Alright, we are back!

This time around we are going to finish up with the fourth of the major patterns.  We have gone through the Bullish Retracement, the Bullish Breakout, The Bearish Retracement and now last but not least the Bearish Breakdown.  The reason we focus on these four major patterns is that they are repeatable, they are easy to spot with a little study and practice and they give us an edge in our trading.  These patterns have a higher probability of success than just some random bunch of candlesticks. Once we find one of these four patterns and we evaluate the criteria that we are looking for then we can start to put together a trading plan on how best to execute one of these patterns.  Just because we have found a pattern and it meets a lot of the criteria we are looking for doesn’t mean we have an automatic winning trade.  There is one thing we must always remember about trading, even if we have what we believe is the perfect trade setup that doesn’t guarantee that it will work out the way we want it to and because of that we need to do certain things that will protect against a bad trade.  Before we get into that, let’s get through this last pattern so that we at least have a good start towards setting up a successful trade.

This week we are going to go through the Bearish Breakout, some call it a breakdown but it can be termed a breakout as well.  As we talked about in the Bearish Retracement, a bearish market behaves differently than a bull market.  We talked about how the bull market tends to go up in somewhat of an orderly fashion whereas the bear markets tend to be more volatile and tend to drop quicker and retrace quicker as well.  This can work well for the Bearish Breakout pattern in a bearish market.  Let me explain what I mean.  In a bullish market, if we have a bullish breakout it tends to break out in an orderly fashion then we might get a structured proportional move to the upside but when the markets are breaking down as in a bear market, then sometimes the down move can be very aggressive and if we are positioned properly to take advantage of those drops then there can be some profit potential there.  The key to bear markets is to be ready to take profits according to your trading plan and be willing to move stops if one is actively watching the markets.

This brings us to the Bearish Breakout.  We require certain criteria to ensure that this is a higher probability trade.  This criterion is not much different than the Bullish  Breakout other than that we are going in the opposite direction.   Like the Bearish Retracement, we need a downtrend as defined by the name.  A downtrend is defined as a series of lower highs and lower lows.  After we get our downtrend, we are looking for the pattern to continue and therefore we are looking for a sub-pattern like one of the ones below.  These patterns give us a few of the other criteria that we are looking for.  For instance, we need consistent selling pressure, that means that on each retracement we see that when it turns back down that the selling is either increasing or at least staying steady, more aggressive selling is better.  We also need to know that once we break support that we have a ways to go before the next support level.  That means we are not running into a round number immediately after it breaks support or running into another known support/resistance level.  We don’t want to waste too much time watching a pattern like this if it isn’t close to breaking down so we want to be close to the support level, within one day’s average movement is ideal.  Once we have the above items in place then we need to look at the volume.  We ideally want to see the volume waning a bit as that indicates that the traders are waiting for the break to happen or to confirm the breakdown.  Once the breakdown occurs we should see volume pick up and the price movement to the downside increase.  That is our breakdown and our profit zone.  We can short stock on these types of patterns or we can use options to play the downside.  The images below are examples of continuation patterns that we are looking for.  There are more patterns but these are some of the more popular ones.

Below is an example of a Bearish Breakout candidate. Take note of the increased selling pressure and the strong support level.  It is the repeated bashing of this support level that ultimately gives us the breakdown we are looking for.  Each time support is tested and not broken then it can be thought of that more energy is being called on so that eventually it will break down and when it does, typically it moves quite a bit giving us an opportunity to make a nice profit.

That is the bearish breakdown trade.  Now that we have found a suitable candidate, we need to make some decisions about how are going to enter a trade.  We need to get confirmation that the pattern is playing out as we expect and we need to decide what the most appropriate tradeable instrument is for this particular entry.  We need to also define our entry point, our expectation for our profit target and most importantly when will we get out.  The real professional traders concentrate more on the exit than the entry.  We will go through all the items necessary to put a trading plan together so that we can take the emotion out of our trading so that it doesn’t interfere with quality decision making and also helps with automation of our trades.  Until next week try to find some examples of these major patterns and watch how they play out so you can get a feel for what we will be doing when we find these great setups!