Daryl Guppy is founder and Director of Guppytraders.com. He is a full-time active private position trader, trading equities and associated derivatives markets. He is an appointed foundation member of the Australian Government Shareholders and Investors Advisory Council.
He is the developer of the Guppy Multiple Moving Average Indicator included in EzyChart. He delivers accredited courses for the Singapore Stock Exchange. He also runs public trading workshops, and equity and futures brokerage sponsored seminars, throughout Australia and Asia.
STIRRUP PATTERN TRADING
We first observed and analysed this trading pattern in late 2003/04 and again in 2012/13. In recent weeks it has reappeared and it develops in the same way. There is one important difference in the 2018 iteration. The long-term measurement of the stirrup pattern is no longer quite as reliable. In 2003/2004 it was around 65% reliable. In 2012/13 we found the pattern did not go on to fully develop so traders need to manage the breakout with an ATR or CBL volatility-based stop loss. However, the stirrup pattern remains a reliable indicator of a substantial and sustained breakout.
This pattern is reappearing in the market so we revisit the trading methods. One of the challenges in fast-moving momentum stocks is to decide how to handle the inevitable pullbacks. Traders who hold open positions in the stock use these pullbacks, or price retreats to take profits. Typically, they apply some variation of a trailing stop loss technique to achieve this. Many other traders watch these rising stocks with dismay, regretting they had not purchased them earlier. When prices do start to collapse, these traders are alert for an opportunity to buy the retreat in anticipation of a rebound.
Rebound trade opportunities include finger trades where prices drop rapidly, then recover quickly and reach a high equal to the previous high. These are very short-term opportunities. Some traders use a Fibonacci approach, buying retracements at particular percentage values. Their objective is to ride a resumption of the trend, but they have no firm idea of how far the new trend might go. We are interested in a pattern which achieves several things in these trading opportunities.
We use the stirrup chart pattern for this. This is a three-part pattern, and unless all the pieces come together, the probability of success is lowered. Not all retreat and rebounds conform to this pattern, but when they do, we can trade with an increased level of confidence. We call them a stirrup pattern because like a stirrup on a saddle, they hang in mid-air and help boost the rider into a higher seat.
This is the broad environment where we look for a stirrup pattern rebound. It starts when a stock has been moving steadily upwards or has perhaps developed a recent burst of good price activity. This is followed by a retreat, or pullback in prices. The retreat is strong enough to trigger an exit for traders who already hold the stock. There is no doubt that a new downtrend has developed. The retreat is often much greater than 50% of the previous major price move, so Fibonacci approaches are not always a useful guide to rebound points. This is not a consolidation pattern where prices move sideways.
What attracts our attention is the possibility that prices may rebound from the downtrend and re-establish a new uptrend. The recent up move in prices has the potential to be the start of a new uptrend and if we enter early we can benefit greatly. Traders look for pattern developments that increase the probability the rebound is genuine.
The stirrup pattern starts with an upward sloping triangle that develops at the bottom of the price retreat. It is not uncommon to see the top of the triangle set at a well-defined support and resistance level. In some cases, the top of this triangle is an extension of the bottom of a failed down sloping triangle. The key feature is a clear resistance level established over 3 to 10 days. The sloping edge of the triangle starts from the lowest point in the pattern.
The base of this up sloping triangle - the stirrup - does not have to show continuous price action in a single direction. This is a requirement when we use triangle targets. We are not using the stirrup for this, so we are more interested in the broad bullish message delivered by this type of triangle development. The upward sloping trend line starts from the lowest low in the price following the original high.
Once the stirrup pattern is confirmed we project two lines. The bottom line is placed on the lowest point of the price retreat, and the point which forms the start of the upwards sloping triangle. For clarity in the diagram we have projected this as a blue line to the left.
The second line is projected from the top of the previous price rise. Again, for clarity, we show this to the left as a blue line. These two lines define the upper and lower limits of recent price activity. They match the retreat and rebound extremes and the red arrow measures this distance in cents. This measurement provides the mechanism for setting the stirrup pattern price target.
This is where the stirrup pattern is different from an upwards sloping triangle pattern. In this case the triangle is used as a confirmation that a broader pattern is in place. It acts as a trigger, telling the trader that a stirrup pattern trade is available.
Once the stirrup pattern is confirmed, the target measurement is projected upwards from the top of the previous high. This makes this style of trade different from a rebound, or finger trade where the target matches the previous high. The stirrup trade sets a much higher target which is generally achieved in a steady continuation of the trend. Where the retreat has been characterised by a very strong bearish chart pattern, the upside target is reduced by 1 or 2 ticks as there is an increased probability of prices not quite reaching the target, or completing only a few trades at this level.
It is not useful to use the classic measurement of the base of the upwards sloping triangle as a target trade in this situation. As shown by the purples lines, this usually sets very low targets. The upwards sloping triangle is important in this chart pattern as an initiating trigger for a much larger pattern trade.
Aggressive traders may act in anticipation of the upwards sloping triangle being completed, but we prefer to wait until there is a close above this level. Returns from this style of trading range between 20% and 35% with around 65% reliability.
Once the target has been achieved there is no guarantee of a continuation of the trend. In some cases prices collapse quickly from these target levels, and this retreat may offer another stirrup trade set up.
The stirrup trade with Singapore listed Nera Telecom illustrates this type of trade. It starts with the price retreat from $0.385 to $0.335. The uptrend has halted, but we do not know if this retreat is temporary, or part of a longer-term downtrend. Prices begin to rebound from $0.335. The upward sloping triangle - the stirrup in this context - is quickly confirmed by the way prices hit the resistance level at $0.355. There is no rush in identifying this pattern as there are no sound advantages in entering the pattern early. We can try to anticipate the development of the pattern and use the base of the trend line as a stop loss point. However, if prices collapse below this up trend line at the bottom of the triangle they can fall very rapidly. It is safer to wait until the high probability trade pattern is confirmed.
After six days of persistent rises to the resistance level, Nera Telecom finally breaks above. This is also in the last third of the triangle pattern. This confirms the stirrup, and we plot the measurement lines from the low at $0.335 and the high at $0.385. These are then projected upwards to set a target at $0.435. A trade entry at $0.335 is available on each of the following two days.
Nera Telecom is a very fast-moving stirrup rebound. It takes six days to reach the stirrup target price. This fast-moving trend lifts prices above the target level, but it also collapses quickly. Traders have six days where it is possible to exit at their target price. This trade returns around 24%.
The stirrup pattern is based on a relatively small and unimportant upwards sloping triangle. What makes it significant is where it occurs in the context of a retreat and rebound environment. The stirrup pattern gives the trader a leg-up into a higher probability trend continuation. This is a useful pattern that provides reliable signals in a situation where many other techniques are less useful. The stirrup pattern signals a resumption of the pre-existing trend. It is a continuation pattern, but it has the advantage of setting target highs. This makes it useful in establishing the risk and reward relationship in the proposed trade. The trade has around 65% reliability, with typical returns between 20% and 30%.
Once the target has been achieved there is no guarantee of a continuation of the trend. In some cases, prices collapse quickly from these target levels, and this retreat may offer another stirrup trade set up.
First Published: 25 June 2018 - Copyright © Daryl Guppy
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