Keep an Eye on This Pattern Shift

 | Sep 29, 2013 | 6:00 PM EDT
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When I see a pattern shift on a chart, I take notice. When this occurs you should look at the next pullback -- because, often enough, it could be the beginning or a more important reversal in that stock or index.

Here's what I mean by a pattern shift, using the daily chart of KB Home (KBH) as an example. As you can see on the chart below, this stock went from a pattern of lower lows and lower highs (see the general swing from the May 15 high to the Aug. 15 low), and then it shifted to taking out a prior swing high of $17.95. That indicates a break in the prior bearish pattern, and the assumption is that the new pattern will be higher highs and lows.

KB Homes (KBH) -- Daily
Source: Dynamic Trader

Now, this type of "pattern shift" is not always followed by a full reversal, but it does happen enough that we should carefully stalk the next market pullback after a break in the prior pattern. KB Homes has already pulled back into support -- and, at least on the lower-time-frame charts, the stock has triggered some new buy entries.

I'm going to look at it this way: As long as the price holds above the Aug. 15 low, I'm going to bet that we'll see at least a deeper upside correction back to the May 15 high and possibly higher. The "possibly higher" would represent a full trend change and take the stock to highs beyond the May 15 high.

If this scenario does start to play out, my first target comes in at $27.74. At this point, we don't have all my favorite moving averages on our side on the daily charts -- but the risk-reward ratio looks good to me. Also note that there was some key Fibonacci price support at the Aug. 15 low that came in at the $14.95-to-$15.67 area. This also supports the bullish scenario.

I will consider myself wrong the trade if the Aug. 15 low is taken out on the downside.

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