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Trend Trading With Flag Patterns

11/19/10 09:51:49 AM
by Billy Williams

Trade with the trend during breakouts without suffering false starts or volatile price swings with bullish flag patterns.

Security:   BIDU, OPEN
Position:   Hold

Trading in the direction of the trend is a fundamental to successful trading and the easiest way to make money in the market, but unfortunately, despite the simple concept, most traders, beginner or experienced, are not very good at it. If trading in the direction of the trend is not just the cornerstone to profitable trading, then why aren't most speculators better at it?

While there are number of angles that you could approach that question, one of the most common approaches would be the lack of an appropriate method. This lack of a method in trend trading has been the culprit for more losses, busted trading accounts, endless nights of frustration, overwhelming anxiety, damaged self-esteem, dwindling confidence, and responsible for more trading careers cut short than probably any other reason.

Now that you know why it's important to have a proper method when looking to trade a trend, it also important for you to understand that the force of momentum is on your side from the moment you take a position on the right side of the trend. However, it is crucial that you use a combination of patience and timing when entering a move that is under way while also utilizing the self-discipline to follow the rules of the method you are implementing. See Figure 1.

FIGURE 1: BIDU. BIDU has a big runup, followed by a brief period of consolidation, forming a bullish flag pattern. Later, it broke out and continued higher.
Graphic provided by:
Approaching the market from the standpoint of entering the market at the precise time the trend offers the greatest return in the shortest amount of time is like knowing when to pick the sweetest fruit off the tree at the exact time it has ripened to its fullest potential. Therefore, using the momentum principle, where the stock is ready to accelerate in value the fastest, would be a critical success factor when analyzing the a potential entry.

Momentum occurs at the moment a stock breaks out of a consolidated price range, moving into expansion in price while also confirming with greater trade volume. The benefit of entering at this point is much like when the surfer waits for the right formation in the waves and latches onto the force that is building up, riding the full momentum of the wave, and stepping off as momentum slows down. Riding the momentum of a stock is much the same, but there are challenges to watch out for. See Figure 2.

FIGURE 2: OPEN. Recently, at the time of this writing, OPEN has formed a bullish flag pattern, which should continue higher after a breakout.
Graphic provided by:
False breakouts are commonplace and floor traders can, at times, manipulate a stock's price action by artificially bidding a stock's price up through significant price highs where momentum traders wait for entry points but then sell out as momentum traders buy into the stock. This type of potential breakout has no force in its upward momentum because as soon as momentum traders begin to buy, the floor traders neutralize the upward force by selling off their position into the buying frenzy, resulting in a false breakout.

A solid approach to overcome this type of frustrating occurrence is to wait for the breakout to occur, then observe the price action for bullish flag patterns to enter safely in the direction of the stock's trend with the added benefit of enjoying momentum to the upside. A bullish flag pattern is a continuation pattern that usually happens when there is a large runup in price after a breakout and, after a brief period of consolidation, price continues in the direction of the trend.

This allows you to enjoy the profit potential of being a momentum trader who trades in the right direction but, potentially, allows you a better entry point without running the risk of suffering a false breakout.

Price will typically run up the same distance as the previous price leg up before it began to consolidate in price with the entry point just over the upper trendline, confirmed by greater volume as price trades up through it.

Billy Williams

Billy Williams has been trading the markets for 27 years, specializing in momentum trading with stocks and options.

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Date: 11/23/10Rank: 5Comment: 

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