Sunday, December 02, 2007

Identifiying Head and Shoulders Patterns before the Neckline Break

I would consider myself a student of two distinct methods of trading. First is the momentum, buy high and sell higher methods used to such great effect by William O'Neil. The other relies on the technical analysis indicators developed by Tomas DeMark. His indicators are used to identify changes in the trend and anticipate tops and bottoms in price movement.

While I feel fairly confident in my O'Neil buy and sell rules, I'm continually learning the great power of the DeMark indicator. Take, for instance, the chart of Force Protection (FRPT), which I wrote about in two previous posts. It first caught my eye when I was looking for TD Sequential buy signals. It came up in a scan and I watched it bounce to its previously defined TDST resistance line. I was amazed by how strong the resistance turned out to be, as every attempt to close above it failed. Taking a look at the weekly chart it seemed to be forming the right side of a head and shoulder top. This would have been a great short entry point and would have given someone a very low-risk short, assuming that a buy stop would have been placed just above the TDST resistance line. Also notice that such an entry would have given the position an extra 9 points (or 35%) well before the traditional neckline entry was reached.

I did not enter this short, but have seen this pattern repeat itself over and over again (both long and short). I do not plan on missing the next one.

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