Chart patterns are one strategy traders can use when trading exchange-traded funds (ETFs) (or other tradeables). There are a number of chart patterns, grouped in two categories: continuation and reversal. Regardless of the pattern being traded, chart pattern traders watch for prices to move outside the pattern (a breakout). The breakout signifies a likely further move in that direction. While not an exact determinant of how far the price will travel following a breakout, by adding the height of the pattern to the breakout point for an upside breakout (or subtracting the height of the pattern for a downside breakout) an approximate profit target is attained. Here are four ETFs breaking out of chart patterns right now.
SPDR S&P Oil & Gas Exploration and Production ETF (XOP) completed a double bottom chart pattern in February, but since then the price has drifted lower and is currently near the original breakout point. This provides a "second chance" buying opportunity. The original breakout point was $50, so buy on a rally above that. Traditionally a stop loss is placed below the double bottom low of $41.63. An alternative is to place the stop loss below a more recent swing low in order to reduce risk (near $46 for example). The height of the pattern is $8.37. Added to the breakout point, the potential upside target is $58.37. (For more, see: The Anatomy of Trading Breakouts.)
iShares MSCI Australia (EWA) broke above a lopsided inverse head and shoulders pattern on March 20. The price is still in the breakout/buy zone near $23.65. The stop loss is placed below the recent swing low of $22.40. The stop loss can also be placed below the low of the entire pattern, $21.30, although taking on this much risk isn't usually warranted. The left side of the pattern is much larger than the right side. The height of the left side is $4.40, giving a price target of $28.05 (when added to breakout price). The right side of the pattern is $2.63 in height, giving a price target of $26.28. Opting to use the more conservative target is often the better play, since it is more likely to be reached than a distant target. (For more, see: How to Trade the Head and Shoulders Pattern.)
iShares Core MSCI EAFE (IEFA) has already provided two chances to get in at the breakout price of a double bottom. The initial breakout occurred in February, with a second chance buying opportunity in March. With the price rallying again, it is uncertain whether another buying opportunity will arise at the entry price of $58.54. If it does, the stop loss can go below $56.87, the March swing low. The height of the pattern is $5.30; added to the breakout price it provides a price target of $63.84. (For more, see: Trading Double Tops and Double Bottoms.)
There is a clearly defined head and shoulders pattern in the Direxion Daily Emerging Markets Bear 3X ETF (EDZ). A breakout occurs if the price drops below $31.65, the low of the pattern (support). A stop loss can be placed above $39.28 — the high of the "right shoulder." The pattern is $14.59 in height. Subtracted from the breakout price, the price target is $17.06. Such large moves are possible because this is a leveraged ETF. Trade cautiously in leveraged ETFs; large price moves are the norm, and can cause significant financial loss (or gain) in short periods of time. (For more, see: Leveraged S&P ETFs: Beware of Volatility.)
The Bottom Line
Chart patterns are a visual way to trade. By connecting prior swing highs and lows, geometric shapes take form. When the price breaks out of one of these shapes it may present a valid trading opportunity. Enter at the breakout point, and place a stop loss above a recent high if going short, or below a recent low if going long. An approximate target is garnered by adding the height of the pattern to the breakout point (or the subtracting height in case of downside breakout). Just because the price breaks out of pattern doesn't mean it will continue in that direction. The main drawback of chart patterns is their susceptibility to false breakouts. Losing trades occur; only risk a small amount of account capital on each trade. (For more, see: What Your Trading Charts Aren't Telling You.)