Pattern Analysis: Using Triangles to Spot Trends in Low-Priced Stocks
In my last column [May 1996] I discussed the potentials that arise from opportunities in investing in past “losers,” primarily low-priced and depressed stocks. I outlined the theories as to why low-priced and depressed stocks could turn into winners, reviewed the studies that support the theory, and commented on some sources for finding these stocks.
However, there is obviously a high risk premium in these stocks, as they are all low-priced and depressed for a purpose. Common sense tells us that if these stocks do indeed provide the better returns, it is reflected in the returns that flow to higher risk takers.
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In addition, simply being on a list of low-priced stocks is no guarantee of success. For the unwary, buying into low-priced and depressed stocks is like trying to catch a falling knife.
Separating the wheat from the chaff is where technical analysis comes into play. Pattern analysis is a branch of technical analysis, and can be very helpful in judging trends and spotlighting both buying and selling opportunities. That’s because patterns are the result of the interplay between support and resistance. Patterns essentially represent the ebb and flow between buyers and sellers, and the implications of the eventual breakouts from patterns can be exceedingly important.
In the last issue, I alluded to the use of one particular pattern, the triangle, in identifying trends in low-priced stocks—a descending triangle in the example of a stock moving lower, and an ascending triangle in the example of a stock moving higher. This article will demonstrate more fully the usefulness of triangles and pattern analysis.
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