Trading on trading patterns on the foreign exchange market
There are many methods of technical analysis in trading. One of the most popular is trading by patterns or, as they are also called, figures. This method of predicting the price direction has a lot of supporters and opponents. Let's try to objectively evaluate the pros and cons of trading on technical analysis patterns.
Why there are technical analysis figures
Proponents of using patterns rely on one of the tenets of technical analysis, which states that price takes into account everything. The price has a graphical representation: a continuous line, bars, Japanese candlesticks. Accordingly, studying the price chart of an asset is essential for predicting price.
In addition, if we take into account that the price moves under the influence of the moods of market participants, then, from the psychological point of view, if the price has formed any patterns in the past, exactly the same patterns will be formed in the future.
Patterns in trading are usually called a certain number of combinations of candles, which periodically repeat. It should be noted that the patterns can be divided into three groups:
- technical analysis patterns - Double (Triple) Top, Head and Shoulders, Flag, etc;
- candlestick patterns - Doji, Hammer, Absorption, etc;
- patterns Price Action - pin bar, inside bar, etc.
Despite the differences, all three groups are united by the fact that a certain candlestick formation that was observed in the past and the price behavior after the appearance of the pattern is used to predict the price.
In simple words, if in the past, after the formation of "Head & Shoulders" pattern, the price reversed, the uptrend ended and the downtrend began, then when such pattern appears in the future, the trader expects the price behavior to repeat the past.
What trading using patterns implies
In order for trading using shapes to be effective, it must necessarily have certain system characteristics:
- Figures of technical analysis, candlestick patterns and patterns Price Action should have a positive mathematical expectation. This means that the probability that the price will go in the direction predicted by the trader exceeds the probability of an undesirable outcome. Otherwise the use of figures in trading is meaningless. For example, it is recommended to use candlestick analysis models on timeframes from H4 and up. On these timeframes, their expectation is positive. When trading candlestick patterns on lower timeframes, their mathematical expectation will be negative, i.e. there will be more false patterns than true ones.
- Do not base your trading solely on patterns. It means that one should not constantly look for any patterns on the charts. Ultimately, it leads to the fact that the trader begins to wish for reality, finding patterns where there are none.
- Trading on the formed model has a short-term nature. This is due to the fact that the lifetime of the patterns themselves is limited. Taking this into consideration, a trading plan must contain not only the variant of reaching the price of the set goal, but also the order of actions in the case of expiration of the "life" of the pattern.
What it looks like in practice
Let's say, having tested on history Flag" trend continuation pattern, the trader determined that this pattern in 80% cases allows to make a profit. The average "life" of this pattern, according to the tests carried out by the trader, is 7 days.
Having seen the "Flag" pattern formed in real time, the trader opens a position, places Stop Loss and Take Profit orders. According to calculations, within 7 days one of these orders will close the position.
The market is not constant, so the trader's calculations can be disrupted. It can be the release of some news, macroeconomic publication or other factors that will lead to a change in market sentiment.
In 80% cases, nothing will interfere with the transaction and it will be closed within 7 days. In 20% cases "something will go wrong". For example, the directional price movement will stop. As a result, the calculation period is over, but the trade is still open. In this case it makes sense to use a trailing stop or close the position altogether, because the trade is no longer in the calculated pattern, and therefore the percentage ratio of 80/20 is meaningless.
Read about other currency trading tricks in the new book "Lifehack for the trader. About Trading Strategies".
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