The Jeff Clark Trader
Guide to Technical Analysis
SPECIAL REPORT
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Technical analysis (TA) is much more of an art than a science. If you try to force it to
conform to strict rules and formulas, it will be wrong almost every time.
Try thinking of TA the way I do… where the chart of a stock (or index) and its technical
indicators is an emotional picture of the stock at a specific moment in time. If I can go
back in that picture and find a time where the conditions were similar, and note how
the chart behaved afterwards, it can provide strong clues about what to expect in the
future.
But TA is emotional. It evolves. So, conditions that used to provide a catalyst for a big
move or reversal may need to get more extreme to cause a similar movement the next
time.
Think about it this way…
When I first got married, I’d often come home from work, take off my socks, and drop
them on the floor next to the couch in the living room. My wife would come home, see
my socks on the floor, and get all ticked off about it. This happened over and over again.
Eventually, though, my wife got a little better about dealing with her slob of a
husband, and I got a little better about not leaving my socks next to the couch.
Leaving my socks on the floor no longer elicited the same reaction from my wife.
She still had the same emotions. But she had adapted. She had evolved. She would
need a bigger catalyst before getting upset with me – like when she found a dozen
pairs of dirty socks tucked underneath the sofa.
Here’s my point…
A lot of my trading strategy revolves around finding emotionally overbought/
oversold conditions that are ready to reverse. TA helps me identify conditions in
which investors’ emotions have gotten extreme, and where I can see how stocks have
reacted to similar conditions in the past.
But you can’t force TA into a strict formula. You have to give it some “wiggle room.”
The Jeff Clark Trader
Guide to Technical Analysis
By Jeff Clark, editor, Jeff Clark Trader
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In this guide, I aim to show you the fundamentals of chart pattern analysis, and teach
you everything you need to know about my approach to TA. I’ll also show you that,
while TA can be a valuable predictive tool, it isn’t foolproof or 100% accurate every
single time. It’s a tool that should support the trade idea, but not be the trade idea.
With all that said, let’s get started...
ANATOMY OF A CHART PATTERN
Before you can start identifying chart patterns, there are important aspects of a
pattern to know and consider...
Trend
A trend is the general direction of the price of a security, asset, or index.
Upward trends form as prices make consistently higher highs and higher lows.
Downward trends form as prices make lower highs and lower lows. And sideways
trends form as the highs and lows of a price stay generally the same.
Trendline
A trendline is a line drawn over a series of highs or lows to show the direction of a
security’s price over a given timeframe. The two trendlines that make up typical chart
patterns are support and resistance lines.
Plotting support and resistance lines is one of the first steps to identifying a chart
pattern. See the chart of the VanEck Vectors Gold Miners ETF (GDX) below for an
example of a sideways trend with consistent support and resistance levels.
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Timeframe
A timeframe is a period in which a trend is identified. For our purposes, trends
manifest over several different timeframes – hours, days, weeks, and months.
We often refer to the short term, intermediate term, and long term when talking about
timeframes. We define the short term as one day to two weeks, the intermediate term
as two weeks to three months, and the long term as anything longer than that.
Support
A trendline formed below the price of a security which the price stays above. This
typically marks the spot where buyers step up and buy the stock.
These trendlines can rise, fall, or stay horizontal.
Resistance
A trendline formed above the price of the security which the price stays below. This
typically marks the spot where sellers prevail.
Like support lines, resistance lines can rise, fall, or stay horizontal.
Breakout
A breakout occurs when the price of a security breaks through a support or
resistance line. This can indicate either that a pattern has completed successfully or
that a security has bucked a trend.
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Volume
Volume is the number of shares or contracts transacted in a security in a given
timeframe. A transaction is made up of both a buy and a sell from two separate parties.
Trading volume can be used as a confirmation tool when analyzing a trend breakout.
For instance, if a stock price breaks out of a trend with high trading volume, the new
trend will likely continue. If it breaks out with lower volume, it indicates the breakout
could reverse.
Price Target
A price target is where a trader predicts the price will be in the future. Traders use
chart analysis and predetermined conditions to predict where the price of a security
will go.
TECHNICAL INDICATORS
While recognizing chart patterns can help traders predict future price movements,
it’s not a foolproof method. It’s also very important to know various technical
indicators and overlays that we use to identify chart patterns, and any short-term
strength or weakness in a security…
Moving Average (MA)
A trend-following indicator used in technical analysis to smooth out price action
by filtering out large spikes and drops in a security’s price. For our purposes,
we’ll most often be using the simple 50-day MA.
Exponential Moving Average (EMA)
A type of moving average that is weighted more towards recent data. Because
of this, the EMA reacts to price changes in a security more quickly than a simple
MA. For our purposes, we’ll most often be using the 9-day EMA.
