There are many markets in the world, and there are many different strategies used by market participants to trade.
With any financial security, there are trends. Whether it is in an “uptrend” or in a “downtrend” is decided by the price action, but there are clues to when these trends might occur or change direction. This is where patterns are formed.
Patterns are used by many traders and financial institutions alike, to recognize trends continuations or trend reversals. While there can be no special software or other means of recognizing the changing trends with 100% certainty, patterns come very close indeed.
What are patterns?
Whether it is a scalper/day trader, or a trend trader or even a long term trader, candlesticks and patterns are an integral element in the technical analysis toolkit of any trader. Patterns can be critical clues regarding which way the price is headed in the short term / long term, depending on the timeframe in question.
Patterns also quantify human nature and have been found in many critical elements of business models. By learning about patterns as a basic strategy to include in the decision-making process while formulating a trading plan, one can achieve a higher rate of success in trading.
Here are some basic patterns that have been observed repeatedly in markets all over the world:
- Double Top
- Double Bottom
- Head and Shoulders
- Ascending Triangle
- Descending Triangle
- Pennants
- Rounding Bottom
Why are patterns so important?
The straight answer is that these patterns repeat themselves over and over again. There is no “pattern” to how they repeat themselves, they just do, and those that are skilled at recognizing patterns are able to catch them. To catch a pattern that can potentially reverse a trend is a rarity and makes for a very lucrative trading opportunity.
What makes patterns so attractive to all kinds of traders is that they have been observed to have formed before the reversal of many trends. However, on the flip side, there are those patterns that have turned out to be hoaxes.
So, what is it about patterns that no one will openly say?
Well, it is as simple as patterns are directly related to the time frame in question. Let us tell you how. There are many factors that decide where the price is headed after the formation of a particular pattern.
As a trader, you are well aware that you cannot make a trading decision based off of just one factor. It is a collection of factors that contribute to a decision. Here, we let you in on the secrets of what goes behind the decision making of a pattern day trader:
Account Value:
First and foremost, what is the value of your account, and how much risk are you ready to take? Answering this question to yourself will help formulate the base of your trading strategy.
Once you know how much you are ready to risk, you can recognize how much each financial security moves each day, and this decides which financial security you must trade with according to your risk. Calculating the risk to reward ratio is an integral part of any trading plan.
If you are able to mitigate and withstand the risks of the trade, you will be able to make a successful trading strategy. How much are you willing to risk compared to how much the security moves each day will lead you to our next question – what time frame are you looking for?
Time frame:
Once you have recognized the risk you are able to take, you are now ready to calculate the potential rewards. Pay special attention to the time frame of the instrument and what is the average range in any particular time frame. Recognizing a pattern in the right time frame is very important.
Different time frames favor different patterns, and each time frame is correlated to the neighboring time frames. The long term trend will always dictate the price action, and any pattern formed in the long term time frames is the result of the shorter time frames helping in the formation of that particular pattern.
Credibility:
There are some financial instruments that favor some patterns, and those are evident facts. Many a times, patterns are completely ignored by some financial instruments, and it is vital to recognize the details. These can offer critical clues of price action. These patterns are governed by historical data, and it is not uncommon to see a few changes in patterns during times of high volatility.
News: It is very possible that you spot a pattern, and it has been recorded to show changes in the trend. There is still one factor that could cause the pattern to be a hoax is the news. News has had a notorious reputation for being market movers, and it is vital to recognize which piece of news will cause what kind of changes to which financial instrument.
Application:
It is also very important for you to use the right application to execute your trades. The new age day traders use bots to place their orders because bots give unparalleled accuracy and execution of trading plans.
A lot of technical traders use limits and price action as an indicator to recognize the outbreak of trends. Using a bot to fulfill these price action based trading strategies demands the use of accurate tools to implement these strategies. This is important because oftentimes, the entry, and the exit window is open only for a few seconds.
In the confusion of adding and setting stop loss and target profit limits at the end moment, the window to place the order is lost – this is what happens with most manual traders. This problem is eliminated with the use of a bot to place and take prompt action – accurate to the millisecond to gain the all-important entry into or exit from a particular position.
Wrapping up
All in all, it is recommended to practice the use of any pattern and use it as one of the indicators in the decision-making process. With the help of a paper trading app like Alpaca, you can put these strategies to the test. Using a paper trading environment to back-test strategies before implementing them in a real environment is vital to the success of any trader.