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In today’s episode, you’ll discover why you still lose money with chart patterns even though you understand most of them.
So listen to it now…
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Head and Shoulders Pattern Trading Strategy Guide
Hey, hey, what’s up my friend?
In today’s episode, I want to talk about why you lose money trading chart patterns. I’m sure you’ve probably know stuff like head and shoulders pattern, the bull flag pattern, diamond pattern, triple top, double top, double bottom, etc.
You memorized all these patterns and what it means but still, you lose money when you trade these patterns. Why is that? There’re a few reasons for it and I want to break it down in today’s episode.
1. You neglect the context of the markets
What do I mean by this? Imagine you spot a bull flag pattern, and price rallies higher then it makes a potential bull flag pattern where the retracement is very weak, signalling the price could break up higher.
But here’s the thing, if this bull flag pattern is formed within an existing downtrend, what are the odds of that bull flag pattern working out?
On the other hand, let’s say another scenario this time around the market breaks out of the range to all-time highs and a bull flag pattern is formed. Now, what are the odds now of this particular setup working out?
Can you see what I mean by the context of the market? I’ll give you two examples:
- When the market is in the long term downtrend and you’re looking to buy the bull flag pattern
- When the market breaks out to all-time highs and it forms a potential bull flag pattern
See the difference between the context of the markets that you’re trading? This is important, if you take into consideration the context of the markets, you’ll find your chart pattern trading will improve – that’s the first thing.
2. You neglect the significance of the chart pattern
What do I mean by this? Let’s say the market is in a long term uptrend over the last 200 candles where the market has been overall going up steadily and now the market forms a head and shoulders pattern.
But this head and shoulders pattern only took 20 candles to form. Now ask yourself what is the significance of this head and shoulders pattern? What are the odds of this head and shoulders pattern? Logic will tell you that the market is likely to continue higher.
Because this head and shoulders pattern is pretty darn insignificant, it’s only 20 candles versus a 200-candle uptrend. Do you see my point? Now let’s change this scenario a little bit.
Now, what if the uptrend is made up of 200 candles, but this time around the head and shoulders pattern is made up of 300 candles? You can imagine at this time around, this head and shoulders pattern is much bigger because it took 300 candles to form.
Do you see the significance of this? Because when you have a head and shoulders pattern that is made up of 300 candles, the dynamics have changed drastically. Now the neckline of the head and shoulders pattern (which is the support level), will be obvious. It’ll capture the attention of many traders.
And when that level becomes significant even for the higher timeframe traders, if it breaks there is now more significant because it breaks a key area of support that has been defined over 300 candles.
That becomes a more significant chart pattern compared to a head and shoulders pattern formed over 20 candles. So pay attention to the significance of the chart pattern as well. If it forms after 5 or 10 candles, it won’t be as significant compared to a pattern that is formed over 100, 200 candles.
3. You neglect the nuance of the chart pattern
Let’s talk about head and shoulders patterns since this is the most popular one out there. You know there’s the left shoulder, the head which is the highest peak of all and followed by the right shoulder.
For the classical head and shoulders pattern, when the price drops quickly from the shoulder to the neckline, that move is quite a distance.
There will be traders who look at this and say this neckline is an area of support and they’re looking to buy when the price reverse from the neckline to continue higher. The price reverses here because it came into an area of support.
But what if now this head and shoulders pattern it falls in a slightly different manner?
Instead of dropping straight into the neckline, the price starts to consolidate at the neckline to form a tight consolidation.
Now, the message by the market has changed because it’s telling you that it has reached an area of support (also known as the neckline) but it failed to rally. This tells you:
- There’s a lack of buying pressure
- Selling pressure is coming in to hold the price down lower
So if the neckline breaks, there will be a flood of other sell stop loss order being triggered, which will add fuel to the selling pressure. And that’s where the likelihood of a reversal is much higher.
These are the nuances to chart patterns and you have to understand these different nuances. You can’t just take the classical chart pattern from the textbook or courses then memorize it and look to trade it.
You’ve got to understand all these different variations and nuances where traders might get trapped and where would their stop loss get triggered and stuff like that. Chart pattern is more than just memorizing all these. It’s not an exam, this is the real world of trading.
4. You think chart patterns can predict the future
I don’t blame you, because that’s what I thought as well. You might think, “Oh a triple top means the market is gonna reversal, or a double bottom means the recovery is in place and it’s time to buy.” No, it doesn’t work that way.
Chart patterns are just tools you have a gauge buying and selling pressure in the market, whether the buyers or the sellers have the upper hand. And that’s pretty much it.
And chart patterns help you define levels, boundaries, on where you can look to enter a trade and set your stop loss. So chart pattern is about:
- Identifying the buying and selling pressure
- Finding useful price levels based to set your entries and stop loss
- Managing your trades (if you want to)
That’s really what chart patterns are used for. Not trying to predict what the markets will do.
When you know there’s always a probability of a loss even though the head and shoulders pattern looks extremely beautiful and all the stars are aligned, there’s always still a probability of loss. You still must take into account your risk management.
I hope these pointers help if you’re struggling with chart patterns because chances are, it’s due to one of those reasons which I’ve just pointed out.
With that said, I’ve come towards the end of today’s episode and I’ll talk to you soon.