same thing with stocks in down trends. The rallies are short lived which gives you an excellent opportunity to short them.

Swing Trading Entry Strategy

Your swing trading entry strategy is the most important part of the trade. This is the one time when all of your trading capital is at risk. Once the stock goes in your favor you can then relax, manage your stops, and await a graceful exit.

This is the basic price pattern that is used to enter stocks. Once you become familiar with it, you can try out more advanced strategies based on the specific pattern that you are trading.

More on that in the Chart Patterns section.

With your entry strategy, the first thing that you want be able to do is identify swing points. What's a swing point you ask? This is a pattern that consists of three candles. For entries on long positions, you look for a swing point low. For entries on short positions you look for a swing point high.

Swing Points

For a swing point low, the first candle makes a low, the second candle makes a lower low, and the third candle makes a higher low. This third candle tells us that the sellers have gotten weak and the stock will likely reverse.

For a swing point high, the first candle makes a high, the second candle makes a higher high, and the third candle makes a lower high. This third candle tells us that the buyers have gotten weak and the stock will likely reverse.

Here are pictures of the candles to help you better understand swing points:

For our long entry strategy, we are trying to find stocks that have pulled back into the Traders Action Zone that have made a swing point low.

Like this:

You can see on the chart above that this stock is in a nice uptrend with the 10 SMA above the 30 EMA. The stock has pulled back into the TAZ and made a nice swing point low (highlighted).

See how the pattern consists of a low, lower low, then a higher low? Great! Our entry strategy would be to enter this stock on the day of the third candle.

Now lets look at a stock on the short side. We are looking for a stock in a nice downtrend with the 10 SMA below the 30 EMA. Then we wait for a rally into the TAZ that forms a swing point high.

Like this:

See how the pattern consists of a high, higher high, then a lower high? We would look for an entry on the third candle.

Consecutive Price Patterns

Ok, now check this out. Look back up at the first chart where the stock pulls back into the TAZ. You will notice that the pullback consists of three consecutive down days with lower highs and lower lows.

That is what you want to look for in a pullback. You can buy the stock the first time it trades above the previous candles high. This will complete the swing point low.

On the second chart, you will see that the stock has three consecutive up days with higher highs and higher lows. The fourth candles still makes a higher high and a higher low. The fifth candle finally makes a lower high and a lower low - completing the swing point.

Pullbacks do not have to consist of exactly 3 consecutive up days (for short trades) or down days (for long trades.) Sometimes you will run your scans and find stocks that have more than that.

When you are looking for swing points to develop, you always want to look to the left of the chart to see if the stock is at a support or resistance area on the chart. That will improve the reliability of this entry strategy.

Also, sometimes you may want to be more aggressive with your entry. Check out this page for an alternate entry strategy.

Ok, now that we know how to get into a trade, how do we get out? We need an exit strategy.

Swing Trading Exit Strategy

Learn how to take profits and control your losses! Your exit strategy consists of two parts: Where will you get out of the trade if the stock does not go in your favor? Where will you take profits if the stock does go in your favor?

These are the two questions that make up your exit strategy. You have to be able to answer these questions before you can place the trade!

Your Stop Loss Order

A physical stop loss is an order to sell (or buy if you are short) that you place with your broker. A mental stop is YOU clicking the sell (buy) button to get out of the trade. From a technical perspective, it does not matter which type you use.

Before you get into a trade you will have a plan that will determine when to get out of the trade if it does not go in your favor. You are a disciplined trader that always follows your plan (right?). Whether you use a mental stop or a physical stop, you will always want to exit the trade when you predetermined plan tells you to.

Note: See this page for why you may not want to use an actual order placed with your broker.

Where is your stop going to be? First of all you need a stop that makes sense and you need it to be out of the "noise" of the current activity in the stock.

Look at the average range of the stock over the past 10 days. If the average range of the stock is, say, $1.10, then your stop needs to be at least that far away from your entry price. It doesn't make any sense to have your stop .25 cents away from your entry price when the range is $1.10. You will surely get stopped out prematurely!

