S P E C IAL REPORT

The Delta Report

Guide to Technical Analysis
The Delta Report
Guide to Technical Analysis
By Jeff Clark, editor, Delta Report

Technical analysis (TA) is much more of an art Here’s my point…

than a science. If you try to force it to conform to
strict rules and formulas, it will be wrong almost A lot of my trading strategy revolves around
every time. finding emotionally overbought/oversold
conditions that are ready to reverse. TA helps me
Try thinking of TA the way I do… where the identify conditions in which investors’ emotions
chart of a stock (or index) and its technical have gotten extreme, and where I can see how
indicators is an emotional picture of the stock stocks have reacted to similar conditions in the
at a specific moment in time. If I can go back in past.
that picture and find a time where the conditions
were similar, and note how the chart behaved But you can’t force TA into a strict formula. You
afterwards, it can provide strong clues about have to give it some “wiggle room.”
what to expect in the future.
In this guide, I aim to show you the fundamentals
But TA is emotional. It evolves. So, conditions of chart pattern analysis, and teach you
that used to provide a catalyst for a big move or everything you need to know about my approach
reversal may need to get more extreme to cause to TA. I’ll also show you that, while TA can be a
a similar movement the next time. valuable predictive tool, it isn’t foolproof or 100%
accurate every single time. It’s a tool that should
Think about it this way… support the trade idea, but not be the trade idea.

When I first got married, I’d often come home With all that said, let’s get started...
from work, take off my socks, and drop them on
the floor next to the couch in the living room.
My wife would come home, see my socks on
the floor, and get all ticked off about it. This
happened over and over again.

Eventually, though, my wife got a little better

about dealing with her slob of a husband, and I
got a little better about not leaving my socks next
to the couch. Leaving my socks on the floor no
longer elicited the same reaction from my wife.

She still had the same emotions. But she had

adapted. She had evolved. She would need a
bigger catalyst before getting upset with me –
like when she found a dozen pairs of dirty socks
tucked underneath the sofa.

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ANATOMY OF A CHART PATTERN Timeframe
Before you can start identifying chart patterns,
A timeframe is a period in which a trend is
there are important aspects of a pattern to know
identified. For our purposes, trends manifest
and consider...
over several different timeframes – hours, days,
weeks, and months.
Trend
We often refer to the short term, intermediate
A trend is the general direction of the price of a
term, and long term when talking about
security, asset, or index.
timeframes. We define the short term as one
Upward trends form as prices make consistently day to two weeks, the intermediate term as two
higher highs and higher lows. Downward trends weeks to three months, and the long term as
form as prices make lower highs and lower lows. anything longer than that. In the Delta Report, we
And sideways trends form as the highs and lows rarely issue long-term option trades.
of a price stay generally the same.
Support
Trendline
A trendline formed below the price of a security
A trendline is a line drawn over a series of highs which the price stays above. This typically marks
or lows to show the direction of a security’s price the spot where buyers step up and buy the stock.
over a given timeframe. The two trendlines that
These trendlines can rise, fall, or stay horizontal.
make up typical chart patterns are support and
resistance lines.
Resistance
Plotting support and resistance lines is one of
A trendline formed above the price of the
the first steps to identifying a chart pattern. See
security which the price stays below. This
the chart of the VanEck Vectors Gold Miners ETF
typically marks the spot where sellers prevail.
(GDX) below for an example of a sideways trend
with consistent support and resistance levels.
Like support lines, resistance lines can rise, fall,
or stay horizontal.

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Breakout

A breakout occurs when the price of a security breaks through a support or resistance line. This can
indicate either that a pattern has completed successfully or that a security has bucked a trend.

Volume

Volume is the number of shares or contracts transacted in a security in a given timeframe. A

transaction is made up of both a buy and a sell from two separate parties.

Trading volume can be used as a confirmation tool when analyzing a trend breakout. For instance, if
a stock price breaks out of a trend with high trading volume, the new trend will likely continue. If it
breaks out with lower volume, it indicates the breakout could reverse.

Price Target

A price target is where a trader predicts the price will be in the future. Traders use chart analysis and
predetermined conditions to predict where the price of a security will go.

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TECHNICAL INDICATORS
While recognizing chart patterns can help traders predict future price movements, it’s not a foolproof
method. It’s also very important to know various technical indicators and overlays that we use to
identify chart patterns, and any short-term strength or weakness in a security…

Moving Average (MA)

A trend-following indicator used in technical analysis to smooth out price action by filtering
out large spikes and drops in a security’s price. For our purposes, we’ll most often be using the
simple 50-day MA.

