A lot can be said about chart patterns, some good, some bad. My father once told me that “every ship on the bottom of the ocean had a chart on it!”. What my dad failed to realize was that ships rarely sink. Most of the time they make their destination. However, he was correct in the fact that the ones that have gone down were quite often not reading the chart properly. The point being is that if you want to use chart pattern trading successfully, you better be sure to separate the chaff from the wheat (commodity pun intended).
Chart pattern recognition can be a very valuable tool in a technical analyst inventory. But it is subjective, not science, rather art. I find it very easy to see something there that isn’t, because it supports my market beliefs. To be employ chart pattern trading successfully, it is imperative that one be meticulous in their analysis. There are components other than price that must be considered.
Price chart trading are inherently tied to the overall emotion of the market. This is something that is almost universally overlooked. The key basic input that most traders ignore in chart pattern trading is volume and (when available) open interest. I have said many times before that market emotion is conveyed in volume as it represents the urgency in which market players feel the need to react. Consider when someone asks “why the market went down?” the flippant response is almost always “there were more buyers than sellers”. While this may seem true, it is a condition that is actually impossible. That’s because for every buyer there has to be a seller. The response to the question should be “the sellers were more motivated than the buyers”. Market volume quantifies the overall market mood.
Think about a simple consolidation pattern, like the flag or pennant. The market has pushed up (or down) very quickly. At a certain moment in time the trade becomes exhausted. Players need a break. What this means is that price simply needs time to overcome the overbought or sold condition. Consequently, if this in fact the case, volume should drop as price catches its breath. If volume does not drop, but expands, it is a very serious sign that it is not a continuation pattern.
To successfully use chart pattern trading, it is imperative to be non-judgmental. Look at the data, especially volume and open interest, and correlate it with market emotion.
I have successfully spent many years charting the markets. However, it is a holistic approach. Make sure you know how the market feels before you make judgments.