Moving Average Convergence Divergence (MACD)
A momentum indicator that shows the relationship between two distinct
moving averages of a security’s price. Traditionally, the MACD is calculated by
subtracting the 26-day exponential moving average (EMA) from the 12-day EMA.
Relative Strength Index (RSI)
A momentum indicator designed by J. Welles Wilder to measure the speed and
change of price movements. The RSI ranges from 0 to 100. Traditionally, traders
consider a security overbought if the RSI is over 70 and oversold if it’s below 30.
The data is generally measured over a period of 14 trading days.
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Bollinger Bands
Points on a chart plotted two standard deviations above and below an asset’s
moving average line. It is used in technical analysis to determine overbought
and oversold market conditions.
The bands are also subject to market volatility – during periods of low volatility
the bands contract, while during periods of high volatility the bands widen.
McClellan Oscillator
An indicator used in technical analysis to determine the balance between
stocks that are advancing and declining. It is calculated by subtracting the 39-
day exponential moving average (EMA) of stock advances, less declines, from
the 19-day EMA of stock advances, less declines. The result is a momentum
indicator that works similarly to the MACD.
Commodity Channel Index (CCI)
A momentum-based indicator that is often used to determine when an
investment is reaching oversold or overbought conditions. In general, it
measures the current price level relative to an average price level over a given
period of time.
If the CCI is high, prices are far above their average. If the CCI is low, prices are
far below their average. This versatile indicator can be applied to indices, ETFs,
stocks, and other securities.
Now, here are some of the most common chart patterns and how to play them…
CHART PATTERNS
Double Top/Bottom Pattern
A double top or double bottom chart pattern indicates a future move beyond two
repeated support or resistance levels.
For instance, if a chart has a big run up to a resistance level, falls, and then returns to
the resistance level (forming two “tops” on the chart), it is likely to head much lower.
See the chart of United Airlines (UAL) on the following page. The chart found two
similar peaks (marked by the blue arrows) near a strong resistance level (the blue line)
and then broke down.
The reverse is true, too… If a chart makes two bottoms at a support level but doesn’t
breach them, it is likely that the next high will be higher than the previous peak.
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Note the double bottom that UAL formed below (the red arrows). After bottoming a
second time at the same support level, the stock overcame its previous peak.
HOW TO TRADE THE DOUBLE TOP/BOTTOM PATTERN:
Traders using a double top pattern should look to enter short trades after a security’s
price has started to decline from its previous resistance level.
For the double bottom pattern, look to enter long trades once the price reverses from
a similar support level a second time.
Head and Shoulders Pattern
The head and shoulders pattern is used to predict a trend reversal from bullish to bearish.
It’s considered one of the most reliable reversal patterns.
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This pattern is formed when the price of a security in a bullish trend forms a peak and
then dips down to form a trough below it. This forms the first “shoulder.”
After finding the bottom of the trough, the price rises again to form a second high,
higher than the first. Again, the price declines to a similar level as the previous
trough. This larger peak is what’s called the “head” of the pattern. And connecting the
two troughs forms the “neckline” of the pattern.
Finally, the price of the security will make another high from the bottom formed by
the second trough – the second shoulder. This high will be lower than the previous
high set by the “head” and closer to the initial shoulder. (See the chart of the U.S.
dollar below for an example.)
It is at this point – if the pattern plays out successfully – that the price will break down
from any bullish uptrend and decline to lows last seen before the initial shoulder.
HOW TO TRADE THE HEAD AND SHOULDERS PATTERN:
Aggressive traders following this pattern should look to enter short trades once the
level set by the first “shoulder” is reached and reverses.
Conservative traders following this pattern should look to enter short trades after
the price breaches the neckline.
If the price can’t break the neckline, it’s called a failed head and shoulders reversal… If
that happens, the stock typically rises.
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Inverse Head and Shoulders Pattern
Charts can also form an inverse head and shoulders pattern. This pattern is used to
predict a downtrend reversal. The pattern is, as the name implies, the inverse of the
typical head and shoulders pattern.
The pattern starts when the price of a security falls to form a trough (the first
shoulder) and recovers. Then, it falls again to form a lower trough and recovers to the
previous high set after the first trough, forming the head.
Finally, after the price falls again to form a third trough – but not as low as the
previous one (the second shoulder) – the pattern resolves in a breakout to the upside.
See the chart of Seattle Genetics (SGEN) below for an example.
HOW TO TRADE THE INVERSE HEAD AND SHOULDERS PATTERN:
Once identified, traders should look to enter long trades once the second shoulder
clearly forms – meaning when the price reverses from a higher low than the previous
trough (the head).
