Rational Behind Profitable Patterns
If you are a trader, then you will ask the question like “What makes the patterns study different from technical indicator?”. This is the right question to ask before using profitable patterns in your trading.
Let’s start with what are the profitable patterns in brief. Profitable patterns can include harmonic patterns, breakout patterns, X3 patterns, Elliott wave patterns and any other geometric patterns in your chart. I am referring breakout patterns to falling wedge, rising wedge, triangle patterns in this article. These patterns are popular and used by countless number of trader each day. Many found their ways of breaking the market with these patterns.
Unfortunately, there are no good educational materials or articles in pointing out the rational behind profitable patterns. These profitable patterns are observed as real and significant phenomena in the market. These practical trader was just using them for their trading without asking much theoretical background. Hence, in many research articles, often patterns are just patterns without much further explanation. I tried to show how these profitable patterns are connected to contemporary science and math in my previous book: Scientific Guide To Price Action and Pattern Trading. You will find many different angles to explain these profitable patterns in terms of existing scientific and mathematical theory. For example, I have outlined how Gardner’s forecasting profile table can be used to extend the logic of profitable patterns. This shows that patterns fit well in the time series forecasting and statistics. At the same time, I have shown that patterns in terms of number of cycle periods. This also connect patterns with Fourier transform and wave theory in signal processing. If anyone want to dig deeper, then I will recommend to read this book: Scientific Guide to Price Action and Pattern Trading. In here, we will rather focus on giving you the short answer on the question ” What is the rational behind the profitable patterns?”.
To find out the rational of the profitable patterns, it is good to ask question on how these patterns are different from the technical indicators. The biggest difference is that technical indicators make use of successive price data in its calculation. For example, to calculate moving average or relative strength indicator values with 20 indicator period, you need to take the successive 20 data points in your calculation. Probably 99% of technical indicator are doing the same thing.
In pattern study, we skip any insignificant data points and we only focus on some meaningful data. For example, in the Gartley pattern, we care about five data points that confirm the structure. We do not concern too much on the rest of data.
Most of time the calculation logic of technical indicator is based on the assumption that price data point will reveal trend or they try to reveal trend by looking at all the data points in the price series. However, are they ? Well, financial market data is one of the toughest data to predict comparing to other scientific and engineering data. Many consider that financial market shows the stochastic trend rather than deterministic trend. What does this stochastic trend means? This means that there could be some trend but not always. In stochastic trend, sometimes, you can have clear predictable trend. However, sometimes, they will never be predictable.
In this end, these Patterns are more suitable to study this sort of stochastic trend behavior in the financial market. Because profitable patterns alert you when market shows some predictable footage, you will be inactive during these unpredictable time.
For example, if you trade with Elliott Wave 1234 or 12345 patterns, then you are not able to fit the Wave 1234 or 12345 structure always in your price series. What does this mean ? This means that market is more chaotic and less ordered during the period. Hence, it is recommending you to stay away and to be inactive in your trading during this period rather than entering unpredictable market time.
Having said that, these profitable patterns are not the bullet proof tools. They are still subjective to probabilistic nature. Hence, you need the right risk management to favor your odd of winning with these profitable patterns. This article does not mean that you should not be using any of technical indicators. I do use them together with these profitable patterns. However, I never use technical indicators alone and they are secondary confirmation most of time.