Q. Dear Sandy, what are chart patterns?
A. A trader has plenty of choices regarding chart patterns. There are many different types of patterns such as reversal patterns, continuation patterns, consolidation patterns and a variety of others. You can also have price patterns and time patterns too. A market may not always move in a straight line and consequently will create a pattern on the charts.
For example, the FTSE 100 has rallied from a certain level, stops at a particular price which we will call the resistance price level and then falls back. At some point the index will reverse its decline – this is known as the support level. If the index then continues higher and breaks past the recent resistance level, then the market has just created a bull flag.
Q. Are patterns reliable?
A. Generally speaking, patterns are not perfect. But chart patterns can be considered a sensible way to make decisions as long as risk management and money management techniques are applied.
There are, however, some very reliable time patterns that can be used. As an example, did you know that the Dow Jones has declined from 28 December to 22 January in the last 12 years? This type of analysis can be useful because it can help a trader prepare for a potential opportunity in advance. We can then look for a trigger to enter the trade.
In this example, a simple trigger would be a break below a weekly low after 28 December. Of course, trade management is of high importance to prevent large losses.
Q. Which markets provide opportunities?
A. At the end of the day all markets trade on price action so you can look for chart patterns in any market. I personally prefer the forex and commodities markets because these can be quite volatile – therefore large price moves and increased activity are likely. I would suggest picking a few markets and practise observing simple patterns. Then once you gain some experience you will start to see that the markets do trade in very specific patterns. It is at this stage that trading can become very interesting.
Learn more about technical analysis with Sandy at his free City Index seminars.