If you asked me to recommend one particular skill that has contributed most to my improvement in analysing charts, I would answer recognising patterns, pretty much without hesitation.
The world of patterns offers a unique opportunity to look at the charts with a deeper understanding that goes beyond the traditional concepts of trend and Support & Resistance.
This article explains why patterns are so critical in my view, how to improve pattern recognition skills, what qualifies as patterns, and which patterns I personally use when analysing the financial markets, such as Forex, CFD trading, and commodities.
Why Are Patterns Important?
Traditional Support & Resistance (S&R) trading is usually reliant on the ability to spot key levels and then to trade reversal setups away from S&R. Simply said, the trading system is focussed on finding a reversal pattern, like pinbar for instance, and trading that reversal.
Knowing pinbars is important, but, in my view, it is not enough to fully grasp the information on the chart. You can compare trading to learning a language:
- Learning just S&R is the equivalent of learning enough for a small talk in a new language.
- Adding patterns to your bag of trading equals speaking the foreign language as a local.
Or think of it this way – the chart is our road map... The more you know about the terrain, the better you will be to analyse and distinguish between better and weaker trade setups.
The price moves on the chart in accordance with a principle called "the path of least resistance" (watch the video below), which explains how the price flows and moves based on price patterns, trend and momentum, and S&R.
Traders are better equipped to analyse this likely path if they take patterns into consideration. The world of patterns is crucial because it opens up your ability to read and understand the chart in a deeper way.
Not knowing anything about patterns puts a limit on how much a trader can analyse. But by analysing patterns, traders are able to interpret and assess whether the price will break or bounce at S&R and whether the price will keep trending or will reverse or will stay in range.
If you can identify patterns, you can trade it because there is a decent chance that price will repeat in a similar way. You will build the ability to make an educated assumption about the direction.
How Do You Improve Pattern Recognition Skills?
The first step is to know which patterns you want to focus on when analysing the charts. I will share my favourite patterns in the next paragraph.
The second and most important steps are practice, practice, and practice. It is said that practice makes perfect… Although I don't think aiming for 100% perfection is worthwhile in the context of trading, practice is certainly a tool that can help heavily with pattern recognition skills.
Practice can be completed in various forms. Traders can practise on actual live charts by adding their analysis of patterns and checking whether their analysis did indeed unfold as expected.
Traders can also do similar practice on historical charts. The advantage of using historical price data is that you are able to practice on more charts in a shorter amount of time. This is useful for learning purposes, whereas real-time practice with patterns remains critical because trades are made in the present, not in the past.
Our live trading webinars are an excellent place to start gathering knowledge about patterns and other concepts. They also offer value with real-time practice because Nenad and I analyse live market conditions, and we always incorporate patterns into our full analysis.
All in all, the first step is knowledge. Knowing which patterns are key and how they can impact your analysis. The second part is practice and testing. The third step is to translate that experience into a trading strategy and apply risk and money management methods.
Source: GBP/USD 4-hour chart from 16 November 2017 to 4 January 2018
What Are Good Patterns and Which Ones Do I Recommend?
Patterns could be any particular sequence that occurs twice and then is confirmed on a third occasion. However, not all patterns make sense and offer actual value.
For instance, if I notice that my first trade has turned out to be a winner five times in row, then, obviously, this particular pattern is based on pure luck and will not help my trading or analysis in any way.
There are many useful patterns. The ones I personally use are listed below:
- Chart patterns
- Candlestick patterns
- Wave patterns
- Divergence patterns
- Time patterns
- Fibonacci patterns
- Bounce and break patterns
In a different article, I explain the details of the patterns listed above, which I named 7 Best Trading Patterns for the Forex and CFD Markets.
I am sure that there are many other patterns available besides these seven. When analysing new patterns, make sure to understand whether the pattern will indeed offer extra value to your analysis before adding it as a permanent part of your trading tools.
Wishing you a happy trading,
Forex and CFD trading carries a high level where losses can exceed your deposits. This material is does not contain, and should not be construed as containing, investment advice or an investment recommendation or, an offer of or solicitation for any transactions in financial instruments. Please note that the trading analyses which refers to past performance, may change over time. No representation is given as to the accuracy or completeness of the information and any person acting upon it does so entirely at their own risk. Before making any investment decisions, you should seek advice from independent financial advisor to ensure you understand the risks involved.