Wedge Pattern
A wedge pattern is a contrary indicator, predicting a reversal move as the trading
range of a security tightens as it rises or falls. The two variants, a rising wedge and a
falling wedge, work similarly.
In a rising wedge pattern, the price of a stock or security is in an uptrend and makes
a series of gradually higher highs and higher lows.
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If the trading range within the uptrend begins to contract, the trend is likely to break
down at the corner of the wedge, below the major support level.
See the chart of Hertz (HTZ) below for an example of a rising wedge pattern resolving
to the downside.
The same is true of falling wedge patterns, in which the price of a security in a
downtrend will break out from the pattern once the series of gradually lower lows and
lower highs contracts tightly. Once the price of a downtrending security breaks above
the falling resistance line, the pattern resolves to the upside.
See the chart of General Motors (GM) below for an example of a falling wedge pattern
resolving to the upside.
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HOW TO TRADE THE WEDGE PATTERN:
Traders following the rising wedge pattern should look to enter short trades once the
price of a security breaks below the rising support line.
Likewise, falling wedge patterns should be exploited on the long side by doing
the opposite – entering a long position when the price breaks above the falling
resistance line.
Flag and Pole Pattern
A flag pattern is a continuation pattern that forms as the price of an asset or security
begins to trend downward after a sharp rise upward, or vice versa.
The “flag” of the pattern is formed by two parallel lines acting as the resistance and
support for the trend as it bucks the initial trend, or the “pole.”
See the chart of GameStop (GME) below for an example of how the “poles” formed by
sharp spikes in price usually resolve to the downside.
Flag patterns usually resolve to the opposite direction of where the flag was trending.
This occurs once the price of a security breaks through resistance or support,
depending on the previously established trend.
HOW TO TRADE THE FLAG AND POLE PATTERN:
Traders following this pattern should look to enter positions when the price breaks
the flag formation in the direction the price was moving before the flag formed.
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Triangle Patterns
A triangle pattern is one of the simplest types of chart patterns to spot and follow.
This type of pattern occurs when a stock price consolidates – meaning the lows and
highs in the stock price trend closer together and volatility tightens. This manifests
as two trendlines that converge at an apex.
This apex marks the end of a triangle pattern. At that point, the pattern will either
complete successfully and the movement predicted by the pattern will manifest, or
the pattern will fail and a new trend will be established. (Note: Traders should not
enter trades using a triangle pattern until it resolves in a breakout to either side.)
There are several variants of triangular chart patterns, all of which predict different
future price action:
a) Symmetrical Triangle
A symmetrical triangle pattern marks a period of consolidation in a trend after
a prior large move in either direction. As the price of a stock chops around back
and forth between lower highs and higher lows, two converging trendlines – a
descending resistance line and an ascending support line – form, leading to an
apex point and completing the triangle.
See the chart of W.W. Grainger (GWW) below for an example of a symmetrical
triangle reaching its apex and resolving to the upside.
Once the chart reaches the apex point, the price typically breaks out in the same
direction as the initial large move. To determine future price action, look for a break
above the descending resistance line if the pattern is playing out after a large run up.
If the pattern formed in response to a large move to the downside, look for the stock
price to break below the ascending support line for another downside move.
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However, if the trend reverses at the apex point and breaks in the opposite direction
of the previous move, it is likely that the trend has reversed.
b)
HOW TO TRADE THE SYMMETRICAL TRIANGLE PATTERN:
Traders following this pattern should look to enter positions in the same
direction as the initial move that preceded the price consolidation.
Ascending Triangle
An ascending triangle pattern marks a potential bullish breakout upon completion.
It is also often preceded by an upward trend, making it a continuation pattern (like
the flag pattern we discussed earlier).
The pattern is formed by two trendlines: an ascending support line formed by
higher lows, and a flat resistance line formed by repeated tests of a high point in the
price. At the apex of this trend, the price of a security is likely to break to the upside.
See the chart of the VanEck Vectors Semiconductor ETF (SMH) below for an example
of an ascending triangle pattern reaching its apex and resolving to the upside.
The key aspect to watch in this pattern is the rising support line. It indicates
declining selling interest. If the price breaks below this support line, the pattern
fails and a new trend is formed.
HOW TO TRADE THE ASCENDING TRIANGLE PATTERN:
Traders following this pattern should look to enter long trades once the price
of the security breaks the sideways resistance line.
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c) Descending Triangle
A descending triangle pattern represents the opposite of the ascending
triangle pattern – a successful completion of the pattern results in a break to
the downside.