Exponential Moving Average (EMA)

A type of moving average that is weighted more towards recent data. Because of this, the EMA
reacts to price changes in a security more quickly than a simple MA. For our purposes, we’ll
most often be using the 9-day EMA.

Moving Average Convergence Divergence (MACD)

A momentum indicator that shows the relationship between two distinct moving averages of
a security’s price. Traditionally, the MACD is calculated by subtracting the 26-day exponential
moving average (EMA) from the 12-day EMA.

Relative Strength Index (RSI)

A momentum indicator designed by J. Welles Wilder to measure the speed and change of price
movements. The RSI ranges from 0 to 100. Traditionally, traders consider a security overbought
if the RSI is over 70 and oversold if it’s below 30. The data is generally measured over a period
of 14 trading days.

Bollinger Bands
Points on a chart plotted two standard deviations above and below an asset’s moving average
line. It is used in technical analysis to determine overbought and oversold market conditions.

The bands are also subject to market volatility – during periods of low volatility the bands
contract, while during periods of high volatility the bands widen.

McClellan Oscillator
An indicator used in technical analysis to determine the balance between stocks that are
advancing and declining. It is calculated by subtracting the 39-day exponential moving
average (EMA) of stock advances, less declines, from the 19-day EMA of stock advances, less
declines. The result is a momentum indicator that works similarly to the MACD.

Commodity Channel Index (CCI)

A momentum-based indicator that is often used to determine when an investment is reaching
oversold or overbought conditions. In general, it measures the current price level relative to an
average price level over a given period of time.

If the CCI is high, prices are far above their average. If the CCI is low, prices are far below their
average. This versatile indicator can be applied to indices, ETFs, stocks, and other securities.

Now, here are some of the most common chart patterns and how to play them…

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CHART PATTERNS blue arrows) near a strong resistance level (the
blue line) and then broke down.
Double Top/Bottom Pattern
The reverse is true, too… If a chart makes two
A double top or double bottom chart pattern
bottoms at a support level but doesn’t breach
indicates a future move beyond two repeated
them, it is likely that the next high will be higher
support or resistance levels.
than the previous peak.
For instance, if a chart has a big run up to a
Note the double bottom that UAL formed below
resistance level, falls, and then returns to the
(the red arrows). After bottoming a second time
resistance level (forming two “tops” on the
at the same support level, the stock overcame its
chart), it is likely to head much lower.
previous peak.
See the chart of United Airlines (UAL) below. The
chart found two similar peaks (marked by the

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 Finally, the price of the security will make
another high from the bottom formed by the
HOW TO TRADE THE DOUBLE TOP/
second trough – the second shoulder. This high
BOTTOM PATTERN:
will be lower than the previous high set by the
Traders using a double top pattern should “head” and closer to the initial shoulder. (See the
look to enter short trades after a chart of the U.S. dollar below for an example.)
security’s price has started to decline
from its previous resistance level. It is at this point – if the pattern plays out
successfully – that the price will break down
For the double bottom pattern, look to enter from any bullish uptrend and decline to lows last
long trades once the price reverses from seen before the initial shoulder.
a similar support level a second time.

HOW TO TRADE THE HEAD AND

Head and Shoulders Pattern
SHOULDERS PATTERN:
The head and shoulders pattern is used to predict a Aggressive traders following this pattern
trend reversal from bullish to bearish. It’s considered should look to enter short trades once
one of the most reliable reversal patterns. the level set by the first “shoulder” is
reached and reverses.
This pattern is formed when the price of a
security in a bullish trend forms a peak and then Conservative traders following this
dips down to form a trough below it. This forms pattern should look to enter short trades
the first “shoulder.” after the price breaches the neckline.

After finding the bottom of the trough, the price If the price can’t break the neckline,
rises again to form a second high, higher than it’s called a failed head and shoulders
the first. Again, the price declines to a similar reversal… If that happens, the stock
level as the previous trough. This larger peak typically rises.
is what’s called the “head” of the pattern. And
connecting the two troughs forms the “neckline”
of the pattern.

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Inverse Head and Shoulders Pattern

Charts can also form an inverse head and shoulders pattern. This pattern is used to predict a
downtrend reversal. The pattern is, as the name implies, the inverse of the typical head and shoulders
pattern.

The pattern starts when the price of a security falls to form a trough (the first shoulder) and recovers.
Then, it falls again to form a lower trough and recovers to the previous high set after the first trough,
forming the head.

Finally, after the price falls again to form a third trough – but not as low as the previous one (the
second shoulder) – the pattern resolves in a breakout to the upside.

See the chart of Seattle Genetics (SGEN) below for an example.

