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 which leads people to think they are not useful.
Over the past 3 weeks I have been sharing the top 4 mistakes traders make with chart patterns, mistakes that often lead people to think they are unusable.
Mistake 1: Failure to accurately identify the pattern
Mistake 2: Failure to wait for confirmation
Mistake 3: Failure to understand the time frame
Today we wrap up this series with our fourth and final mistake.
Mistake #4: Trying to force a pattern where none exists
This mistake is probably rooted in excitement more than anything. Really, it is a personal psychology that has to be trained.
When I see new students learning about chart patterns, I often watch them immediately turn around and try to make every market turn into a chart pattern. This is born out of a genuine desire to apply the knowledge correctly, and an anticipation that once this knowledge is applied, great fortunes must rest on the other side.
I wish I could give lots of visual examples here. Unfortunately, the examples I would give are not very simulating visually! With rare exception, in almost every Power Trader Live I teach, I have someone who asks about such and such stock and says "is XYZ stock in a [fill in the blank] pattern". I pull up the stock and I just stare at it. I hate uttering the words but I have to tell these people "there is literally no pattern anywhere on this chart."
These students and traders are well intended. They truly want to find patterns. They are just trying too hard and in the end, they end up creating patterns where none exist.
Not every turn is going to be a chart pattern!
Stock market riches is a lot more method than secret sauce.
As traders we would love nothing more than to have the world of trading completely predictable - but it’s not! Not every turn is a chart pattern. Not every pattern will always play out as expected. And believe it or not, not every trend will always make sense.
As traders, 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 traders. New traders, in particular, enter the marketplace dead set on making a small fortune very quickly. That can happen, but just because it can happen it does not mean it’s the norm.
What a lot of new traders want is the “secret sauce” that will be a magic wand to provide an endless fountain of cashflow. In reality, nothing is that consistent. The most consistent trading profits come from a disciplined, methodical approach that allows for frequent and manageable drawdown.
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 appropriately.
So how can you learn the formations?
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.
According to the U.S. Department of Treasury, there are $70Million in counterfeit U.S. currency floating around. There are literally 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. If you want to avoid trying to call out a chart pattern where none exists, get very good at knowing what really is a chart pattern.
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. That means practice is the key. The more your practice the better you will get.
Just remember this: even if you want a chart pattern to exist, it doesn’t have to! Patterns appear when they appear. Your job is to identify them when they do.
As I started off saying at the beginning of the series, 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 “right” on a trade, but when applied incorrectly, they will appear to be a big giant bust. Avoid these 4 mistakes and you will be way ahead in your chart pattern analysis skills.