Section 9:

Setting Price and Time Targets Using Price Patterns

 

Price patterns can be used to forecast price targets and the time in which a stock might be expected to hit its target. Most of the price patters generate two different price targets: long-term and short-term. A few of the patterns, such as double and triple bottoms, only generate one price target.

Calculating price targets from price patterns is an inexact science. It’s more of an art. There are so many changing variables in the market that tomorrow is promised to no one and certainly no stock. It’s best to think of the price and time targets as general guides that provide context to trading. These targets can be used to assess the risk versus reward in a particular trade, set expectations for the time requirement of staying in the position, and even help in the management of the trade after entering.

It is best to apply price and time targets generated by price patterns in two different ways, depending on if the price pattern is bullish or bearish. The reason for the two different approaches to setting targets is due to the nature of the market. Remember that stocks tend to go higher, that there’s an overall upward trend in the stock market. But when stocks do drop, they tend to do so rather abruptly. These two characteristics of the stock market factor into the application of time and price targets generated by price patterns.

Bullish Price and Time Targets

Bullish price and time targets should be applied with a lot of flexibility. This is especially true of price and time targets generated by bullish continuation patterns. In fact, of the four categories of price patterns, targets based on bullish continuation patterns require careful consideration.

Remember that stocks can go higher indefinitely. Stocks can increase by 100, 200, and even 10,000 percent. Setting price targets and prematurely exiting from a very strong bullish stock could potentially leave a lot of profit on the table. There’s no way of knowing which stock is going to be the next five or ten bagger, but the opportunity is presented by at least participating in strong upward trends.

Recall one of the great trends used as an example earlier in the tutorial in Potash (POT). (See Figure 9.1)

Figure 9.1

POT traced several bullish continuation patterns during this rally from around $50 up to near $135. There were several instances when a trader could have taken a profit because POT met a bullish price objective based on a bullish continuation pattern. Doing so might have caused a missed opportunity in continued upside in the stock. Alternatively, a new entry could have been taken after the initial exit from a profit, but it would have most likely been at a higher price and after spending another commission.

Price and time targets generated by bullish reversal patterns can be treated differently. Bullish reversal patterns generally form near the tail ends of bear markets or short-term bearish trends. The bullish reversal patterns usually take shape during transitional periods in the market, before a bullish market has been established. There are usually a lot of starts and stops in stocks that are segueing from a bullish market to a bearish market; therefore, price and time targets can be applied more rigorously. Stocks can still be given some room and leeway, but the price and time targets generated by bullish reversal patterns tend to be a bit more effective due to overall market conditions.

Bearish Price and Time Targets

Bearish price and time targets should be applied more rigorously than bullish targets. The reason is simple: stocks can only fall to zero. Meanwhile, stocks can rise indefinitely. This skews the risk and reward dynamic in bearish positions, so it’s ok to take profits quicker when trading bearish price patterns.

Of the two different types of bearish price patterns, bearish continuation patterns can be afforded more flexibility than bearish reversal patterns. Bearish continuation patterns can often lead to huge bearish trends. An example of such a bearish trend was offered earlier in the tutorial in Beazer Homes (BZH). (See Figure 9.2)

Figure 9.2

Catching the majority of a huge bearish wave lower like the one in BZH would be difficult if each and every bearish price objective were followed and profits were taken when the stock reached its bearish target.

Letting bearish profits run might be a better choice when trading bearish continuation patterns, especially during the depths of an establish bear market either in the broader market on in a specific industry. Letting profits run, and ignoring the bearish price and time targets, would require an opinion that the stock would continue lower. These opinions can come from fundamental or sector analysis and compliment the analysis from price patterns.

Bearish reversal patterns are another matter. Of the four categories of price patterns, the price and time targets generated by bearish reversal patterns should be followed the most rigorously. That’s because bearish reversal patterns form at the tail end of bullish trends. The bulls, or buyers, don’t often give up without a fight. This translates into a lot of chaotic volatility. The volatility that accompanies transitions from bullish to bearish trends is difficult to trade. That’s why it makes good trading sense to take profits quickly when trading bearish reversal patterns.

*** To learn how to determine price and time targets based on price pattrns, order the Trading Price Patterns Interactive Tutorial. The tutorial will teach you, in detail, how to set price and time targets for the different patterns, across different timeframes.***

Setting Price and Time Targets Summary

The price and time targets generated by price patterns add context and organization to what is likely to happen in a stock, sector, or market. Although the future remains unknown to all of us, the targets projected by price patterns serve as a roadmap to the future.

Of the four categories of price patterns, the targets projected by bullish continuation patterns should be given the most latitude. In fact, sometimes it might even make sense to completely ignore the time and price targets projected by bullish continuation patterns and instead focus simply on the pattern itself.

The reason for giving so much leeway to targets projected by bullish continuation patterns is due to the fact that stocks go exponentially higher. Catching trends of 100, 200, 500 percent, or more, is only possible by sticking with bullish trends for long periods of time. The formation of bullish continuation patterns confirms bullish trends and help traders to stick with them.

Price and time targets stemming from bearish continuation patterns can be given some leeway, but not nearly as much as the targets that come from bullish continuation patterns. Stocks can only fall to zero, and only a small minority ever does. There are factors such as acquisitions and dividends that serve as a tremendous head wind to the would-be bearish trader. That’s why it doesn’t make sense over the long-term to be frequently betting on stocks to reach zero. Instead, a smarter bet is using price targets from bearish continuation patterns, and then consistently taking profits when stocks are reaching their price targets.

Picking bottoms is a difficult task in the market. The process can be made easier with the assistance of bullish reversal patterns. The time and price targets stemming from bullish reversal patterns can be used to measure the risk and potential reward when trading stocks that seem poised to reverse bearish trends. But trading bullish reversal patterns should be reserved for special situations and be done with relatively tight trade management. Unlike bullish continuation patterns, bullish reversal patterns should be traded rather rigorously, taking profits often and relatively quicker.

Of the four categories of price patterns, bearish reversal patterns are the most difficult to trade. Bearish reversal patterns predict tops, or the ends of bullish market trends. Since the market tends to trend higher over time, the probabilities of success trading bearish reversal patterns are quite low. Trading the patterns should be reserved for rare occasions when the time is just right for bullish trends to reverse. Even when the time is just right, it makes good trading sense to take profits quickly when trading bearish reversal patterns.