Trading strategies can be boiled down into two primary groups: Fundamental and Technical. Fundamental traders focus their efforts on the underlying factors that may fuel market behavior. Technical traders, on the other hand, focus on one thing and one thing only: Price action.
A technical trader does not care why soybeans or corn may be going higher or lower, only that it is. Technical traders use a variety of chart patterns to determine buy and sell signals, and may also use numerous technical indicators to exit positions.
Some of the most popular technical trading patterns include:
- The head and shoulders
- Double tops or double bottoms
- Cup and Handles
- Rounded tops or bottoms
Each pattern has specific nuances that need to be carefully studied in order to be used effectively. There are, however, a few general rules of thumb to consider:
Technical trading patterns should be used on daily, weekly and monthly time frames: A head and shoulders pattern on an intraday five minute chart does not carry the same weight as a head and shoulders pattern on a weekly chart. Intraday price action tends to be simply nothing more than market noise, and any patterns seen on an intraday basis tend not to stick.
Pay attention to the close: For traders who use technical trading patterns to determine potential buy and sell signals, the close is especially important. A market can look as if it is about to complete a pattern on an intraday basis, only to reverse and void the pattern’s completion on a closing basis. Larger commercial traders are far more concerned about where the market closes, therefore you should be as well.
Wait for completion: Many traders have a tendency to jump the gun, getting into a trade before the pattern has actually completed. A head and shoulders bottom, for example, may not be considered valid until prices have a solid close above or below the neckline. Oftentimes, market prices can look as though they will complete a pattern, only to reverse course. Therefore, patience can pay off when it comes to trading technical patterns.
Look for string risk/reward setups: Risk management should also always be considered when trading technical price patterns. It doesn’t make a lot of sense, for example, to risk 10 ticks to potentially make 10 ticks. It is important to remember that even some of the best traders out there win less than half of the time. Consequently, the goal should be for winners to be larger than losers. Potential patterns to consider may depend on the individual trader’s risk tolerance and methodology. A simple rule of thumb, however, is to look for setups that potentially provide a 4 to 1 risk/reward or better.
Set reasonable targets: One of the other nice things about chart patterns is they can provide not only potential trade setups, but can also provide a means of quantifying risk and setting profit targets. The head and shoulders pattern, for example, calls for a profit target that equals the distance from the top of the head to the neckline. Other patterns also have similar guidelines. This can make levels for stop orders and potential price targets easier to identify.
Strong technical price patterns can provide significant trading opportunities. In order to be successful, however, traders must utilize risk management techniques as well as trade management techniques. Due to their simple nature, chart patterns can be a very simple, yet potentially very effective trading tool that may allow traders to focus on larger moves with more favorable risk/reward ratios.
There is a substantial risk of loss in trading futures, options and forex. Past performance is not necessarily indicative of future results.