NEW YORK (TheStreet) -- The best thing about using pattern recognition for stocks is that whenever you recognize the same pattern, it is still a valid strategy.
One of the benefits of the Decision Support Engine is that it's tuned to search for historically repeating patterns that have highly correlated outcomes. Whenever it finds one, it warns for an outcome that is probability-ranked higher than random.
Tesla (TSLA) - Get Free Report is now such a situation. The following chart shows red squares at the recent instances when the weekly stochastics became extended above the 90% threshold then crossed down upon each other and fell back below the 90% threshold.
What followed were significant declines averaging 34%. Again, two data points don't make a historically repeating pattern. However, the DSE searches more than just Tesla stock. It searches everything. So, whether TSLA follows through with a third (in 18 months) 34% crash, the pattern that is currently manifesting allows "informed" action to be taken or contemplated. Tesla closed Thursday at $268.79.
First, investors who are long (especially those who are leveraged) can place sell stops at a break of the June 15 low near $245. Second, as can be seen in the graph, Tesla is about to test the upper two-standard-deviation band ($276, plus or minus $4).
The last two times it has done this, the result wasn't great for those buying on the hype. Two standard deviations represents 95% of normalcy. So, remaining long at prices testing these extremes requires the arrogance that you can succeed in the 5% of normalcy that is represented in the "tail" of the bell curve. This lack of humility is rarely rewarded (at least for very long). Therefore, reducing or eliminating long exposure into the two-standard-deviation band is a prudent risk-adjusted action plan.
Third, assertive traders can sell short into this range, using last September's high near $291 as a protective buy stop to limit risk. That would be around a 5% risk in order to play all or part of a potential 34% decline, if the pattern repeats. At nearly 7-1, this is a highly desirable play, if you have the clarity to make it.
Finally, some will notice what could be a classic head-and-shoulders pattern forming, if the stock doesn't break above $292 and turns down from near current levels. Trading With Waves doesn't use this pattern, because the outcome is not correlated as high as the ones the DSE is tuned to search for.
That said, if this is a head-and-shoulders pattern and becomes active, it won't be "triggered" until Tesla stock closes below the neckline, which is at $181. Most investors who use this pattern fail to wait for the trigger and end up betting on a pattern that hasn't become a pattern yet. But, we're only human, right?
Ideally, investors expect to do the right thing, and it seems so easy to describe what that is: buy low and sell high, or vice versa. However, when investors mix emotion (the very thing that makes them human) with money, the outcome is usually suboptimal. Therefore, using an objective decision support engine, where one simply take action when and only when action is objectively indicated, minimizes the emotional component of decisions, and should improve performance.
This article is commentary by an independent contributor. At the time of publication, the author held no positions in the stocks mentioned.