HOW TO TRADE THE INVERSE HEAD AND SHOULDERS PATTERN:

Once identified, traders should look to enter long trades once the second shoulder clearly
forms – meaning when the price reverses from a higher low than the previous trough (the head).

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Wedge Pattern

A wedge pattern is a contrary indicator, predicting a reversal move as the trading range of a security
tightens as it rises or falls. The two variants, a rising wedge and a falling wedge, work similarly.

In a rising wedge pattern, the price of a stock or security is in an uptrend and makes a series of gradually
higher highs and higher lows. If the trading range within the uptrend begins to contract, the trend is likely
to break down at the corner of the wedge, below the major support level.

See the chart of Hertz (HTZ) below for an example of a rising wedge pattern resolving to the downside.

The same is true of falling wedge patterns, in which the price of a security in a downtrend will break
out from the pattern once the series of gradually lower lows and lower highs contracts tightly. Once
the price of a downtrending security breaks above the falling resistance line, the pattern resolves to
the upside.

See the chart of General Motors (GM) below for an example of a falling wedge pattern resolving to the
upside.

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 HOW TO TRADE THE WEDGE PATTERN:
Traders following the rising wedge pattern should look to enter short trades once the price of a
security breaks below the rising support line.

Likewise, falling wedge patterns should be exploited on the long side by doing the opposite –
entering a long position when the price breaks above the falling resistance line.

Flag and Pole Pattern Flag patterns usually resolve to the opposite
direction of where the flag was trending. This
A flag pattern is a continuation pattern that occurs once the price of a security breaks
forms as the price of an asset or security begins through resistance or support, depending on the
to trend downward after a sharp rise upward, or previously established trend.
vice versa.

The “flag” of the pattern is formed by two parallel HOW TO TRADE THE FLAG AND
lines acting as the resistance and support for the POLE PATTERN:
trend as it bucks the initial trend, or the “pole.”
Traders following this pattern should look
See the chart of GameStop (GME) below for an to enter positions when the price breaks
example of how the “poles” formed by sharp the flag formation in the direction the
spikes in price usually resolve to the downside. price was moving before the flag formed.

Triangle Patterns

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A triangle pattern is one of the simplest types of chart patterns to spot and follow.

This type of pattern occurs when a stock price consolidates – meaning the lows and highs in the
stock price trend closer together and volatility tightens. This manifests as two trendlines that
converge at an apex.

This apex marks the end of a triangle pattern. At that point, the pattern will either complete
successfully and the movement predicted by the pattern will manifest, or the pattern will fail and a
new trend will be established. (Note: Traders should not enter trades using a triangle pattern until it
resolves in a breakout to either side.)

There are several variants of triangular chart patterns, all of which predict different future price
action:

a) Symmetrical Triangle

A symmetrical triangle pattern marks a period of consolidation in a trend after a prior large move
in either direction. As the price of a stock chops around back and forth between lower highs and
higher lows, two converging trendlines – a descending resistance line and an ascending support
line – form, leading to an apex point and completing the triangle.

See the chart of W.W. Grainger (GWW) below for an example of a symmetrical triangle reaching
its apex and resolving to the upside.

Once the chart reaches the apex point, the price typically breaks out in the same direction as

the initial large move. To determine future price action, look for a break above the descending
resistance line if the pattern is playing out after a large run up. If the pattern formed in response to
a large move to the downside, look for the stock price to break below the ascending support line for
another downside move.

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However, if the trend reverses at the apex point and breaks in the opposite direction of the previous
move, it is likely that the trend has reversed.

HOW TO TRADE THE SYMMETRICAL TRIANGLE PATTERN:

Traders following this pattern should look to enter positions in the same direction as the
initial move that preceded the price consolidation.

b) Ascending Triangle

An ascending triangle pattern marks a potential bullish breakout upon completion. It is also
often preceded by an upward trend, making it a continuation pattern (like the flag pattern we
discussed earlier).

The pattern is formed by two trendlines: an ascending support line formed by higher lows, and
a flat resistance line formed by repeated tests of a high point in the price. At the apex of this
trend, the price of a security is likely to break to the upside.

See the chart of the VanEck Vectors Semiconductor ETF (SMH) below for an example of an
ascending triangle pattern reaching its apex and resolving to the upside.

The key aspect to watch in this pattern is the rising support line. It indicates declining selling
interest. If the price breaks below this support line, the pattern fails and a new trend is formed.

HOW TO TRADE THE ASCENDING TRIANGLE PATTERN:

Traders following this pattern should look to enter long trades once the price of the
security breaks the sideways resistance line.

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c) Descending Triangle downside. This is the opposite of the
ascending triangle, in which a break from
A descending triangle pattern represents the pattern to the upside occurs when the
the opposite of the ascending triangle pattern culminates at the apex formed at
pattern – a successful completion of the the sideways resistance line.
pattern results in a break to the downside.

