Two Patterns to Catch New Trends Early: The Bowtie and

the First Thrust

Contributed by Dave Landry
The trend is your friend is one of the few true market adages. Critics will
argue that a trend is your friend until it ends. And, admittedly, this is
true. Trends do not last forever. Eventually they exhaust themselves but
quite often, a new trend in the opposite direction emerges. However,
established trends can often last much longer and go much further than
most anticipate. Trying to buy a stock (or other market) because it is low
or sell short a stock because it is high is a loser's game. The good news is
that the stock will leave clues that a trend is turning and will usually have
a minor correction before resuming its new trend. Looking to enter after
that minor correction and only if the new trend shows signs of resuming is
the goal of my transitional patterns and is illustrated below.

When you catch a new trend early, the payoff can be huge. Unfortunately,
since you are fighting
what could turn out to be only be a correction in a longer-term trend, you
have to realize that there will be a higher failure rate than trading
pullbacks in established trends. Like the pioneers, when trading
transitions you are either going to get the gold or the arrows.
Let's look at two of my favourite transitional patterns, First Thrusts and
Bowties.

First Thrusts
Markets in major trend transitions often begin with a bang. They make a
sharp thrust in the new direction. This tends to catch participants off
guard. Trapped on the wrong side of the market, they find themselves
waiting for the market to reverse so they can get off the hook. Bottom
pickers and top pickers who missed the top or bottom and do not want to
pay up are also waiting for some sort of meaningful correction.
Unfortunately for these traders, the meaningful correction may never
come. Often, markets making a sharp thrust in a new direction only pull
back very briefly before resuming their new trend. The old market
participants will soon be forced out at adverse prices and the bottom/top
pickers must pay up or risk being left behind. By waiting for the market to
have a sharp thrust in the new direction, you avoid the pitfalls associated
with picking tops/bottoms. By looking to enter at the first signs of a
correction rather than waiting for something more substantial, there is
the potential for your position to be helped along by the predicament of
the aforementioned traders.
Let's look at the pattern. Referring to figure below, after making a
significant new low (1), the market should have a sharp thrust in the new
direction (2) and then make a lower low and a lower high; in other words
a 1-bar pullback (3).* Look to enter above the high of the pullback (4).

*Rule 3(a). Occasionally markets are in such sharp reversals that they will
only make a lower high (vs. lower high and lower low). These make for
somewhat risker trades. With risk comes reward though. Sometimes
you're able to get into a major trend early.
The best transitional patterns come off of markets that are making major
new lows for longs. This helps to ensure that the most people as possible

are on the wrong side of the market when the trend turns. Notice below
that Berry Petroleum is at its lowest level in over a decade (1). The stock
then has a sharp thrust higher (2). The stock makes a lower-low and a
lower high (3). Go long (4) above the high of (3).

The great thing about transitional patterns is that they occur in all
markets and in all time frames. Here's an example in the weekly
Australian Dollar (AUD/USD). The currency makes an all-time high (1)
and then begins to sell off (2). It then makes a higher high and a higher
low (3) to complete the setup*(4). A short is triggered when the stock
turns back down. The contract resumes its slide over the next few weeks.

*Note: a somewhat more aggressive entry would have been to enter after
the higher low only (a)
Bowties
The First Thrust is a fairly abrupt pattern that occurs over very short
periods of time. These new trends begin with a bang. Sometimes though,
new trends start more gradually. Markets go through a distribution phase
and then begin to accelerate in the new direction as the new trend
emerges.
For this pattern, I use a 10 day simple, 20 day exponential, and 30 day
exponential moving average. Although all indicators are prone to lag, I did
notice that these moving averages would often come together and then
spread out in the opposite direction right before a market makes a major
transition. That is, they would go from proper downtrend order - the
faster moving averages (shorter periods) below the slower moving
averages (longer periods) - to proper uptrend order - the faster moving
averages above the slower moving averages. When this happens over a
short period of time, it gives the appearance of a Bowtie. This is
illustrated below. Notice that the moving averages are in downtrend
"proper downtrend order" 10-SMA < 20-EMA < 30-EMA but quickly flip
over to uptrend proper order 10-SMA > 20-EMA > 30-EMA). Ideally, this
should happen over a period of three to four days (1). After this occurs, it
suggests that the market has made a major trend shift. However, it is still
prone to correct. Therefore, you wait for the market to have at least a 1bar pullback (2) and then look to enter after that minor correction (3).

Like all my transitional patterns, I prefer those that come off of major
highs or lows.
Let's take a look at an example. USG Corp. (USG) makes 6-year plus lows

(a). Notice that the Bowtie moving averages are in downtrend proper
order (10SMA <20EMA <30EMA). Then as the stock begins to bottom, the
moving averages come together and then change to uptrend proper order
(10SMA>20EMA>30EMA) over a short period of time. This creates the
appearance of a bowtie( 1). This makes a lower low and a lower high
followed by another lower low and lower high (2). Enter when the high of
(2) is taken out (3).

Although I'm not a big fan of day trading, the following Bowtie caught my
eye on the 5 minute chart when asked about the ETF during a recent
webcast. It actually was triggering during the live show.
The Direction Small Cap Bull Shares (TNA) make an intra-day high (a). In
fact, this is actually also a multi-day high. The moving averages come
together and quickly cross over to form the bowtie (1). The ETF pulls back
(3). Enter as the trend begins to resume (3).

Staying on the right side of the market

Transitional patterns can often alert you to the fact that an old trend is
coming to an end and a new one is emerging. In fact, they can signal the
beginning of major bull or bear markets for stocks and other markets
(e.g. Forex, commodities, bonds, etc). This is especially true if the market
is making a longer-term high or low. If you study major market turning
points - such as the stock tops in 2000/2007 and the bottoms in
2003/2009, and now the top (?) of 2011, you'll see that transitional
setups occurred as the market turned on a variety of time frames. Not
every transitional pattern will turn into a major top or bottom but all
major tops or bottoms will have some sort of transitional pattern. Let me
repeat, all major tops or bottoms will have transitional patterns. This is
what makes watching for them so worthwhile.

Summary
Trying to picks tops or bottoms is a loser's game. You're much better off
waiting for the market to show signs that the trend is turning and then
look to enter after the first correction. The First Thrusts and Bowties are
two of my favorite patterns I use to catch new trends early. The best
setups occur after major highs and lows. Multi-year or even lifetime
highs/lows work the best. This helps to ensure that the most traders are
trapped on the wrong side of the market. Not all transitional patterns will
turn into major tops or bottoms but all major tops or bottoms will have
transitional patterns. Like the pioneers, when trading transitions you are
either going to get the gold or the arrows. I think the chance for gold
makes it all worthwhile.