Hikkake pattern

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					                      TRADING Strategies




TRADING FALSE MOVES
with the hikkake pattern
Whether you call it a hikkake pattern or an inside day false breakout,
this simple chart formation reflects basic price principles.

                                               FIGURE 1 REVERSAL AND CONTINUATION

 BY DAN CHESLER, CMT, CTA                      Hikkake patterns function both as continuation patterns (A and B) and reversal
                                               patterns (C and D).
                                                                                     T-Bonds (USZ03), daily
                                                                       C                                                          112.00
                                                                                                                    D
                                                                                                                                  111.16




T
                                                                                                                                  111.00
                                                                                                                                  110.16
              he “stutter step” is a com-                                                                                         110.00
              mon tactic used by athletes                                                                                         109.16
              to bait and evade a pursu-                                                                                          109.00
              ing opponent. The hikkake                                                                                           108.16
pattern represents a type of stutter step                                                                                         108.00
found in the market — a false breakout.
                                                                                                                                  107.16
   Hikkake is a Japanese verb that means           A
                                                                                                                                  107.00
to “trap,” “trick” or “ensnare,” which is
also the effect of false moves on unsus-                        B                                                                 106.16
pecting traders. In Western terminology,                                                                                          106.00
the correct name for this pattern would                                                                                           105.16
be an “inside day false breakout.”                                                                                                105.00
                                                                                                                                  104.16
                                                                                                                                  104.00
The basic hikkake pattern consists of
                                                September                  October                    November            December
two price bars — two hourly bars, two
daily bars, two weekly bars, etc. The first     Source: FutureSource
bar in the pattern is an inside bar, which
is simply a bar with a lower high and         a well-timed stutter step to throw off an          pattern is ignored. Upon entering a posi-
higher low than the preceding bar. The        opponent, so does the market. The mar-             tion, one way traders can define their
second bar in the pattern must have a         ket’s true intent becomes clear only after         risk is by using the highest high (for
higher high and higher low than the pre-      it begins moving in a direction opposite           shorts) or lowest low (for longs) within
vious (inside) bar for a bearish hikkake      that of the initial breakout.                      the pattern as a stop-out point.
set up, or a lower low and a lower high          As with all patterns, it is important to           Note that the basic hikkake pattern
than the previous (inside) bar for a bull-    wait for signs of verification before act-         ignores the open-to-close relationship,
ish hikkake set up.                           ing. With the hikkake pattern, a false             also known in candlestick terminology
   The essence of the pattern concept is      move should not be anticipated unless              as the “real body” portion of the price
captured in these two bars. The market        price crosses above the high of the inside         bar. This is not atypical. For example, a
has just broken out from an inside bar.       bar (for a bullish setup) or below the low         number of traditional candlestick pat-
Traders are positioned to go with the         of the inside bar (for a bearish setup).           terns, such as tweezers, hanging-man
market in the direction of the breakout.      Verification must occur within three bars          lines and hammers, also ignore the
However, just as an athlete will execute      of the hikkake pattern, otherwise the              open-to-close relationship.


42                                                                               www.activetradermag.com • April 2004 • ACTIVE TRADER
                                               FIGURE 2 VERIFICATION

