How our charting guides work
Get into the market with the odds in your favour
- Every trader wants a clear view of where a market’s going. Then he buys or sells. Some look at macroeconomic statistics, others feel it in their bones, while traders who use charts - Chartists - predict a market by looking at its past behaviour – as revealed in the pattern of historic prices.
- Technicians think that the market has a psychology much like a person. They argue that because the market is made up of many individuals whose responses to events can sometimes be predictable, so the market as a whole has a personality that will predictably respond to stimuli. Even more predictably than in any one person’s case.
- They have studied the market’s behaviour in the past and found those predictable responses characterised by recurring patterns of price action.
There are many types of Technician; indeed, a new ‘school’ is discovered every few years. And they each have a favourite group of predictive patterns. There are great debates about which school of charting performs best. But since none are mechanistic and all require interpretation, you may be sure that there are no clear-cut winners. Certainly, some work better than others in particular market conditions, but over time, most chart styles will be usefully predictive when applied with rigor and experience.
Do patterns always work?
- No. This is because pattern recognition is a question of judgement, an art not a science. One man’s ‘Head and Shoulders Reversal (a Classical Bar Chartist’s trend reversal pattern that is a personal favourite) may not be another’s.
- Even if a pattern was so perfectly constructed as to be universally agreed, the expected move might not happen. One reason for this is that anticipating behaviour is not an exact science but a question of probabilities. Another reason for this is simply that a bull trend over the course of a week may be a blip in a larger bear trend over the course of the last month, which in turn may be a blip in a larger still bull trend over the last year. Patterns exist within larger patterns. The result of this is that a perfectly formed bear pattern may be overwhelmed by a larger bull pattern of longer standing before it can complete.
- Even though rigorous chartists always check the context of any pattern (and many aren’t rigorous) looking for opposing forces that might nullify their prediction, they cannot always be sure when one pattern’s influence will begin and another’s ends.
So when Chartists trade on patterns they are swinging the odds in favour of the predicted outcome, not pursuing a certainty. That is the first job that Charts can do for the trader – they reveal patterns whose effect on the market is predictable. When the Chartist spots a pattern he buys or sells and sits back, waiting for the profitable move to come. He is happy. But that is only the beginning. When is he going to get out?
Charts control your risk by disciplining your decisions
Someone once said ‘there are no great traders only great risk controllers’. What they meant by that is that lots of traders think they know where the market’s going, but very few really control the risks of a trading position – when to take a profit and when to cut a loss. In short, when to get out of the market.
When the price moves, however little, the trader often finds himself pressured by conflicting emotions as his position registers profits or losses. A small profit is both gratifying and a source of intense anxiety in case it disappears. Similarly, a small loss is simultaneously worrying and tempting – is it an opportunity to buy again more cheaply in line with the original trade? Managing these emotions is the hardest part of being a trader.
This is where charts can help again.
- Charting’s greatest gift to the trader is disciplined approach to decision-making once a position has been established. Charting can help eliminate emotion from trading.
- The Chartist who has entered a position need only ask himself two questions: Has the pattern achieved its minimum target? Has the pattern failed? If the answer to either of these is yes, then he should close the position. Otherwise he should leave the position alone.
- The answers to these two ‘exit questions’ can be complex. For one thing, not all patterns have a target. They may simply suggest a continued move in a particular direction. And even when they do have a target, they are minimum targets. The trader must still judge how far the market may travel beyond.
- Pattern failure is not always clear either. Markets can tease by briefly re-entering critical areas before rejecting them. Too-cautious an interpretation of pattern failure will often get the trader out of a profitable trade. On the trading floors market insiders (looking at the same charts) will push the market briefly through significant levels to flush out the weak or cautious. If stop orders are left to exit a position in case a pattern fails, they need to take this market volatility into account.
These considerations all require experience to handle. But even so, the disciplined approach to decision-taking that comes from charts is a huge benefit to the trader. The challenge for all traders is to filter out the noise and concentrate on the essentials. Let the probabilities take care of the position. The challenge is not to track the market but to win more than you lose. Chartists do this in a particularly successful way.
No trader can predict the market correctly all the time. But with the help of charts, some develop disciplined profit-taking and loss-cutting strategies. They are the great risk controllers.
And those are the ones that get rich.