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Pattern Failure
| Patterns appear at the end of thrusting price movements. They
are characterized by constricted swings between key support and
resistance levels. Pattern development completes when a new
trend leg breaks through this wall into directional price
change. This new thrust may be in the same or opposite direction
as the previous one. A pattern between adjacent price moves in a
single direction continues that trend. Alternatively, when a
breakout turns and retraces the last trend leg, the intervening
pattern reverses the prior move.
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You can categorize most patterns by their tendency toward
continuation or reversal. This familiar bias underlies the
predictive power of these structures. By their repeating nature,
a well-marked chart landscape can be drawn to profit from the
expected breakout. Use classic observation and well-chosen
technical indicators to examine patterns as they develop. Their
bullish or bearish nature can often be identified well before
completion and exact entry points chosen where new price
momentum will likely erupt.
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But sometimes patterns won't do what the crowd expects.
One of the most powerful signals in pattern analysis flashes
when a setup fails to act according to its tendency. This
pattern failure often triggers sharp price movement in the
opposite direction from the formation's natural bias. Have a
contrarian entry system based on this reversal waiting in your
trader's toolbox. But first exercise sound risk management as
you recognize this event in progress and wait for ripe
opportunity to appear.
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Probability underlies all prediction. Through skilled
observation or system-driven signals, technicians anticipate
future price movement and enter trades they hope will profit
from it. But the most common price patterns often fail to act as
expected. Look to the edges of these rogue formations to
identify trigger points where price signals a break in the
low-odds, high-profit direction. One obvious example can be seen
in the unexpected Tellabs rally after it drew a recognized
reversal formation.
The classic Head and Shoulders reversal has been subject to
intensive study over the last century. In fact, one popular
investigation discovered this well-known pattern works only 79%
of the time. While this figure lies well outside random outcome,
it illustrates just how wrong you might be the next time you
sell short at the H &S neckline.
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| Think Contrary: Sell short
at the Head and Shoulders neckline? That classic TA
advice got traders into major trouble in early 1999 on
TLAB. When price rose beyond the level of the right
shoulder, the pattern failed and smart traders prepared
for low-risk long entry. The break at the tops of the
head and right shoulder signaled confirmation AND also
offered an easy pullback trade. |
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