Candlesticks, Fibonacci, and Chart Pattern Trading Tools : a synergistic Strategy to Enhance Profits and Reduce Risk

Examples with Selected 3-Point Chart Patterns
The chart patterns discussed in the following subsections are well
known, and more importantly, they are highly relevant to combina-
tions with candlestick patterns and Fibonacci trading tools. Our f ind-
ings are in line with the results of Thomas Bulkowski’s computer test
Figure 4.32a
Trailing stop rule on a valley out of long position.
Figure 4.32b
Trailing stop rule on a peak out of short position.
c04.qxd 6/16/03 4:18 PM Page 92

---

3-POINT CHART PATTERNS FOR TREND REVERSALS
•
93
runs. In Chapter 6, we use the same examples to show how traders
can modify our entry rules by integrating candlestick charts and Fi-
bonacci trading tools.
Head and Shoulder Formation
Head and shoulder formations are one of the best chart patterns for lo-
cating trend reversals. They often can be found on tops or bottoms, but
there are exceptions. A head and shoulder top formation is sometimes
at the end of a downtrend as well. Ideally, the right shoulder should be
on the same level as the left shoulder.
Figure 4.33 shows the German Dax member stock BMW.
On this chart, the neckline connects two valleys between the left
and right shoulder of a head and shoulder top formation. At the bottom
formation, the neckline connects the two peaks between the right and
left shoulder. To complete the formation, the market price must break
the neckline.
Figure 4.33 BMW chart from 12–00 to 07–01. Head and shoulder formation daily.
c04.qxd 6/16/03 4:18 PM Page 93

---

94
•
APPLICATIONS OF TRADING STRATEGIES
Figure 4.34 shows a head and shoulder formation for Eastman
Kodak from late in the year 2001.
To successfully make trades based on price chart patterns, we
need to check the profitability of our entry rules, stop-loss rules, profit
target, and trailing stop rules.
Once the right shoulder is formed, we can buy (or sell) on a break-
out of the neckline to the upside (or to the downside). With a head and
shoulder top formation, the success rate of this approach is 93 percent
according to Bulkowski’s test results.
The stop-loss is placed just above (short trades) or below (long
trades) the right shoulder. Setting the prof it target to twice the