The Myth of the “Ultimate Price Pattern”
10/23/2009 12:01 am EST
The quest to find that “ultimate” pattern that will make him/her rich is one of the most misunderstood ideas that the novice or uneducated trader has to contend with. How many traders spend countless hours sifting through books, learning this or that pattern, only to get frustrated when the pattern isn't as successful as advertised? And so they look for new patterns...
What are they missing? Why is it that their search ends up most of the time being a wasted effort? The answer my friends, lies in the title of this short commentary. A price pattern can only exist in the context of a market. What does this mean? In order to understand this concept, let’s go to the basics. A price pattern is also a behavior pattern.
The behavior of countless buyers and sellers interacting in the markets, most patterns are pictures of a point in price and time where one group (buyers or sellers) cedes control of the price action to the other. A buy pattern is one that suggests that sellers have exhausted their strength and there's the potential for buyers to retake control. Vice versa for sell patterns. So what's this have to do with the market? Well, most stocks are influenced by the market trend and sentiment. This is because stocks don't move by themselves; people buy and sell these stocks, causing their prices to move up or down, depending on whether buyers or sellers dominate.
In a bullish market environment, market participants have bullish expectations of higher prices. Few of them think that prices will move lower, and so they have little interest in parting with their stock. The same is true for bearish market environments. This market direction and sentiment has a lot to do with the odds of a pattern.
In a bullish market environment, either in an intraday or daily time frame, the strength of the trend is to the upside. Most traders’ expectations are of stocks moving higher. Thus, profit taking tends to be mostly light and most of the selling pressure isn't long-lived. The opposite is true for a bearish market. In this sense, bullish patterns will have better odds of continuation in a bullish market, as traders are willing to pay higher and higher prices for stocks.
On the other hand, bearish patterns, in general, in a bullish market might not see the level of selling necessary to produce several days of declines in the price of that security. This is one of the reasons why many bearish patterns fail in bullish scenarios.
Of course, there will be sectors and stocks that will definitely act bearish in a bullish market, and vice versa, but these are the exception rather than the norm, usually the product of sector rotation or other reasons for countertrend trades to be possible on some days.
By Ron Wagner