The pattern is formed by two trendlines: a declining resistance line of lower
highs, and a steady support level of repeated lows.
See the chart of the iPath Bloomberg Coffee Subindex Total Return ETN (JO)
below for an example of a descending triangle pattern reaching its apex and
resolving to the downside.
The descending triangle culminates at the apex near the sideways support
line (the resistance line in the ascending triangle) and typically resolves in a
break to the downside. This is the opposite of the ascending triangle, in which
a break from the pattern to the upside occurs when the pattern culminates at
the apex formed at the sideways resistance line.
HOW TO TRADE THE DESCENDING TRIANGLE PATTERN:
Traders following this pattern should look to enter short positions once a
break to the downside of this pattern has occurred.
Cup and Handle Pattern
A cup and handle pattern occurs when a security rebounds from a low period over an
intermediate- to long-term timeframe to retest old highs. This action forms a rounded
bottom in the stock’s trajectory – the “cup.”
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After reaching those previous highs, traders who held the stock since then would
be looking to exit their positions, as they’re now profiting on the trade. This selling
pressure then forms a new trend from the recent test of the previous high. This
channel is the “handle” of the pattern.
If the pattern completes successfully, the price should break above the trend
established by the “handle” and go on to reach new highs.
See the chart of the VanEck Vectors Coal ETF (KOL) below for an example of a
sideways-trending handle forming after a cup.
HOW TO TRADE THE CUP AND HANDLE PATTERN:
Traders following this pattern should look to enter long positions once the trend
established by the “handle” breaks to the upside.
Rectangle Pattern
A rectangle pattern is a continuation pattern which marks a pause in the trend for a
security’s price. The pattern is formed by a series of at least two consistent highs and
lows. These highs and lows make up the connecting point for two parallel lines that
form the top and bottom of the rectangle.
This pattern completes once the security price breaks below the top or bottom of
these two parallel lines. Thus, the rectangle is similar to the symmetrical triangle, but
not as predictive. This is because a series of higher lows and consistent highs is not
established.
See the chart of Chevron (CVX) on the next page for an example.
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HOW TO TRADE THE RECTANGLE PATTERN:
Traders following this pattern could look to enter trades once either the support or
resistance line has been breached. But as we mentioned, the rectangle pattern isn’t a very
good predictive pattern. So it shouldn’t be relied upon like the other patterns listed here.
Instead, the rectangle pattern can help pin down other potential patterns or trends.
Crosses
While not technically a pattern, a cross can be an important catalyst to watch when
looking to enter new trades in either direction.
A cross occurs when the various moving average lines of a security – like the moving
average (MA), exponential moving average (EMA), or Bollinger Bands – cross one
another.
This can result in a number of buy or sell signals, depending on the lines involved and
the direction.
One example of a bullish cross is when the 9-day EMA crosses above the 50-day MA.
This indicates that the most recent, ultra-short-term price action has been favorable
when compared to longer-term price action. This means that momentum has shifted
in the opposite direction, and typically results in a broken trend.
See the chart of the United States Oil Fund (USO) on the next page for an example of
the 9-day EMA crossing above the 50-day MA, and the effect it has.
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HOW TO TRADE A CROSS:
Traders watching for crosses should look to establish long positions as the 9-day
EMA crosses above the 50-day MA.
And on the downside, look to establish short positions when the 9-day EMA crosses
below the 50-day MA.
Sledgehammer Pattern
Another important trend to watch out for is the “sledgehammer.” Like the cross, the
sledgehammer isn’t technically a pattern like most of the others on this list. But it is
still a valuable TA tool.
The sledgehammer is a bullish reversal pattern. It plays out when a stock get crushed,
bounces a little, and then gets crushed again.
See the chart of Target (TGT) on the next page for an example of where to buy in when
observing a sledgehammer pattern.
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HOW TO TRADE THE SLEDGEHAMMER PATTERN:
Traders following this pattern should look to enter long positions on that second
crushing – the reason being that when sledgehammer patterns play out, the momentum
indicators are usually stretched so far to the downside that a reversal move is highly likely.
IN SUMMARY
So, there you have it – a quick and easy illustration of some of the most frequently
used chart patterns, and how to use them.
I suggest keeping this guide handy – maybe print it out and keep it near your desk.
And refer to it whenever I issue a trade recommendation. It’ll keep you in tune with
how I use TA. Then, once you’re more comfortable, you can start searching for these
patterns in your own trading.
There are other patterns, for sure. But the patterns I’ve explained here are the ones
I look for most. They tend to be reliable at forecasting future price movements. And
they’ve helped to identify many successful trade setups for me over the years.
I expect they’ll continue to do so.
Best regards and good trading,
Jeff Clark
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