For long positions, your stop should go under a support area and a swing point low. Like this:

You can see in the chart above, that the stock comes down into the TAZ and then reverses with the low at a previous resistance area. We know that resistance can become support so it makes sense to put our stop under the low of the hammer.

Ok, that takes care of the first part of our exit strategy, now lets look at second part: taking profits!

Taking Profits

Use trailing stops! This is an easy and unemotional way of exiting a trade. If this trade is going to be a typical swing trade with a holding time of 2-5 days, then you can trail your stops 10 or 15 cents under the previous days low or the current days low - whichever is lower.

Here is an example:

There i a day by day example of a traili stop loss order on this page.

If this is a first pullback scenario, then you may want to hold this for a longer time frame. Having some big winners every now and then will fatten up your trading account In this case you can trail your stops under the swing lows (or highs for shorts) until stopped out. Like this:

In either case, you should always determine where your stop is going to be and how you are going to take profits before you get into the trade. Have a solid plan in place (write it down). This will take all of the emotion out of the trade. Then you can relax and trade the "map" that you have created. This will make your exit strategy easy to follow and it will put you on the path to success.

How To Trade The T-30

This pattern is my "everyday" pattern. This is the one pattern that I trade the most often because of its reliability. It is easy to spot on a chart and very easy to trade. For those reasons, I strongly suggest that if you are new to trading stocks then focus on this pattern exclusively until you master it.

The Setup

The name T-30 refers to a "tail" that slices down through the "30" period exponential moving average. This looks like a hammer candlestick pattern on the chart but it doesn't have to be a perfect hammer to be considered a T-30. Also, the color of the real body is not important. This tail on the chart flushes other traders out of the stock.

Note: There is nothing special about the 30 period moving average. It is just a reference. Look to the left on the chart to determine support and resistance.

When you are trading any kind of tail or hammer pattern, always look for to be higher than the previous day. This suggests that many traders were shaken out and demand is picking up. This is important!

Here is an example:

How To Trade This Pattern

There a multiple ways to trade this setup depending on your desired risk/reward. I'll tell you how I trade it and give you an alternative that you may want to consider.

The Entry

If you are able to trade during the day then buy the stock on the day of the hammer (tail) near the end of the day. You not need any kind of "confirmation" or anything else. You only need to see that this stock is at a support level and that demand is coming into the stock (volume). That is all the confirmation that you need.

If you cannot trade during the day, then place your buy stop above the high of this hammer day. The next day you will have to check to see if you get filled and then place your stop loss order. You could also use a bracket order.

The Stop Loss Order

There are two options for the placement of your stop loss order. Each has advantages and disadvantages. You decide what is right for you.

Option 1

Put your stop under the low of the hammer. The advantage to this is that your stop is far away from your entry price and you will not likely get stopped out prematurely. The disadvantage to this is that because your stop is so far away, you will have to buy fewer shares in order to comply with your money management rules.

Option 2

Move down to the 60 minute chart and put your stop under a support area closer near the real body of the candle. The advantage to this is that you get to buy more shares because your stop is closer to your buy price. The disadvantage to this is that because your stop is so close, you may get stopped out more often, before a big move happens.

Personally, I prefer option 1. I have no problem buying fewer shares in order to have a successful trade. I like that fact that my stop is far away from the "market noise". Then I can sit back and wait patiently for the stock to move in my favor.

Taking Profits

When you are trading wide range days like hammers, you will find out that many times, the stock will trade sideways for a day or two. That is fine. You are already in the stock just waiting for other traders to enter. Also, the days that follow a hammer are typically low volatility, narrow range days like stars or doji's.

Be patient! Do not get anxious to move your stop up. Wait for the stock to actually move in your favor before you begin trailing your stop.

