Top 4 Mistakes When Trading Chart Patterns #2

One of the top mistake traders can make is the failure to wait for confirmation. Waiting for a confirmation is one of the most effective way to increase the consistency and the profitability of trading chart patterns. After all, a chart pattern itself is a setup, and just because something sets up it does not mean it will break out and follow through. Confirmation is always established on the breakout. The moment a pattern breaks out it is:

  • A confirmation of the pattern
  • A trigger to ​enter that trade

You will substantially increase your winning trades by waiting to enter the trade until there is a confirmation of the pattern you are observing.

Here is an example of a confirmation on a double top vs. a “double-top” that never confirmed:

As you can see, the pattern that confirmed also played out in the direction expected, whereas the other one did not. Remember, nothing is guaranteed in the stock market as it is possible to have a pattern “breakout and confirm” and still reverse and go the other way. But if you will wait for the breakout confirmation to place your trade, your percentage of losing trades will plummet as the odds become heavily weighted in your favor.

​The Mistake of Many

You have ever watched dogs jumping after a piece of meat; it’s a crazy sight. There is little or no control. These dogs will bite anything in their way. A normally gentle dog might even bite its owner's hand, trying to get to a piece of meat. In the end, the dog may get rewarded, or it may lose out to another dog trying to get the same piece of meat.

Contrast that to a nice steakhouse. A steakhouse has etiquette. You enter, wait to be seated, wait to order, wait for the food to be prepared, and when it is served up, you eat it in a nice orderly fashion with the guaranteed result of feeling extremely full. The stock market is the same way.

If you become part of a pack hoarding after a trade, you may or may not get the “meat.” You get lost in the hoard. It becomes uncontrolled. Crazy things happen. You might end up biting the hand of your owner. It’s chaos. Unfortunately, that is exactly how some traders approach the market. They are so anxious to get that “piece of meat” that they imagine chart patterns where they don’t exist. Or they identify a pattern, but the second they see it, they place the trade, days, or even weeks before the actual entry should have taken place.

This creates unpredictable results and should be avoided at all cost. It’s also a reason that some people think chart patterns don’t work - they’ve been trading them like dogs jumping for steak.

Now let’s contrast that idea with someone who is trading in a nice orderly fashion. They identify the pattern, but instead of jumping after the trade, they wait patiently for the trade to confirm. Once the confirmation happens, they enter the trade, and they find more often than not, they are satisfied with the outcome.

This image is the same idea as visiting the nice steak house. You may have to wait. It might be a long process. But in the end, the dining experience is orderly, more planned out, and you have a higher chance of getting your desired outcome.

​What Is the Confirmation Point?

All chart patterns essentially function the same when it comes to both setup and entry. Patterns appear because of the short-term support and resistance boundaries that appear with them. It doesn’t matter which pattern your trading; there is a short-term support and resistance boundary associated with it.

Look at these two patterns:

The large triangle has a support and resistance boundary associated with it, and similarly, the smaller pennant does as well. These are two different patterns with different meanings, but they function in setup the same way.

The confirmation for almost every pattern comes on the breakout of the pattern. When that pattern breaks the boundaries that have been containing it, the setup has changed. Now we move into a trigger. Now we know something bigger is going to happen. This is the confirmation we needed.

In the example above, you can see the pattern had formed. This pennant pattern was clear; however, we still needed confirmation that it is going to do what we expect. When it breaks out, we have a trigger into the trade, and simultaneously we have confirmed the pattern is what we thought it was.

Now, from time to time, you will find patterns that break out as though they are going to confirm the pattern, and then they reverse and go the other way. This is annoying, but it happens. When that happens, you have to remember the statistics overall and not discount all patterns just because this particular one didn’t work out.

There is one set of patterns that kind of breaks the rules a little bit. In general, we need the pattern to break out to confirm the pattern. Consolidation patterns such as channels and triangles, however, do not need such a confirmation.

These patterns are so big and take so much time to develop that it is very simple to identify them. Moreover, they are neutral patterns that do not specifically expect a breakout in one direction or the other. Because of this, it’s easier to identify them early.

But just because you can identify it early, it doesn’t mean you can randomly enter the trade. Consolidation patterns are, by nature, neutral, which means you still have to set an entry trigger and use that to confirm the trade.

​In closing, chart patterns are great. They are a wonderful tool with powerful anticipation potential, and to use them to your advantage, wait until the confirmation is triggered. When you do, your consistency of trading for profit will dramatically increase.

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