We did this because if you take every buy and sell signal an indicator produces, your trading career is guaranteed to be short lived.
It is not that the indicator is not working properly, they always work exactly as they are programmed to work.
The issue is that most traders don't use indicators properly. Today, we will apply some more simple yet important logic to conventional chart patterns.
There are many chart patterns such as Triangles, Flags, Pennants, The Cup and Handle, The Head and Shoulders, and many more.
While I chose to stick to pure demand (support) and supply (resistance) in my trading, many new traders like these conventional chart patterns.
One thing all these patterns have in common is that the entries are all "breakouts". No matter how much you like these patterns however, whether each trade taken ends up in a gain or a loss depends 100% on the supply and demand equation at the price levels to which price is breaking out into.
In other words, before pushing the buy or sell button to enter the breakout, you must assess the "profit margin" to make sure there is room for price to run, after you enter. Let's look at some examples.
Here we have an intra-day chart of RIMM. Notice the Descending Triangle. While it looks to be a picture perfect pattern, whether we take it or not depends on the profit margin.In other words, where is the first support (demand) level below our short entry point, which is a break of the bottom of the triangle?
We can see here that there is plenty of room to the first target and a little more room to the second target. In this case, shorting that breakdown from the triangle is fine. Had support below the triangle been too close, this trade likely would not have worked out.
Let's now look at a daily chart of DRYS. Here again, we have a picture perfect Descending Triangle.The difference in this case is that the support level below the triangle is somewhat close meaning our profit margin is not ideal.
In the RIMM example, our reward to risk was about 5:1. In the case of DRYS, our risk reward is much less because support is much closer to our entry point.
This profit margin may still be fine for some traders but the point is, you must know what that profit margin is.
To quantify your profit margin, you must be able to quantify demand (support) and resistance (supply) based on objective information.
Keep in mind that the task of quantifying supply and demand is beyond the scope of this article, however, we do cover it extensively in class.
Here we have the popular "Bear Pennant". This one seems to be a class favorite and that's great, as long as you know where your objective targets are.In the case of EBAY, we can see that the support level gives us a decent profit margin as it is well below our entry point.
This pattern, just like the descending triangles is a continuation pattern. Notice in this example, price spends very little time in the pattern.
This is typically a very good sign. With all these patterns, the less time price spends in the pattern, typically the better the outcome.
Why write about conventional chart patterns you might wonder? Along with my trading, I teach the Stock, Futures, Options, and Forex classes for Online Trading Academy and in all of these classes, I always find some people looking for the conventional chart patterns.
The two issues that they fail to consider are the difference between profits and losses and they are as follows:
Almost all the entries for conventional chart patterns are "breakout" entries. This means you are going to have a hard time getting a good fill on your entry order so be careful not to chase price too much.
If you miss the low risk entry, let it go. There is always another trade.
People need to realize that you can have a picture perfect chart pattern and it can still fail miserably.
When this happens, it is because the breakout entry was right into a support or resistance level.
There are many ways to trade and keep your trading low risk and high reward. You can use chart patterns, indicators, Moon and Star patterns, and much, much more.
The one governing dynamic that will determine the outcome of all these types of trading, however, is how well you can quantify supply (resistance) and demand (support).
Sam Seiden,
www.educational-dvd.com
DISCLAIMER:
This newsletter is written for educational purposes only. By no means do any of its contents recommend, advocate or urge the buying, selling or holding of any financial instrument whatsoever. Trading and Investing involves high levels of risk. The author expresses personal opinions and will not assume any responsibility whatsoever for the actions of the reader. The author may or may not have positions in Financial Instruments discussed in this newsletter. Future results can be dramatically different from the opinions expressed herein. Past performance does not guarantee future results.
Reprints allowed for private reading only, for all else, please obtain permission.
