Learning about pattern trading is a very important skill when it comes to technical analysis. The market spends the majority of its time going sideways and within those sideways phases, you’ll often be able to detect patterns. The best reward/risk ratio exists at the breakout area of those patterns and new trends emerge when a pattern is completed. Thus, pattern trading should be the cornerstone of all technical analysis. Patterns are the connectors of trending phases and if you want to trade trends, you need to learn how to trade patterns.
How to draw patterns
If you have been following me for some time, you will know that I like to boil things down to the very basics. And when it comes to pattern trading, it becomes very easy. Although there are dozens of ways to find patterns, when you get started, stick to the obvious patterns.
What are the obvious patterns? Patterns that are based on horizontal structures. If you look at Head and Shoulders, Cup and Handles, Double/Triple tops or triangles, they are all based on a horizontal structure.
The screenshot below provides an idea of how what we are going to talk about. The chart snapshot shows uptrends, downtrends and sideways phases. Most traders say that they want to trade trends, they overlook that at the core of those trends you will find patterns that are based on horizontal structures.
On the left, the uptrend was over when the price entered the sideways range. The new downtrend only started when the price left the pattern. The following downtrend came to an end when the pattern entered a new sideways phase. The pattern was very well defined by a horizontal structure at the top and when the price broke out, the next trend could emerge. During the trend, the price temporarily paused and formes another sideways phase. This time, the price established another horizontal structure at the top and when the price broke out, the trend was able to continue.
Drawing patterns: tips
This is no rocket science but it immediately makes sense. Patterns connect trends. And a good pattern is defined by a horizontal structure. So going forward, I urge you to start drawing horizontal levels whenever two or more price points line up. And only stick to the obvious ones. Sometimes, the price points won’t line up and that is OK. Skip those and only focus on the ones that really jump out from your charts.
The Head and Shoulders is among the most profitable patterns in technical analysis, confirmed by many reports and reviews. And at the core of this pattern is a horizontal level as well. Although you will be able to find Head and Shoulders patterns that are made up of diagonal trendlines, I do not recommend trading those. Such patterns are very subjective and hard to time. Instead, just focus on Head and Shoulders patterns where you can easily draw a horizontal level, connecting the lows and you are set. It will make your chart reading more objective and repeatable.
The same holds true for all other patterns. The Cup and Handle pattern has a horizontal resistance level which helps define it. I hear people saying now: “but you are only picking the obvious examples.” And you are 100% right. That is what good technical analysis is all about. In my trading, I focus on the most obvious patterns. The patterns that do not make me think and the ones I can see after looking at a chart for just a few seconds.
And once you adopt such an approach, your chart reading will change forever. You have to be OK with skipping many setups that look OK but are not perfect. Knowing when not to trade is a skill that all successful traders had to develop. Amateurs struggle with this mindset because they want to trade all the time.
Pattern trading: More chart studies
When we look at the next whole chart snapshot, we find hundreds of candlesticks. But only once are we able to find a period where the price moved sideways and established a horizontal structure.
This sideways phase is the connector between the downtrend on the left and the emerging uptrend on the right. This is such an important principle that I cannot repeat it often enough. Put those concepts on your trading desk somewhere:
- Sideways patterns are the connectors between trend phases
- The best patterns are based on horizontal structures
- All classic chart patterns are horizontal structures
- You need at least two touchpoints to define a horizontal structure
- Always wait for the breakout
Most traders make things way too complicated because they believe that trading can’t be that easy. But when it comes to technical analysis, it really is that simple. Once you focus on the core principles of technical analysis and how the price moves, you will start seeing those patterns everywhere.
The scenario below shows it once again: the horizontal patterns really stand out and they mark important turning points as connectors between trends. The patterns have well-defined horizontal levels that are 100% objective and very obvious. The breakout initiates a new market phase.
Pattern trading tips for your trading
KISS is a term that many traders are striving for in their trading, but only very few will get there. Most conventional trading literature and tips are overcomplicating things. Technical analysis does not have to be that complicated and the principles of pattern trading will hopefully bring new clarity into your chart reading.
You must fight the urge to add things to your charts. For the next few weeks, try this approach of pattern reading and see what you can learn from your charts. Don’t get discouraged if it doesn’t make sense right away. As with anything, it takes practice and time. But the trader who truly understands the premise will soon realize how powerful this simple technique is.