When I was in grade school there was this bully named Greg that used to steal all of our lunch money every single day. After a few weeks, I started to notice that he would leave his bag that had everyone’s lunch money in the classroom while we were at recess. I had enough so I grouped together some of my friends who were also victims of this treatment and made a plan. We would fake the agony of giving up our lunch money to Greg to satisfy his lust for bullying and then one of us would go and take all the money back from his bag each day. Since there was only a few of us involved, we were actually turning a profit!
Since those days, I have always wanted to be in control of my outcomes and it has led to greater success in the stock market. Let’s say you want to lose some weight but then don’t make any changes in your diet or exercising habits. This is the same as just buying a stock and hoping it goes up. Many investors fall prey to this kind of thinking or think that when a stock is up, it will just keep going indefinitely. You need to have a plan to exit a trade. You need to be in control of the outcomes. n previous lessons, we have talked about different charting patterns like SMA and Head&Shoulders. We have discussed how these patterns can be good indications of when a breakout is about to occur. In today’s lesson, we are going to be discussing another charting pattern called the wedge and how you can calculate exactly when to take profits.
The wedge is simply a price pattern in which the trendlines above and below the pattern form an arrow. Once the price breaks out of this wedge then there is said to be a major breakout coming. If the price breaks above the top trendline then we can see a price breakout in a positive direction. If it breaks below the bottom trendline we can expect to see a price breakout in a negative direction.
A wedge shape pointing upwards is used in analyzing an upward price trend within a bearish potential breakout. A wedge pointing downwards is used to analyze a downward price trend within an overall bullish potential breakout
The wedge play is one of my favorite technical indicators to get into a stock position. If you see this kind of pattern on a chart you can put a buy stop in above the upper trend line so that you buy in if there is a price breakout. If this does not occur, then you never buy in and never risk any money. That’s the beauty of a stop. If you don’t recall what a buy stop is check out my article on order entry tools at your disposable, “Putting your Account on Autopilot.”
After we see the price breakout on one of these patterns, how far can we expect it to go? There is a specific formula to calculate the anticipated move from the wedge pattern. This formula and percentage to target price is based off of the research done by Thomas Bulkowski. Thomas was able to retire off of his investments by age 36 and is known as an expert in technical analysis. The figures and formulas are based off of thousands of successful trades.
- Compute the height from the highest peak (A) to the lowest valley (B)
In this case 32(A) minus 26.5(b) to get 5.5
- Multiply it by the “percentage for price target” which is 70%(created by Bulkowski)
- Add it to the breakout price which is the point at which price crosses the trendline (shown as a blue line) to get a price target (C).
So as you can see our target exit price with SFR would be $33.85. If you entered into this trade at the breakout price (C) and exited at the target price, then you would have made close to a 9% return on your investment (30/33.85)
Ideally, you want to see above average volume on the price breakout to confirm the success of the pattern. Remember that while these patterns enhance your probability of success, they do not GUARANTEE results. Always protect yourself against downside risk with an exit strategy incase things don’t go your way.
Homework: Screen for some head and shoulders patterns using finviz.com and see if there are an potential price breakouts coming in the future.