7 Feb

How The Market Soared To All Time Highs – The Failed Pattern

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There are many stock patterns underneath the umbrella of technical analysis.

Some of these patterns are trend reversal patterns and others are trend continuation patterns.

Each individual chart pattern is unique— like snowflakes— no two are alike.

You see, stocks will do what they want.

While the chart pattern will tell us something completely different.

Stubborn traders lose money believing that the stock they are in must behave in a certain matter according to the chart—but that’s foolish thinking.

Today I’m going to talk about how we can take advantage of these stubborn traders. And how to profit off failed chart patterns. 


Chart pattern failures

Chart patterns fail for many reasons… some from fear and others from greed.

When a pattern fails to materialize it leaves traders panicked and running for the exit.

This perfect storm of the winning traders orders mixed together with the losing traders stop loss orders being triggered create this momentum that is a unique trading opportunity for the guys on the sidelines.

But first…

What exactly is a failed pattern?

Let’s take a look at an example of a failed technical pattern called a “Double Bottom”.


Source: www.tradingview.com

Typically, a Double Bottom is a bullish pattern formed when the stock price re-tests an important prior pivot or support level.

According to technical analysis, this will be where sellers would be looking to cover their positions and buyers would stop in to drive the price higher.

But… that didn’t happen!


Because sometimes patterns are actually meant to fail…

And this failure often is described as a Bull Trap. Causing buyers to be stuck in their trade and often the only thing they can do is hope for a reversal and hope that the hard stop won’t be triggered.

Instead what happened was the opposite.

The bears maintained control, causing the Double Bottom support level to be violated.

At this point, more sellers stepped into the trade and drove price below the technical support level causing hard stops to be triggered with long traders being “caught” on the wrong side.

This added momentum from hard stops being triggered results in over a 4% drop in the stock price within the next two days!


The Trapped Traders

Being able to know when a pattern fails and when it works is black magic.

Some skill and a lot of luck will get the trader on the correct side of the markets most of the time.

It’s important and essential to your success as a professional trader to make sure you are able to understand WHY failure patterns occur in the first place in technical analysis.

Truthfully, failed patterns are usually part of something bigger picture that traders are unaware of lurking in the markets, or a conflicting technical pattern on a higher time frame.

Let’s take a look at what I mean…

Source: www.tradingview.com

Unbeknownst to the trader, on a Weekly timeframe the QQQ’s were being influenced by multiple technical levels.

Two factors impacting the QQQ’s on the weekly chart:

  1. Market was drawn to the 50-period moving averages by longer term traders looking for a favorable risk-to-reward entry before taking the stock higher.  
  2. Market was also drawn to a famous Fib Retracement level of 0.618 prior to reversing and taking the stock higher.

So why are these two factors important?

Well, the markets work in a “top down” approach to trading, starting with the monthly charts and going down to the 1 minute chart, or lower.

The largest money managers follow the monthly or weekly charts as they look to navigate the markets over the long run and don’t want to be going in-and-out with large sums of funds.

Such firms that trade at these levels are, and not limited to; pension funds, retirement accounts, and other large investment businesses.

The 2 Types of Pattern Failures

First, it’s important to understand the two main types of failures that can occur in a pattern.

The 2 types of failures:

  1. Non-Confirmed patterns
  2. Confirmed patterns


Non-confirmed patterns:

These patterns are formed or are forming and have yet to actually breakout through a trigger line of the chart pattern.

Due to this, further price action is required to prove that the anticipated pattern is going to be correct or fail.

Once the price proceeds in the opposite direction, the failure is confirmed.


Confirmed patterns:

Confirmed pattern failures are the most tricky to spot for new traders.

These chart patterns are the most difficult to spot as they have already been deemed as being “true” due to the confirmation of the trigger line which signaled a pattern that has “worked” as intended.

This means that traders are actively trading this pattern since it is understood to be holding its direction as designed in technical analysis.

In order for this pattern to reverse, traders must have a very strong reason to pursue the opposite direction of this chart formation.

And once this chart pattern fails, it leaves many traders on the wrong side of the markets with little time to react to the new direction.


How To Trade A Failed Chart Setup


In many cases, before you trade a failed chart setup you will want to understand the cause of the breakout.

If you were a trader who already experienced a loss caused by the initial false breakout, you will want to make sure you are mentally ready for taking the trade… As this can lead to revenge trading.

For traders who have some trading experience, this is nothing to worry about, as long as you make sure to adhere to strict risk management techniques.

The key is to realize that the pattern is a fake-out or false breakout, and quickly prepare to take a trade in the opposite direction to catch the real move.

