Cluster of Signals

Cluster of Signals

Often more than one reversal signal occurs near the same price level. Multiple signals clustered together should give a trader more confidence that the set-up will follow through in the anticipated direction. An example would be when a Japanese candlestick pattern forms within a larger western chart pattern. For instance, often the second top of a bearish Double Top is a bearish candlestick reversal pattern. Figure 8-1 shows a Double Top that formed on the Waste Connections chart during the summer of 2005. An Evening Star formed at the second peak of the larger pattern. Stochastics confirmed by turning down from the oversold line.

Another technical event that may make a set-up stronger is when price tests a long-term Moving Average, such as the 50- or 200-period. These Moving Aver­ages are watched closely by experienced traders. They often provide support when price declines to those levels. Conversely, when a downtrend reverses, longer-term Moving Averages above may act as resistance.

Figure 8-2 shows a chart of Remington Oil & Gas. This is a good example of several signals coming together. A Double Bottom formed at the 200-period Moving Average. The additional support provided by the strong indicator should increase the likelihood of a reversal. In addition to the Western signals, a bull­ish candlestick reversal pattern formed the second bottom of the larger pat­tern. Usually the Stochastics will also curl up from the oversold level. However, if the second bottom is slightly higher than the first bottom, because of the loss of momentum on the second bottom, the Stochastics may not drop back below the 20 line. It should still curl up though.

Candlestick patterns are very common at reversal points. Figure 8-3 shows a bearish Head and Shoulders Top that formed on Take-Two Intera Software. A bearish candlestick pattern formed at each shoulder, and at the head, of the larger pattern. The larger chart pattern alone is bearish. The formation of a bearish candlestick at the right shoulder should increase the likelihood of fol­low through to the downside. Stochastics also confirmed the turns. By the time the right shoulder of the Head and Shoulders Top forms, price is already in a downtrend. Because of that downward momentum, Stochastics may not rise back up to the oversold level on the right shoulder.

To confirm a short position, price should close below the neckline of the Head and Shoulders pattern. The neckline touches the swing lows between the two shoulders. Traders may choose to take an early entry rather than waiting for confirmation, especially if there is bearish candlestick pattern that forms the right shoulder. By that time the neckline is breached, the move is well under way to the downside.

In the Take-Two example, there is potential support at the May low. If a short position is still open by the time price reaches a visible support level, it should be covered. Price generally bounces, at least temporarily, at a strong floor.