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Trading Chart Patterns Prematurely 7/18/2016 8.45am

Trading Chart Patterns Prematurely

Historical Chart Posts of CTSH

I am a believer in trading patterns or any setups after they are fully confirmed in its development and clearly given entry signals. But some times, I get into the trap of Confirmation Bias (with a hint of Over-confidence), I tend to ignore one or the other factor and enter into trades little pre-maturely. Here is such a case of Cognizant Tech Solutions (CTSH) stock's ABC Bullish and Inverse Head and Shoulders Patterns trades, clearly demonstrating my pre-mature entry and its results.

During the first week of May 2016, I spotted CTSH stock was building a nice ABC Bullish setup with a 58% C retracement (into AB) and had good tones of becoming a great ABC Bullish Pattern to trade. On 5/6/16, CTSH rallied over $4 on earnings to trade above EL ($58.14). This triggered a ABC Bullish trade (long). The CTSH chart also had another important pattern Inv. Head and Shoulders development with Neckline at $63.19. Well, a Strong ABC Bullish + Inv. Head Shoulders pattern with underlying strong uptrend gives a sense that it is about to move up and reach at least ABC first Target Zone ($63-65) and potential second target zone ($71-75). The initial Stop is placed at $56 (below C).

Here comes the over-confidence based on Confirmation Bias

While I am already in ABC Bullish trade, I realized price may be breaking out above Neckline in Inv. Head and Shoulders pattern ($63.19). The following 8 days after my entry (5/6) into CTSH & my ABC Pattern did show the strong uptrend as the price reached near the first ABC target zone ($63-65) as expected. I usually exit part of my position at 1st Target zone. But looking at the underlying Inv. HS pattern and my ABC Bullish trade, I thought I should build up a larger position for impending Inv. HS pattern breakout (pre-maturely). This is a Confirmation-Bias (kinda overconfident built from my already profit based ABC Bullish position). So, I added more (long) to my position before Inv. HS Neckline breakout. Now I have a larger trade built, kinda correctly first and then added based on over-confidence.

Trading Inv. HS Logic (on 5/23)

If I were to only trade Inv. HS pattern (without ABC) on 5/23 or thereafter this is what I would have done. CTSH already showed a clear up-trend and confirming a strong Inv HS pattern (SF score: 0.68). I would wait for a close above Neckline (63.19) and place a long trade above the high of the bar closed above Neckline with a stop-loss at $59.5 and targets $70-72 and $78-82. Pretty good RR (2:1 to 5:1) and have great odds as Market Context was solid with eSIX and SuperBars all strong. Well, CTSH never really closed above Neckline as it only reached a high of $63.15.

Reality

Well, as soon as I built a larger position (5/23) instead of taking profits at the first target zone, CTSH started a down-trend. Usually, I am cautiously confident for this type of lower-drift as I know from my experience it is healthy. Next 2-3 weeks CTSH drifted lower as I kept my cool. My ultimate Stop was below $56 (original ABC Stop). Midway through I did realize my error and knew I entered InvHS without confirmationand brought my profitable ABC trade to loss (due to adding). But now instead of closing trade, I am waiting for either to hit my stop or reverse and trade up as I intended.

During the week of 6/16-6/23, suddenly markets started moving higher on the hopes of BREXIT may not happen (false polls). CTSH moved higher to build my hope that now it will break out of Neckline ($63.19). On 6/24 BREXIT happened, pretty much making a mockery of every pundit and polls and markets fell big. CTSH opened roughly $2.50 lower and closed $4 lower. Following trading day (Monday, 6/27), CTSH fell even lower and hit my Stop $56. I was out of the trade with the loss. A good lesson to wait for confirmations.

Conclusion

I do love trading InvHS patterns with strong ABC trades like CTSH. These are my bread & butter setups. I am always confident with trading patterns which support my belief with the market context. But I also know Patterns do FAIL and FORM and RE-FAIL and RE-FORM. As a trader, we have to follow a trading methodology and keep up the rules. The sliver of brightness in this trade is I did keep my rule and exited at my pre-determined stop loss of $56. Entries were: $59.5, $62.8. Going forward, I will be careful with confirmation bias and keep a cautious tone on premature entries.

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