The pattern is formed by two trendlines: HOW TO TRADE THE DESCENDING

a declining resistance line of lower highs,
and a steady support level of repeated TRIANGLE PATTERN:
lows. Traders following this pattern should look
to enter short positions once a break
See the chart of the iPath Bloomberg to the downside of this pattern has
Coffee Subindex Total Return ETN (JO) occurred.
below for an example of a descending
triangle pattern reaching its apex and
resolving to the downside.

The descending triangle culminates at the

apex near the sideways support line (the
resistance line in the ascending triangle)
and typically resolves in a break to the

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Cup and Handle Pattern

A cup and handle pattern occurs when a security rebounds from a low period over an intermediate-
to long-term timeframe to retest old highs. This action forms a rounded bottom in the stock’s
trajectory – the “cup.”

After reaching those previous highs, traders who held the stock since then would be looking to exit
their positions, as they’re now profiting on the trade. This selling pressure then forms a new trend
from the recent test of the previous high. This channel is the “handle” of the pattern.

If the pattern completes successfully, the price should break above the trend established by the
“handle” and go on to reach new highs.

See the chart of the VanEck Vectors Coal ETF (KOL) below for an example of a sideways-trending
handle forming after a cup.

HOW TO TRADE THE CUP AND HANDLE PATTERN:

Traders following this pattern should look to enter long positions once the trend
established by the “handle” breaks to the upside.

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Rectangle Pattern

A rectangle pattern is a continuation pattern which marks a pause in the trend for a security’s
price. The pattern is formed by a series of at least two consistent highs and lows. These highs
and lows make up the connecting point for two parallel lines that form the top and bottom of the
rectangle.

This pattern completes once the security price breaks below the top or bottom of these two
parallel lines. Thus, the rectangle is similar to the symmetrical triangle, but not as predictive. This
is because a series of higher lows and consistent highs is not established.

See the chart of Chevron (CVX) below for an example.

HOW TO TRADE THE RECTANGLE PATTERN:

Traders following this pattern could look to enter trades once either the support or
resistance line has been breached. But as we mentioned, the rectangle pattern isn’t a very
good predictive pattern. So it shouldn’t be relied upon like the other patterns listed here.
Instead, the rectangle pattern can help pin down other potential patterns or trends.

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Crosses

While not technically a pattern, a cross can be an important catalyst to watch when looking to
enter new trades in either direction.

A cross occurs when the various moving average lines of a security – like the moving average (MA),
exponential moving average (EMA), or Bollinger Bands – cross one another.

This can result in a number of buy or sell signals, depending on the lines involved and the
direction.

One example of a bullish cross is when the 9-day EMA crosses above the 50-day MA. This
indicates that the most recent, ultra-short-term price action has been favorable when compared
to longer-term price action. This means that momentum has shifted in the opposite direction, and
typically results in a broken trend.

See the chart of the United States Oil Fund (USO) below for an example of the 9-day EMA crossing
above the 50-day MA, and the effect it has.

HOW TO TRADE A CROSS:

Traders watching for crosses should look to establish long positions as the 9-day EMA
crosses above the 50-day MA.

And on the downside, look to establish short positions when the 9-day EMA crosses
below the 50-day MA.

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Sledgehammer Pattern
HOW TO TRADE THE
Another important trend to watch out for SLEDGEHAMMER PATTERN:
is the “sledgehammer.” Like the cross, the
sledgehammer isn’t technically a pattern like Traders following this pattern should
most of the others on this list. But it is still a look to enter long positions on that
valuable TA tool. second crushing – the reason being that
when sledgehammer patterns play out,
The sledgehammer is a bullish reversal pattern. the momentum indicators are usually
It plays out when a stock get crushed, bounces stretched so far to the downside that a
a little, and then gets crushed again. reversal move is highly likely.

See the chart of Target (TGT) below for an

example of where to buy in when observing a
sledgehammer pattern.

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 IN SUMMARY
So, there you have it – a quick and easy illustration of some of the most frequently used chart
patterns, and how to use them.

I suggest keeping this guide handy – maybe print it out and keep it near your desk. And refer to it
whenever I issue a trade recommendation in the Delta Report. It’ll keep you in tune with how I use TA.
Then, once you’re more comfortable, you can start searching for these patterns in your own trading.

There are other patterns, for sure. But the patterns I’ve explained here are the ones I look for most.
They tend to be reliable at forecasting future price movements. And they’ve helped to identify
many successful trade setups for me over the years.

I expect they’ll continue to do so.

Best regards and good trading,

Jeff Clark

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