Let’s examine some examples of this pat-       In the case of a bearish hikkake pattern, verification occurs after price trades
tern. Admittedly, the following exam-          below the low of the inside bar (dashed line).
ples have been pre-selected; as a result,                                    Cotton (CTH04), daily
they do not illustrate the pattern’s suc-                                                                                 85.00
cess and failure rates.                                                                                                   84.00
   In Figure 1 (opposite page), the                                                                                       83.00
hikkake pattern reversed short-term
                                                                                                                          82.00
price action (points A and B) in an exist-
                                                                                                                          81.00
ing uptrend. The chart also demon-
                                                                                   A                                      80.00
strates how the hikkake pattern can sig-
                                                                                                                          79.00
nal trend reversals (points C and D).
                                                                                                                          78.00
Verification occurred within three bars
                                                                                                                          77.00
following the setups at A and C, within
two bars at D and within one bar at B.                                                                                    76.00
   In Figure 2 (right top), a well-defined                                                                                75.00
hikkake pattern forms in the context of a                                                                                 74.00
downtrend in cotton; verification                                                                                         73.00
occurred after price traded below the                                                                                     72.00
low of the inside bar (dashed line). In                                                                                   71.00
Figure 3 (right bottom), compact                                                                                          70.00
hikkake patterns with clearly defined                                                                                     69.00
entry and risk points led to significant                                                                                  68.00
price moves in natural gas. This chart
demonstrates a continuation type                             November                                       December
hikkake (point A) as well as a trend-          Source: FutureSource
reversal hikkake (points B and C). In
Figure 4 (p. 44), points A and B mark
                                               FIGURE 3 COMPACT HIKKAKES
examples of successful hikkake setups
reversing intermediate-term trends.            This example features compact hikkake patterns that provide clearly defined
   In Figure 5 (p. 44), verification did not   entry and risk points.
occur at points A or B, hence no signals
were generated. Verification did occur at                                 Natural Gas (NGF04), daily
                                                                                                                          6.50
point C, leading to a continuation of the
                                                                                                                          6.40
uptrend.
                                                                                                                          6.30
   Figure 6 (p. 45) shows two hits and
two misses. Successful patterns formed                                                                                    6.20
at points A and C. Verification occurred                                                                                  6.10
at B, but a trade would have resulted in                                                                                  6.00
a loss. Verification did not occur follow-                                                                                5.90
ing the potentially bearish hikkake pat-                                                                                  5.80
tern at point D, and no trade signal was                                                                                  5.70
generated.
                                                              A                                                           5.60
   At point A in Figure 7 (p. 45), a bear-
                                                                                                                          5.50
ish hikkake pattern occurred but lacked
                                                                                                                          5.40
verification. Another bearish hikkake
pattern formed at point B, this time with                                                                                 5.30
verification. Small bearish hikkake pat-                                                B                                 5.20
                                                                                                        C
terns led to a continuation of the down-                                                                                  5.10
trend at points C and D.                                                                                                  5.00
   In Figure 8 (p. 46), hikkake patterns at                                                                               4.90
B and D lacked verification and did not
trigger reversals. Hikkake pattern E was                                     November                          December
verified, but would have resulted in a         Source: FutureSource
                        continued on p. 44


ACTIVE TRADER • April 2004 • www.activetradermag.com                                                                              43
                                                                                           losing trade. Successful hikkake rever-
 FIGURE 4 INTERMEDIATE TREND REVERSAL                                                      sals occurred at A, C and, most notably,
                                                                                           point F.
 The two hikkake patterns (points A and B) successfully reverse interme -
 diate-term trends.
                                     Lean Hogs (LHG04), daily                              Given its simplicity, traders and ana-
                                                                                62.50      lysts may want to experiment with the
                                                                                62.00      basic hikkake theme. One variation of
                                                                                61.50      the basic pattern applies the following
                                                                                61.00      set of requirements to the bar immedi-
                                                                                60.50      ately preceding the inside bar:
                                                                                60.00
                      A                                                         59.50
                                                                                              1. The bar must close at the top of its
                                                                                59.00
                                                                                                 range (for bearish patterns) or the
                                                                                58.50
                                                                                                 low of its range (for bullish
                                                                                58.00
                                                                                                 patterns).
                                                      B                         57.50
                                                                                57.00
                                                                                              2. The range must be less than the
                                                                                56.50            range of the previous bar.
                                                                                56.00
                                                                                55.50         This version occurs far less frequently
                                                                                55.00      in the data than the basic hikkake pat-
                                                                                54.50      tern. In addition, the modified hikkake is
                                                                                54.00      primarily a trend reversal pattern, where-
                                                                                53.50      as the basic hikkake functions as both a
                                                                                53.00      reversal and a continuation pattern.
      October                                 November                   December
     Source: FutureSource                                                                  The hikkake pattern fits into the gener-
                                                                                           al “false move” category. Richard
                                                                                           Schabacker gave perhaps the best
 FIGURE 5 NO VERIFICATION, NO SIGNAL                                                       explanation of the mechanics behind
 Price action did not verify patterns A or B, so no signals occurred. The pat -            false moves when he wrote in his book
 tern at point C was verified, and led to a continuation of the uptrend.                   Stock Market Theory and Practice:

                                     Altria Group (MO), daily                                 “Having completed its accumula-
                                                                                49.50
                                                                                              tion and brought the stock range to
                                                                                49.00         the apex of its coil or triangle, the
                                                                                              pool will figure, quite correctly,
                                                                                48.50
                                                                                              that many traders have sensed
                                                                                48.00         their accumulation, expect the
                                                                                47.50         stock to go up, have brought it, but
                                                                C                             have it protected by stop-loss
                                                                                47.00         orders, or even reverse stop orders.
                                                                                46.50         The pool, therefore, engineers a
                                                                                              quick false move, or shake-out,
                                                                                46.00         sending the price of the stock
                                                                                45.50         sharply down perhaps two or three
                                                                                              points, catching the close stop-loss
                                                                                45.00         orders and thus buying for the
                                                                                44.50         pool’s further account the stock
                                 B
                                                                                              thus automatically thrown to the
                                                                                44.00         market.”
                            A
                                                                                43.50
                                                                                              Essentially, Schabacker gives the
                       October                                      November               credit for shakeouts and false moves to
     Source: FutureSource
                                                                                           manipulation by large “pool operators”
                                                                                           — today’s equivalent of institutions.


