Surprisingly, many traders don't even know what a good trade looks like. They chase the market around instead, hoping to capitalize on the latest news or chat-room buzz. This sloppy approach can work for short periods of time, but will eventually led to major losses.
Price patterns represent the machine language of market prediction. Take time to study their inner workings because they reveal the nature of opportunity. In other words, they tell us when to trade, how to trade and why the trade should work.
Here are 15 ways to manage opportunity through price patterns:
1. Learn the classic patterns first to recognize them immediately on any price chart. These archetypes describe broad, predictable forces that print through all time frames and offer outstanding trades. Then move on to more original and complex patterns.
2. Trade patterns that match the current market phase and reduce size when forces are in conflict. For example, most breakout patterns will fail in a weak market, no matter how pretty they look on the price chart.
3. Patterns predict outcomes as they reveal the will of the crowd. They point to time and direction because herd behavior drives a common will at key market intersections. Patterns lose their effectiveness when the crowd finally catches up to the prevailing market theme.
4. Opportunity has many faces. Popular patterns, such as the head-and-shoulders top, capture the attention of traders, but charts show dozens of lesser-known predictive formations. Because these patterns avoid the crowd's interest, they're dependable over longer periods of time and are less susceptible to whipsaws.
5. Perfect patterns rarely appear in the modern market environment. Learn to execute comfortably in a debris-filled landscape. Alternatively, don't chase every moving average crossover as a major signal or see meaningless candlesticks as textbook trades.
6. Pattern recognition doesn't work for everyone. Some folks will find far greater success building trading systems or studying balance sheets. Avoid mixing systems and discretionary trading into one strategy because they don't mix well.
7. A good pattern never signals when to trade or when to stand aside. It points to a convergence of time and direction that should trigger predictable movement under the right circumstances. It's the trader's responsibility to formulate tactics that capitalize on a setup if it unfolds, and protect the trading account if it fails.
8. There is no single method to trade any pattern, and no setup will evolve the same way twice. The chosen trading strategy must capture expected opportunity while managing unexpected risk.
9. Categorize each pattern as original or classic. This predicts the level of public participation and potential whipsaw. Shift strategy to a more defensive posture when a large crowd trades a popular pattern. Consider going the other way if it fails, or standing aside and letting other traders risk their capital first.
10. Enter a pattern before it breaks whenever possible. Risk remains low until price finally expands or reverses, setting off signals for all of the other players. Early entry lets traders execute several low-cost positions while waiting for a bigger move to unfold.
11. Always keep one eye on the clock. Time eventually turns against a pattern if price just sits there. Technical indicators start rolling over and the pattern can morph into an unpredictable mass of price bars. Choose entry levels wisely and exit immediately if the pattern deteriorates.
12. Exercise patience after the pattern breaks out or down without you. Shift attention to pullback entry and be willing to stand aside if the market starts to run. The pullback trade must stand on its own merits after a pattern breakout. Keep in mind that many patterns predict only one price swing, and profit potential evaporates after the initial move begins.
13. Align setups to natural time tendencies. Watch out for options week, turnaround Tuesday and the midday doldrums. Think contrary during the holiday season and don't get caught with the crowd when the market opens on Monday morning.
14. Patterns should correspond with well-established support or resistance levels. Use multiple time frames to confirm that larger market forces align with the current opportunity. Check the major averages and technical indicators to uncover divergences that could undermine the trade.
15. Define a low-risk entry, the profit target and a stop-loss for each pattern. Consider the impact of pattern failure on every new setup. When price goes the wrong way, it can produce better profits than the expected outcome.
