Sunday, May 4, 2008

Trend Reversal patterns

Trend reversal patterns can be very helpful when trading in the stock market. They can help you get into stocks near the bottom, or the top.

So, what is a trend reversal pattern? They are simply patterns that are seen time and time again at the end of a trend. There are a number of different ones, Double bottom, head and shoulders, ect. But they tell you the same thing.

Every reversal pattern is said to have a target for which to shoot for. Most of these patterns will hit their target most, but not all of the time. In fact there are three different thing that can happen when one of these patterns form.

The stock could actually be at a bottom. It could start heading up and make a nice uptrend. This is the one that most people want happen.

Another thing that can happen is the stock heads up once it breaks out. Then it goes and hits its target. Once it hits its target however the stock may actually crash. People see the stock as overvalued and a selloff occurs.

The third thing that can happen is the pattern can just fail. The stock doesn’t go up and actually breaks down lower.

All this uncertainty is why trend reversal trades need to cut their losses short and let their winners ride. For instance stock XYZ is trading at $59 and has broke out of resistance of a bottom pattern you may want to set a stop below resistance.

If the stock goes back below the resistance of $57 it probably means the stock will fall. However it has a target of $70. In this case it may be wise to put a stop at $56. That way if you lose you lose $3. If you win you win $11.

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