Understanding Stock chart Patterns - Part II
As you are probably aware, professional investors use stock chart patterns to show them the direction where a stock is going in the foreseeable future. I have wrote some basic understanding on stock chart patterns earlier. If you have not read it, you can have a look over here.
Why Do Chart Patterns Fail?
If you have been applying your knowledge on chart patterns in the stock market, you will realize quickly that using these indicators to make money on stocks is no magic formula to riches. This is usually the case due to a phenomenon called a failed or false breakout.
A false upside breakout occurs when the share price rises above resistance and sucks in buyers before reversing and falling. According to GuerillaStockTrading.com website, false breakouts happen more often than not due to the actions of institutional funds selling off once the share price break the resistance point.
The website goes on to say that false breakouts provide institutional traders with most of their best trading opportunities which is why institutional traders most often are the ones who cause these patterns to form in charts.
It sounds like some low down dirty trick an institutional traders and large players use against you but hey this is all legal and above board. Remember this is just a game to them.
How To Win On Chart Patterns?
Since you now know why chart patterns often failed in your setups, the next question will surely be as to how to win on chart patterns, right? Here are some of the few tricks and tips I found useful in this area.
Go For Highest Probability Chart Patterns
Stock patterns are not created equal, period. Some patterns have higher chances of success than others. Some of the top successful patterns are the cup-and-handle, ascending triangles, bullish flag and bullish pennants. Use these high probabilities chart patterns for more success.
Always Be Disciplined
If the indicator is telling you to buy, you go ahead and buy. Whereas if the indicators say it is a sell, cut off without hesitation. And if you have miss the trade, forget it. Don’t worry about losing the trade because there will be plenty of other opportunities later. Be disciplined.
Only Have Small Positions
According to ThePatternSite.com who conducted 14,0000 chart patterns covering the years between 1991-2008, the failure rate of chart patterns have been increasing over time. They go on to say that their studies found the failure rate averages between 30-40% of the time. I can tell you that 30-40% failure rate is high. So, even though all the indicators are strong, you should NOT get overconfident and invest a large amount of your capital into each trade.
Analyse The Past Chart Patterns
They say the past trends could be an indication of what might happen in the future. The chart patterns found in a stock are no different. Many traders make the mistake of just analysing the present chart but neglecting the past. If you see the chart patterns failing often in the past, it could be an indication of what could happen in the stock later.
Need Lots of Spare Time
Stock pattern trading is time consuming. Seriously! Patterns traders would need to spend considerable time to wait for the trade to happen. Most of the top traders in this area have a lot of spare time to watch the market. If you do not have the time, don’t trade the patterns. Invest instead.
Conclusion
People who are serious about the stock market use stock chart patterns as an integral part to their everyday trading in the stock market. This is because stock patterns can indicate the future direction of the stock. However, there is some risk involved due to the failure rate brought about by the institutional traders. I hope you agree with me on this point. But if you use the techniques and apply them properly, they can bring you much success in the markets.
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