Once the stock moves in your favor, then you safely begin to trail your stop using your favoriteexit strategy to lock in profits. Trading Tips

y Focus on those stocks where the real body of the candle is close to the 30 EMA. You want as many traders as possible shaken out of this stock before you get in. y This setup is reversed for short positions except now you are looking for stocks with a shooting star pattern through a declining 30 EMA. y Give more weight to setups with multiple tails over several days. y Give more weight to setups where the stock gaps away from the previous candle to end the day in hammer. y Always look to the left on the chart to make sure the stock is at a significant support or resistance area.

When Good Patterns Go Bad

Yes, you will have losing trades with this pattern. There is no pattern that will guarantee all winning trades! But with proper money, trade, and self management, you can do very well with this setup.

How To Trade The Ghost Town Chart Pattern

What happens when traders ignore a stock? You get narrow range candles and low volume. When you see this developing on a stock chart, it will remind you of a ghost town - deserted. Get ready, the stock is about to explode.

The Setup

The name "ghost town" refers to a low volatility setup. And what follows low volatility? High volatility! This repeats over and over again on every chart - in every time frame.

With this chart pattern, you will see pullbacks into the Traders Action Zone that end in narrow range candles. These candles are also known as stars or doji's. Combine these price patterns with low volume and you have a winning trade in the making!

Note: In candlestick terminology, stars, technically have to gap away from the previous candle to be called stars. I don't find this to be necessary to trade them.

Here is an example:

See how AMB pulls back into the TAZ, there are narrow range candles (stars), and low volume? Now look at what happens at the next swing point high ($44.50). See the narrow range candles again? Volume drops off for a couple of days, momentum has slowed, and the stock pulls back again.

This is where professional traders come into the stock. Here is another example:

How to trade it

This can be tricky. When you have a potentially explosive situation, the stock can be prone to whipsaws. Here is how to avoid them.

The Entry

With this pattern, you want to avoid just putting your buy stop above the previous high. You will get likely get filled prematurely!

Method 1: Put your buy stop above the high of the highest narrow range candle. In the first example (long), there are three candles that I highlighted. The middle one has the highest high. Put your buy stop in above that. This is reversed for short positions.

Method 2: Wait for another pattern to develop before you enter the stock. Did you notice the T- 30(s)?

Method 3: Move down a time frame to the 60 minute chart and wait for it to breakout. Many times the 60 minute chart will give you an early warning sign that the stock is about to break (in one direction or another).

The most difficult part of this pattern is the entry. Many times the stock will move up and then sell off. Or, it will move down, and then rally. This can cause whipsaws. The advantage to this pattern is that your stop can be very close to your buy price, so your risk is small. If you get stopped out, consider another entry. The move that follows is usually worth it!

Taking Profits

There isn't anything special here. Just trail your stops using your favoriteexit strategy. However, when the stock market offers you a gift, take it! If the stock explodes, and goes up 15% in a couple of days, at least take partial profits and trail your stops on the rest.

Trading Tips

y Low volatility leads to high volatility. y High volatility leads to low volatility. y Narrow range candles mean that momentum is slowing. The buyers or sellers are losing strength. y Always look to the left on the chart to make sure the stock is at a significant support or resistance area.

It's amazing what happens on a stock chart. Right when everyone loses interest in a stock, it takes off. Go figure!

Think of the ghost town pattern this way: When you see a pullback into the TAZ and narrow range candles develop, the price action that preceded it, is coming to an end.

A reversal is coming.

How To Trade The Swing Trap Chart Pattern

You will see this chart pattern ALL the time. It took all of about 5 minutes to run a scan and find an example for this page! Learn it. It is one of the most reliable patterns I know of. You'll see why in a second.

The Setup

Like the name implies, this chart pattern "traps" swing traders (and momentum traders) right in the middle of a move.

In Elliott Wave theory this pattern is known as an A-B-C pattern - just on a smaller scale. I call them "swing traps" because it's a lot more descriptive!

Let's look at a chart...

