Chart patterns are one of the best tools technical traders have for anticipating market sentiment shifts. However, as great as they are, chart patterns are often misunderstood and misinterpreted. Over the past three weeks, we have been sharing the top four mistakes traders make with chart patterns, mistakes which often lead people to think they are unusable. Today we wrap up this series with our fourth and final mistake.
This mistake is probably rooted in excitement more than anything. When we see new students learning about chart patterns, we often watch them immediately try to make every market turn into a chart pattern. This is born out of a genuine desire to apply the knowledge correctly. These students and traders are well intended as they truly want to find patterns. They are just trying too hard, and, in the end, they end up creating patterns where none exist.
As traders, we would love nothing more than to have the world of trading completely predictable, but unfortunately not every turn is a chart pattern and not every pattern will always play out as expected. We have to adapt to what is before us. When we see the price action taking shape, we analyze it as best we can, and do a trade setup if it’s appropriate to do so.
This bothers many new traders as they enter the marketplace set on consistently making profits trade after trade. In reality, the most consistent trading profits come from a disciplined, methodical approach that allows for frequent and manageable drawdowns. Thus, if you want to be a good trader who knows how to use chart patterns, it is very important that you learn the pattern formations and apply them correctly.
According to the U.S. Department of Treasury, there are seventy million dollars in counterfeit U.S. currency floating around. There are thousands of people who attempt to print their own money. Some of it is not very good, and yet some of it is exceptional fake currency. So how can the FBI and other law enforcement agents possible tell which bills are fake and which ones are real? There is only one way to train an agent to spot a fraudulent piece of money: Train them to know the real deal. When the FBI and other agents learn to recognize every single detail of the real currency, spotting a fake dollar becomes very easy.
The same is true with chart patterns as the best way to learn a series of pattern formations is to study the real deal. The more you know what a pattern should look like, the less chance you have of trying to create one where it doesn't exist.
Learning to trade chart patterns and identify them is a skill. Just like any other skill in life, once you learn to do it, you will be good at it which means practice is the key. The more you practice, the better you will get. Just remember this: patterns appear when they appear, and your job is to identify them when they do.
In closing, chart patterns are a fantastic tool for increasing insight into the trading sentiment of a stock. When used correctly, they will dramatically increase your chances of being on the right side of a trade, but when applied incorrectly, they will lead to misanalysis of stock movement and trends. If you can avoid these four mistakes, you will be ahead of the pack in your chart pattern analysis skills.