William O’Neill’s book, How to Make Money in Stocks is an invaluable tool for any investor. The seminal book, which is based on a major study of some of the greatest stock market winners over more than a century has sold more than two million copies.
One of the critical chart formations that he discusses in the book is the “high tight flag”. In the rare bullish pattern, a stock that is generally benefiting from excellent fundamentals surges by double in as little as four to eight weeks. The stock will then consolidate with a minimal correction or trading range before extending its run explosively higher again.
The base can be considered somewhat counterintuitive because an investor’s tendency is to buy low and sell high. But in a high tight flag, a stock is seeing a queue of traders ready to buy high and sell even higher. It shows just a small portion of investors taking profit, while others are not interested in selling at all.
In many cases, the best flag patterns will just move straight up following the consolidation, yet a large number will experience an initial failed move as the market fakes people into a new high. These fake-outs can result in huge differentials in performance. However, they can ultimately strengthen the pattern as buyers become more determined the second time around.
As a result, it is critical for traders to keep these tactical patterns in mind when considering their overall exposure. Traders need to be always cognisant of what they can withstand and use critical thinking when making these plays. Splitting buy entries rather than going all-in, ensures that even when caught in a reversal, a trader is not fully exposed.
Having the patience and thoughtfulness to effectively exploit these tactical patterns is a key difference between those blindly following the herd and those that want to take things to the next level and approach their trading as a professional.