The circled area is what we are interested in. That is what you want to look for when you are running your scans. It is very easy to identify this pattern. You'll recognize it in a second!

This is what is happening in the pattern:

This stock rallies hard to $42.00 (see chart). It then pulls back real nicely into the TAZ. This would have been a nice pullback to trade. But look at what happens next. It rallies up a little bit, but then it fails and goes right back down. This traps the swing traders who are long this stock. They put their stop loss orders under the first rally attempt. But, when the stock fell, it took out their stop loss orders.

Now that the majority of sellers are out of the trade, the stock can rally.

And that's exactly what it did.

How To Trade This Pattern

The key with this chart pattern is to look for the "shakeout". The final swing MUST go below the low of the first swing. Many times, this final swing will end in a hammer. This hammer will take out all of the stop loss orders and you are ready to go!

The Entry

Wait for a candlestick pattern to develop on the final swing (in this case, it was a hammer). Then you can buy the stock on the day of the pattern, or wait, put in a buy stop above the high of the candlestick pattern.

It's up to you how you want to enter the stock.

Your Stop Loss Order

Nothing special here. Just put your stop where it makes the most sense. Usually this will be under the low of the day of entry, but look to the left on the chart to identify support and resistance levels.

Taking Profits

On the exit strategy page, you will find several options for trailing your stops. If the stock is entering into a stage two cycle, then I will usually want to give the stock a little room. In this case I would just trail my stops off of the weekly chart (a trend trade versus a swing trade).

Trading Tips

y The secret to this pattern is for the final swing to go below the low of the first swing. This is crucial. y You will find this exact pattern on the short side also. The pattern is just reversed. y This pattern is not limited to the daily chart. You will see it in all time frames.

Your going to love trading this chart pattern. It represents a short term extreme in the market that gets a lot of potential sellers out of the stock before you get in.

Yagotta love that!

How To Trade The Side Trap Chart Pattern

This chart pattern is a good example of why the majority of stock traders lose money. They get caught (trapped) on the wrong side of a move. This results in some potentially explosive moves in a stock.

The Setup

We have talked about the swing trap chart pattern. This pattern is similar in that it catches traders on the wrong side of a move.

Let's begin...

First, I want you to look at the highlighted area in the following chart:

What are your thoughts about this stock?

You, like most traders, are probably thinking that this stock is trading sideways (consolidating) but since it is in an uptrend, it may breakout soon. And you would be right in thinking this. There are some traders that are buying this stock inside of the consolidation in anticipation of a breakout. But really, there is nothing to do with this stock except wait for a breakout.

Remember that there are thousands of traders looking at this stock. And they are thinking the same thing that you are.

Now look at what happens on the next day:

Now, what are your thoughts about this stock?

Well, the stock broke down through the consolidation. And, it closed with a very bearish candle that closed near the bottom of the intra day range. There are some traders that got stopped out (they put their stop under the lows of the consolidation) and there are some traders that have aggressively shorted this stock.

So no matter how you look at it - at this point this stock looks bearish. Plain and simple.

Now, look at what happens on the following day:

Whoa! What just happened? There was no follow through to the down side. This means that there are no sellers left to move this stock lower. So, with all sellers flushed out, this stock can now move higher.

And, that is exactly what it did...

Also keep in mind that those traders that shorted this stock on the day of the breakdown probably put their stop loss orders above the consolidation. When the stock moved above that area, their stop loss orders were taken out - causing the gap up.

How to Trade It

There are three components to trading this chart pattern:

y consolidation y breakdown y reversal

(see stock chart above)

You need a sideways consolidation, then a breakdown causing the chart to look bearish, and finally a reversal pattern. This is why this pattern is called a "side trap". The stock trades sideways and then traps traders who shorted the breakdown.

Here is another example:

Here is an example where the consolidation doesn't last very long:

another example...