Let’s discuss some basic rules when trading a failed chart setup.

Entering A Failed Pattern

In order to enter a failed pattern, you would want to identify why and where the failure occurred in the first place.

Pro tip: Try to avoid failed patterns that are tied to macro-economic reasons as they are controlled more by fear and “higher forces” and less by technical analysis.

Typically, a trader will notice a breakout with weaker follow thru. This will cause a swift retracement back to the breakout level, typically called a “retest.”

If the momentum turns out to be stronger on the retest than the initial breakout, you are more than likely dealing with a failed chart pattern setup.

So… where would you want to enter this trade?

It’s acceptable to enter a failed pattern when the price action breaks, closes and confirms the original breakout level and trades in the opposite direction.

It is common for traders to use volume to confirm new trend and the likelihood of a failed pattern.

Failed Patterns – Examples

Let’s take a look at a few examples on the markets that were failed patterns and drove the markets higher recently.

Failed Triple Top Pattern

Digging into the bearish pattern called a Triple Top…

Source: www.tradingview.com

As you can tell in the image above, the traders were expecting a technical pattern called a “Triple Top” to form.

This is considered a bearish technical pattern and typically results in lower prices in the future.

Instead, there were 2 key takeaways that gave the trader clues as to what was actually going on.

The 2 key factors to the failed pattern:

  1. There was decreasing volume going into the triple top pattern.  This signaled that sellers were not coming into the markets to sell the stock. Ultimately, traders did not believe lower prices were the correct direction of the trade.
  2. Increase of volume and re-test of the resistance level after the breakout confirms the new direction. Short traders are now trapped and long traders are piling into the markets to drive the stock higher.  

The result?

The markets soared higher by over 10% after the failed pattern as a result of the bulls taking control of the new direction from the bears.  

Failed Bear Flag Pattern

Digging into the bearish pattern called a Bear Flag….

Source: www.tradingview.com

Like the pattern above…

As you can tell in the image above, the traders were expecting a technical pattern called a “Bear Flag” to form.

This is considered a bearish technical pattern and typically results in lower prices in the future.

Instead, there were 2 key takeaways that gave the trader clues as to what was actually going on.

The 4 key factors to the failed pattern:

  1. There were no closes that occurred below the lower support level of the bear flag signaling buyers were still interested in buying the markets at this price.
  2. During the Bear Flag, there was decreasing volume throughout the 7 trading days. This signaled sellers were never in full control of the markets and could not drive price lower. 
  3. There was a breakout above the top of the bear flag pattern. If held, this is a possible failed pattern.
  4. There was increased volume that corresponded with the breakout above the upper bear flag level signaling bears lost control of the stock to the bulls.

The result?

The bears ultimately lost control of the stock to the bulls, and this was confirmed in both price action and volume studies.

This new direction resulted in the markets being driven higher by over 13% in the following months.

What’s Next

Well traders… look what is currently setting up in the markets as we speak.

Source: www.tradingview.com

As we can see, there are nesting failed patterns that are occuring at these levels in the SPY’s.

There is a Bear Flag that appears that it has failed along with a possible Double Top pattern that may fail as well.

What’s the trade?

Well, this is where the job of the trader becomes more difficult… and you want to make sure you are on the right side of the markets when the new trend is established.

But from everything we have learned there are only two missing components of the failed patterns…

Two things to watch out for that are missing from the current failed pattern:

  1. A re-test of the prior price levels
  2. Increased volume showing bulls are in control of the markets

The next steps are up to you… do you go long here before the confirmation to get into the markets early, or do you risk missing the trade higher while you wait for the signal to get in.  


Both confirmed and failed chart patterns are some of the strongest and most reliable trading patterns a technical trader can take advantage of.

It’s of utmost importance that a trader understands how to identify both situations in order to avoid being trapped on the wrong side of the trade during important trading levels like we are seeing today.

To summarize:

  • A chart pattern failure occurs when a chart formation does not materialize and act as expected
  • When a pattern fails, you are likely to experience a loss if you were currently in the trade. However, this sets you up for a reversal to capture the pattern failure.
  • In many cases, the process of creating another larger pattern requires smaller pattern failures.  
  • Failures can be classified into 2 main classes: Confirmed, and Not Confirmed
  • In order to trade a chart pattern failure, you must:
    • Watch for volume to confirm traders are in the markets
    • Wait for retest of the prior pattern
    • Confirm the pattern failure 
    • Trade in direction of new trend
  • Volume analysis is an important tool when trading chart pattern failures…
    • Breakouts on high volume are usually real and confirmed 
    • Breakouts on low volume are usually fake and not confirmed


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