Top 4 mistakes with Chart Patterns #2 Failure to wait!

Chart patterns are a popular tool. They have been around for over 100 years and many traders know them.

A big challenge: Many traders don’t trust them!

I have found that learning chart patterns is not very difficult.  A lot of people have spent hours reading books or using tools like our Chart Pattern Flash Cards to learn what a chart pattern looks like. And yet they still can’t seem to apply that knowledge to make money. 

Why?

One of the top mistakes is the failure to wait for confirmation.

What is Confirmation?

A chart pattern itself is a “setup”. Just because something “sets up” it does not mean that it will break out and follow through the way you want it to.

I have found in my trading that waiting for a confirmation is the most effective way to increase the consistency and the profitability of trading chart patterns.

Confirmation is always established on the “breakout”. The moment a pattern “breaks out” it is

  1. A confirmation of the pattern
  2. A trigger to actually 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. This is typical.

I want to make a point clear: It is possible to have a pattern “breakout and confirm” and still reverse and go the other way.  Nothing is guaranteed in the stock market. But if you will wait for the breakout confirmation to place the trade, your percentage of losing trades will plummet as the odds become heavily weighted in your favor.

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The mistake of many

People are interesting creatures. Sometimes I think traders in the stock market remind me of dogs anticipating a piece of steak… they just jump and bark and start snipping at the smell of a good trade, rather than waiting for the trade to be served up. 

Following this analogy of “dogs chasing steak” vs. a nice steak dinner in a restaurant, let see how each experience could be different.

If 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 will 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.

But that is exactly how most people (who do not know how to control emotions) approach the market. 

Most people 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 hunting meat.

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’.

This image is the same idea as visiting the nice steak house. You may have to wait. It might be a longer 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

So what does a confirmation point look like? What does order and patience mean?

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

Look at these two patterns:

The large triangle has a support & resistance boundary associated with it, and in a similar way, 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 pretty obvious but we still needed the 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. 

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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, however, do not really need such a confirmation. 

The patterns I’m talking about are:
  • Channels
  • Triangles

 

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 fairly 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. 

 

Wrap up:

Chart patterns are great. They are a wonderful tool with powerful anticipation potential. But traders who fail to wait for confirmation will end up looking like a bunch dogs fighting over a piece of fresh steak. 

If you want to be a great trader who can use chart patterns to your advantage, wait until the confirmation is triggered. When you do, your consistency of trading for profit will skyrocket. 

To read part 1 of this series CLICK HERE


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