44                                                                             www.activetradermag.com • April 2004 • ACTIVE TRADER
                                              FIGURE 6 TWO HITS, TWO MISSES
This idea does have merit. Because of
the size of their orders, institutions and    Successful patterns occurred at points A and C. The pattern at point B was
large commercial traders often enter and      verified, but a trade would have resulted in a loss. The bearish hikkake pat -
exit positions over time, rather than all     tern at point D was not verified.
at once. In the process they often
                                                                               KLA-Tencor (KLAC), daily                   61.00
attempt to “manage” the tape to facili-
tate their end goals. This is as true today
as it was 100 years ago.                                                                                                  60.00
   But don’t underestimate the role of
small traders. There is evidence that                                                                                     59.00
suggests small traders find selling price
strength and buying price weakness                                                                                        58.00
anti-intuitive, preferring instead to go                                                                   C
                                                                                B                                         57.00
with the prevailing price direction. It is
not hard to imagine how this group of
traders could become trapped at the top                                                                                   56.00
or bottom of a move once less-informed
demand or supply is exhausted. The                                                                                        55.00
                                                                                                                   D
unwinding of these losing positions
could be the fuel behind hikkake pattern                      A                                                           54.00
signals.
                                                                                                                          53.00


For traders, the main benefit of price pat-                                                                               52.00
terns might be the establishment of
parameters such as entry price and risk,                             October                        November           December
rather than outright price prediction.        Source: FutureSource
Peter Brandt, an avid classical chart trad-
er and one of the most successful traders
in Commodity Corporation’s history            FIGURE 7 CONTINUATION PATTERNS
(now Goldman Sachs Princeton LLC),            A bearish hikkake pattern occurred at point A but lacked verification; a second
summed up the usefulness of patterns          bearish hikkake formed at point B, this time with verification. Small bearish
this way in his book Trading Commodity        hikkake patterns led to continuations of the downtrend at points C and D.
                        continued on p. 46
                                                                          General Electric (GE), daily

   References:                                                                           B                                32.00
                                                               A
   Stock Market Theory and Practice                                                                                       31.50
   by Richard W. Schabacker,
   B. C. Forbes Publishing Co., 1930.
                                                                                                                          31.00
   Trading Commodity Futures
   with Classical Chart Patterns
                                                                                                                          30.50
   by Peter Lewis Brandt,
   Advanced Trading Seminars, 1990.
                                                                                                                          30.00
   How Charts Can Help You
   in the Stock Market                                                                                         C
                                                                                                                          29.50
   by William L. Jiler, Trendline,
   Division of Standard & Poor’s                                                                                   D
   Corporation, 1962.                                                                                                     29.00

   “Index Funds and
   Stock Market Growth”                                                                                                   28.50
   by William N. Goetzmann
   and Massimo Massa,
   Journal of Business,                                      September                           October
   Vol. 76, no. 1, (2003):1-28.               Source: FutureSource



ACTIVE TRADER • April 2004 • www.activetradermag.com                                                                              45
Futures with Classical Chart Patterns:         FIGURE 8 CATCHING A BREAK
                                               The most notable pattern of this collection of successful and unsuccessful
  “Over 50 percent of chart forma-
                                               hikkake setups occurred at point F, a bearish hikkake that was followed by a
  tions fail to deliver profitable
                                               sharp sell-off.
  trades. This may be an indictment
  of classical charting as a forecasting                                 Electronic Arts (ERTS), daily                 53.00
  tool, but not as a trading tool.
  Charting principles do not explain                                                      C                    F       52.00
  all the markets all the time. I am                                                                     E
  just looking for market situations                                                                                   51.00
  that meet certain guidelines.”
                                                                                                                       50.00

   Skilled athletes know that in the heat                                       B                                      49.00
of battle a properly applied stutter step
can have dramatic results. But knowing                                                                                 48.00
when to use such a move only comes                                                        D                            47.00
through experience and practice.
Likewise, patterns such as the hikkake
                                                                                                                       46.00
must be applied based on a trader’s
experience and understanding of the                               A                                                    45.00
current market context. Ý
                                                                                                                       44.00
The author wishes to acknowledge Yohey
Arakawa, Associate Professor of Japanese,                                                                              43.00
Tokyo University of Foreign Studies, for his
help with translation.
                                                                      October                       November

For information on the author see p. 10.       Source: FutureSource

				
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