Lessons from Crude Oil Intraday Head and Shoulders Roller Coaster

Jan 4, 2011: 4:05 PM CST

Wow – you don’t see these sort of “Mirror Image” patterns that often, but they are stellar when they set-up and complete.

Let’s learn some quick lessons you can apply to the future from the recent intraday 30-min Head and Shoulders price pattern reversal – with perfect divergences – and the trade that accompanied the support breakdown.

First, the chart:

Ok – first things first.   This is the Crude Oil futures (CL) contract on the 30-min frame with pure price (pattern) and 3/10 MACD Oscillator.

Price ended 2010 on a surge up from $89 to $92, and then began 2011 with a subsequent (and expected) new price high (according to the “momentum precedes price” principle).

The second componet of that principle is that DIVERGENCES precede retracements, and multi-swing divergences – as we see above – often precede reversals.

Pay close attention to the 3/10 momentum oscillator to note the series of LOWER oscillator highs that corresponded each time with HIGHER price highs – a classic deterioration of momentum ahead of a reversal.

The big clue was the “Kick-off” – or new momentum low (when price was NOT making a corresponding new low) I highlighted at the end of January 3rd – which also forecast odds favored a reversal.

Beyond the Momentum Principle and divergences, we had a classic, textbook Head and Shoulders pattern I labeled as well.  I won’t go into detail on that – the picture should say it all.

Now – how do you trade this when the price trend deteriorates and a Head and Shoulders is forming?

Momentum divergences DO NOT always precede reversals, so it’s often best to WAIT for price to confirm the structural deterioration via an official price breakdown of support.

In this case, that breakdown conveniently happened when price sliced under the rising neckline (trendline) support at the $91.50 level this morning.

Traders look to enter short on such breakdowns and place stops at one of two locations:

Conservatively above the prior/immediate (right shoulder) swing high at $92.00 or

Aggressively above the head swing high (absolute high) at $92.50.

Ok – all’s well – so what target do we play for?

The pure Price Pattern Projection Target from the Head and Shoulders (classic) targets an equal measure down from the head to the neckline – or in simpler terms – the swing high at the head ($92.50) subtracted from the neckline trendline at $91.50.  That’s about $1.00 – not very much.

Price nailed that without stopping.

What then becomes logical Target #2?

Easy – it’s the prior swing low and support level from prior sessions at the $89 level.

Notice now that we also call the entire move a “Mirror Image Fold-back” because the right side of the pattern – if you divided it with a vertical line in the middle – looks almost exactly like the left side.  Mirror Image Foldbacks similarly target a swing down to where the pattern began – $89.

Price actually slipped under this target but then reversed violently a full dollar – leaving traders who exited their short-sales at $89 safe (and those who held on greedily in trouble).

So, the lessons from this example include:

Multi-Swing Negative Momentum Divergences
Intraday Head and Shoulders Pattern (with rising neckline)
“Mirror Image Foldback” Pattern (an advanced concept)
Two Levels to Place Stops
Two Types of Price Targeting

The more we learn from the recent past, the more we’ll be able to apply it when these concepts appear again – on any market and any timeframe – in the future.

Corey Rosenbloom, CMT
Afraid to Trade.com

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3 Responses to “Lessons from Crude Oil Intraday Head and Shoulders Roller Coaster”

  1. Caroline Says:

    Good post.
    Why don't you place the stop just above the neckline? price coming back there would cancel the whole pattern so it seems a good stop price to me.
    Also, when it's the moment to sell short? in the candle that breaks the neckline, or in the next one (pullback)? since we don't always get that pullback.
    Thank you.

  2. TraderAndyM Says:

    Ill take a $1 any day on the crude thats a $1000 on 1 contract

  3. Ps Says:

    Classic after the fact analysis.