There
is More to Hats than Style
How to use Single Bar Formations for Market Timing
Though long-term
equity market advances or declines are fueled by corporate earnings,
or the lack thereof, short-term price fluctuations
often do not have such clear cut motivations. From moment-to-moment,
day-to-day, and often week-to-week, the major indices and individual
issues alike are led captive by the seemingly whimsical demands
of human emotion. Perhaps you have noticed powerful price moves
that followed on the heels of seemingly innocuous news, good or
bad. Sell-offs often result from fear of possible negative fallout
of current bad news, which may or may not be seen for quarters
into the future.
In the stock market even the slightest uncertainty about some
distant tomorrow can easily cause price stampedes today. Because
this psychological side of the markets is quite real and vigorously
functioning, you, as a short or mid-term trader, cannot afford
to ignore it.
Because the
charts are illustrative of this psychological factor, you can
gain great
advantage by searching for and heeding the subtle
signals that are available, if you look for them. One very simple
and useful tool in this regard is the Lincoln’s Hat formation.
This single bar configuration, and its brother the Reverse Lincoln’s
Hat, are often present at or near the terminations of price trends.
The Lincoln’s
Hat is seen when the opening and closing flags are near one another
and found within the lower 1/3 of the overall
length of the bar. On the chart below, I have identified a Lincoln’s
Hat for you. Similar in rough appearance to Abraham Lincoln’s
famous stove pipe hat, the body of this price bar extends well
above the opening and closing flags.
Following
a strong upsurge in price that lasted about 4 weeks, a Lincoln’s Hat bar signaled the end of the trend. Often,
the bar immediately following the Lincoln’s Hat will show
a down close. On a Lincoln’s Hat day or bar, after the open, strong buying
is seen.
The Bulls are
flexing their collective muscle, driving price up. This is, in
fact, a last gasp which flushes the remaining
bullish money out into the open. As the Bears sell into this
buying spree, the Bulls give in. The bar then shows a close quite
near
the level of the open with little trading below the opening price.
Take another
look at a Lincoln’s Hat as seen on the following
DP chart. This
time, the bar after the Lincoln’s Hat did not show
a down close, though the next bar in line dropped impressively.
Remember that
the Lincoln’s
Hat formation is only valid when seen after a series of up-trending
bars–the more the better.
In a down trend,
look for the Reverse Lincoln’s Hat. This
bar, as would be expected, resembles Lincoln’s stove pipe
hat placed upside down, as if on a table. After the open, a good
deal of selling takes place. Bulls then buy into this selling to
the point that the Bearish energy is used up. Prices then return
to a level near the open with little trading above it. To view
such a bar, we can use this same DP chart just two weeks after
the Lincoln’s Hat marked above.
Following
the Lincoln’s hat seen in early May, prices dropped
sharply over a two week span. As this down-trend terminated, a
Reverse Lincoln’s Hat appeared followed immediately by
an up-turn in prices. In fact, prior to the May Lincoln’s
Hat, another Reverse Lincoln’s Hat signaled the conclusion
of a prior down-trend and the start of a new up-trend. Though
these two single
bar formations are obviously not present at the end of every up
or down-trend, they do develop often enough that they are well
worth putting on your “Things to watch for” list.
How to Profit
In actual trading
situations, I have found the Lincoln’s
Hat and Reverse Lincoln’s Hat bars to be of best use to assist
in trade exit timing. As a position trader, my approach is to capture
40-50% of a trend during the time covered in a trade. If in a mature
trade, the appearance of a Lincoln’s Hat in a long position,
or Reverse Lincoln’s Hat in a short position, is sufficient
to persuade me to take profits right away.
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