Friday, July 12, 2013

Pattern Failures

by Brandon Wendell

When we are trading, we often identify chart patterns to trade. The problem with these patterns is that they do not always follow through to their targets. Even worse is that these patterns may fail and cause a thrust in the opposite direction, causing losses for those traders who were caught unaware. So should we not trade these patterns? Patterns can offer great trading signals with entry, targets, and even stop placement identified for you. Ignoring them altogether would be a mistake. However we must be smart in how we trade them and we must remember that nothing will replace our core strategy of supply and demand. Patterns should only complement it.

Follow up:

Chart patterns fall into one of two categories, continuation or reversal. Continuation patterns usually involve consolidation of price into a channel or triangle and mark a pause of a powerful trend. Instead of reversing, the trend rests before proceeding. In a reversal pattern, you are seeing the exhaustion of a trend and the start of either a correction or new trend in the opposite direction. Before attempting to trade any of these patterns, I recommend you gain the knowledge and experience necessary to properly identify, plan and execute trades on them.

So is there a way for us to identify whether a pattern is more likely to work and achieve our trading target? Of course there is. When trading, most people focus only on the time frame in which they are trading. For intraday traders, that may be a five minute or 15 minute chart. For longer term traders, it could be a daily or weekly chart. However focusing on only one timeframe reduces your perspective of the larger trends that effect your trading. That’s right! One of the secrets to trading patterns is to view the larger timeframe.

Take for instance the double bottom that occurred in the Nifty Index. Many traders may have entered into a long position in early March when the resistance level broke. However, they were quickly stopped out for a loss as the pattern failed and a retracement took the index lower.

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A trader who confirms chart patterns with larger timeframes would have noticed that the reversal pattern was occurring on the impulse of the downtrend. They would then check the larger timeframe to verify that price was making this reversal at a demand level. Impulses tend to violate the supply or demand levels of the trading timeframe but halt and correct at the levels from a larger timeframe.

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As we can see from the weekly chart, the pattern occurred between levels and not at demand. This meant that there was a lower probability of the pattern reversing trend as it normally would. Having this knowledge would prevent a trader from entering a trade only to incur losses. Knowing when not to take a trade is just as, if not more important as knowing when to trade.

If you do not know how to: identify impulses vs. corrections, trade chart patterns or how to properly use multiple time frame analysis for trading, I welcome you to join one of our courses at the Online Trading Academy, India center in Mumbai. It is a life changing experience for anyone who is interested in learning how to profit from the markets.

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