Stock chart – not to trade

One Stock Chart pattern to avoid

The purpose of this post is to tell you about one technical trading pattern I avoid putting my hard earned capital towards. What do you like to do in your free time? One of my free time activities is to look at stock chart patterns.  I call this hobby ‘graphs for laughs’. I believe if you become familiar with a number of basic patterns you will have the ability to pick stocks better. It is all about pattern recognition.

I am not longer a big believer in looking at every technical pattern iteration like they are a sign or has a meaning. Rather I am looking more broadly for a trend in relation to a moving average. Then I subsequently confirm if my prediction, based on my reading of the tea leaves , I mean stock trading charts, was correct.

Instead learning every trading pattern from the “cup and saucer” to “Fibonacci retracements”, I would rather become a specialist at simply looking at the stock price trend in relation to the moving average. That is being good at recognizing patterns of basic technical analysis,  the subtle over the exotic.

This is one trading pattern I avoid. I do not know what other technical traders call it or what they recommend. However, in my experience, it is not to be traded. I call it the snake.

This is a stock that has moved up rather rapidly.  It does not matter the time frame. It could have been many months or even a few weeks. However once it makes the initial move, the curve flattens out.

The reason this technical pattern tricks people is:

  • The moving average is usually still be increasing.
  • The price has not broken down below the trend line.
  • The fundamentals are usually good.
  • It comes up as a ‘buy’ on many quantitative screens.
I do not trade this stock chart pattern

But still every time I have traded this stock I have not had a good experience.

The reason this technical pattern does not perform well is it has moved too far from the moving average trend line

What is happening is it has made a positive move because of some valuation, and then it hits resistance above the moving average. This is because many of the traders want out. Traders take profits and it hits a plateau. All these guys need to exit before it as any potential to move up again. In simpler terms the moving average needs to catch up to the price, it is over bought. These equities often move to highs above the moving average line, and then come back closer with a correction.

This stock will come up on stock screens as a recommended buy. This is why I have seen it so many times.  This is because software to pick stocks will see price momentum as positive, and the fact that it it is trading above moving average. However, many stock trading software (not all) have a hard time recognizing a patterns like a human.

Stock chart in relation to the moving average it moved too far from the moving average then flattens out

Now people can argue, Bollinger bands etc would tell you this anyway. But like I said at the start, I know simple moving averages work. I try not to get to complicated with every type of technical indicator or exotic pattern . This is because the marginal benefit of using complicated investment tools or examining the granularity of a pattern is small. Time, could be better used studying something else.

My conclusion is if you want to make money in stocks by trading stocks on technical patterns, it is best to avoid this pattern.

4 Replies to “Stock chart – not to trade”

  1. What it appears you are describing here could be simply a rebound of long term forming wedge. Linear regression of both long term high and lows defines statistical price channels. Its when the two line close in but not necessarily intersect is where price resistance forms. The trend that is formed by the channel begins to show low probability of continuing. A correction forms redefining the future direction of price. Long term averages play into this price regression simply regulating the value of the equity. In either direction, stocks, funds, ETF define a future discount. Overbought and over sold conditions are brought back into perspective purely by statistical probabilities.

    1. Mark Biernat says:

      A rose by any other name would smell as sweet – Shakespeare. You could call it that, but no matter how you see it or label it, I still would not trade it. Thanks for the input Greg and I look forward to seeing your write a little more on this as I know you were pretty successful big day trader.

  2. Oscar Wilson says:

    Mark,

    If you own a stock that the differance between the stock price and the moving average is alot, would this be a sell signal? If so, do you have a rule of thumb percentage that you use?

    Oscar

    1. Mark Biernat says:

      I keep this stock if I am playing the long term. I wait until it break the moving average. However, if I have made a nice profit already, I sell it. If you are unsure, you can sell part of it. I do not yet have a rule of thumb but looking at charts for years I can generally estimate if something is over price and driven up too high. If the angle looks like too big of a slope I ussually sell if I made a good profit. On the other hand in relation to past fluctions if it is like 10% or 15% higher I keep it. I have many stocks I sit on for years. If your obective is to trade for money, I would look if the graph looks like a snake – up and flat, if so I do not like the patten. If it is grandual, this can be OK for the long term, but lock in profits if you are going for the short term.

      I have not been trading much lately as I am working on finishing my software programs. I am forgoing income and trading to live frugal and develop this product. I need to finish soon. 🙂

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