The Odds of a Pattern
06/12/2009 12:01 am EST
It’s a common question we get in our seminars: What is the rate of success of “this” or “that” pattern? To which I'll answer with another question: What type of market are we talking about; up-trending, down-trending, sideways? After observing the puzzled look of the individual asking such a question, we'll tend to explain that a pattern is just a part of the whole equation that comprises what we call a setup. Let me explain.
When we consider the odds of a pattern, besides the obvious consideration as to the quality of its formation, we have to consider the conditions that surround such patterns. A buy pattern typically fares better under bullish market conditions, whereas its performance tends to be less spectacular in bearish scenarios. Vice versa for a short pattern. This means that in a bullish environment, any pattern that suggests that buyers are about to retake control of a stock will have better odds of success. This doesn't mean that the setup can't fail, but the odds of that pattern following through are better.
So now we're adding the market factor to the equation. Is the market bullish or bearish? There are also other factors to consider, like market internals, for example. Do they favor bullish patterns or bearish ones? How about the sector to which a particular stock belongs? The odds of a buy pattern for a stock belonging to a strong sector are better than the odds of the same buy pattern in a stock belonging to a weak sector. Either pattern might have a great or poor performance, but when talking about the odds of something happening, we should consider whether money is actually flowing into this sector (indicating strength), or flowing out of it (indicating weakness).
When trading professionally, you have to educate your mind to think in terms of probabilities in order to understand the implications of market environments in the potential outcome of any trade, and to properly apply those tools that best fit the market situation in any timeframe.
Until we meet up again, stay safe and remember, no one is making you trade. So, only take trades and investments that line up with the highest probabilities and that fit into your specific plan!
By Ron Wagner