CHART PATTERNS

Trading based on chart patterns are one of the most visibly simple but also 'difficult' strategies in the stock market. Before applying pattern based strategies, the trader/investor must be mindful of its nature.

Identifying chart patterns

Chart patterns are divided loosely into 3 categories:

1. Continuation patterns i.e. flags, pennants etc.
2. Reversal patterns i.e. head and shoulder, double bottom etc.
3. Both continuation and reversal i.e. rectangles, triangles, wedges etc.

While patterns generally adhere to a set of characteristics that differentiate them, actual application and recognition is difficult due to the following:

1. Patterns grow i.e. what seems like a triangle now could unfold and change into a channel later. Therefore confirmation is required.
2. Text book examples of chart patterns are usually clearly defined for illustration purposes but in reality, patterns can be confusing.
3. Some chartists must have more flair for recognising patterns than others. It is not unlike the 'ink-blot' test. Where one sees a 'cup and handle' another one may see an 'inverted head and shoulder'.

Application of chart-pattern strategies

1. Identify if the trade may be a continuation trade or a reversal trade.
2. Identify the point of entry. Entry is usually determined by a move out of a trading boundary defined by the pattern. In other words, it is akin to trading breakout.
3. Determine if the breakout is true or false with inspection of other inputs such as trading volume, market depth etc.

Sell to close (buy to close)

1. Wait for new pattern to form.
2. Sell to close when price breaks out of new pattern towards entry position.
3. Buy to add if price breaks out of new pattern away from entry position.

Suitability

Pattern-based trading strategy is not for everyone. Persons attempting pattern based trading should observe that:

1. He/she has personal affinity for recognizing patterns correctly.
2. A longer time frame is required i.e. it is not usually suitable for contra or short term traders as many patterns could take weeks or even months to emerge.
3. The good thing is, pattern recognition could be improved with plenty of practice.