The Entry

You want to establish a position with this stock on the day of the reversal candle. But, you do not want to trade just any reversal candle. You want the candle to be strong one. Make sure it closes at least halfway into the range of the breakdown candle. This will show up as a piercing candlestick pattern or a bullish engulfing candlestick pattern (see the examples above).

Taking Profits

Nothing special here. Just trail your stops using your favoriteexit strategy. However, when the stock market offers you a gift - take it! If the stock explodes, and goes up 15% in a couple of days, at least take partial profits and trail your stops on the rest.

Keep in mind that you are wanting to see this stock move above that sideways trading pattern (consolidation). That is where the explosiveness will kick in.

Create a Scan For This Pattern?

I don't scan specifically for this pattern. I just run a general pull back scan and look for this pattern. If I see a consolidation forming, I will add it to my watch list to see if the breakdown candle forms - then wait to see if a reversal occurs.

You could create a scan that searches for a piercing candlestick pattern or a bullish engulfing candlestick pattern. Then you can sift though the stocks to see if this pattern shows up. It's up to you. Trading Tips

y The longer the consolidation the more potential for an explosive move. y The reversal candle must be a powerful one. y Volume is not important but you may see high volume on the breakdown candle. y If the overall market (S&P 500) has a big down day, the odds of this pattern showing up increases.

There are two things that I love about this chart pattern. First, you are establishing a position after a wave of selling has occurred. And second, you are trading opposite the crowd.

These are the two components of successful swing trading.

Learn the Basic Elliott Wave Pattern

The Elliott wave pattern is a structure that defines how a stock behaves. All stocks tend to move in a basic five wave structure that consists of a motive phase and a corrective phase.

For swing traders, the motive phase is what we are interested in. You will see that the Elliott wave theory falls neatly into my favorite type of trade: The First Pullback Trade.

Note: There is a much more comprehensive tutorial on Elliott Wave theory over at Elliott Wave International. This 10 lesson course covers much more ground than I ever could!

First, look at the following graphic to get an idea of what the pattern looks like...

The Phases

The motive phase of an Elliott wave cycle consists of five waves. You can see the waves labeled on the chart above numbered 1 through 5. Think of the motive phase as a detailed view of an uptrend.

The corrective phase is labeled on the chart above as Wave A, Wave B, and Wave C. This is the phase that "corrects" the uptrend. We are not really concerned with this phase, but I wanted you to learn the basic cycle!

Wave One

This wave breaks the previous downtrend and begins a new uptrend. This marks the beginning of the trend. You want to start watching for a pullback when this wave starts.

Wave Two

The pullback! Now you want to start looking for an entry using candlestick patterns. This sets up our First Pullback scenario. You are hopping on board at the beginning of an uptrend. Wave Three

Wave three of an Elliott wave cycle is the longest and the strongest of all five waves! That is why we want to get on board during wave two (the pullback) right as wave three is beginning to unfold.

When you can find stocks that are beginning a wave three, you want to hold on to your position for a longer time frame. Don't treat is at a little swing trade, instead, treat it as a trend trade. You want to ride this powerful wave to completion! Why? Because you will make the most amount of money in the least amount of time.Ya,gotta love that!

Wave Four

This wave is pretty disappointing for those that bought this stock too late. The stock moves a lot slower and is a signal that the best part of the trend is over.

Wave Five

Again, this wave is usually sluggish and not near as dynamic as the third wave of an Elliott wave cycle. This also marks the last burst of buying before a new downtrend starts.

Wave A, B, and C

These waves finally start the downtrend. You will notice that wave A looks like just a regular pullback. Nope. This is a bull trap. You will also notice that wave B doesn't get higher than wave 5. This is the first pullback of the downtrend and wave C is the third wave in a downtrend!! This is where you would look for shorting opportunities.

This is the basic structure of an Elliott wave pattern. There is a lot more to Elliott wave theory, but some of it can get very complicated. Also, sometimes it can be very difficult to identify exactly which part of the cycle a stock is in!