Why Pattern Trading Works
09/26/2011 4:00 pm EST
Trading patterns on the charts is one way that short-term traders find high-probability trades, and Suri Duddella describes important concepts and one type of pattern that is working well now.
I’m speaking with Suri Duddella on pattern trading. Suri, tell me why pattern trading is important.
Pattern trading is one of the most objective ways of trading. Patterns are quite repeatable and then they run cycles. Because of that reason, you can actually predict what a pattern is going to do next.
So it gives you a great, precise way of entering into the markets, and before you enter into a trade in pattern trading, you’ll know exactly what your risk/reward ratio is.
See related: Make Sure Risk/Reward Is on Your Side
Because of that reason, pattern trading, in my view, is a very superior method of trading over any other forms of trading.
What are some of the components of that?
Pattern trading involves both the structure of the pattern itself, which includes both the time and the price structure. Within that, there are a lot of patterns. In fact, I wrote in a book about patterns, about 65 patterns, but all of which I may be pretty good and fluent in ten patterns, because nobody can be very fluent in all the patterns.
So I use out of this ten, my primary way of looking at the patterns is through the harmonic patterns. Harmonic patterns are the patterns which use and decide the harmonic ratios, which are like Fibonacci ratios.
See related: Find Great Trades with Harmonics
So in that, I think that probably has a higher probability of success in the harmonic trading. So I use those patterns, which include both the time and price, which is very critical.
Also, the structure itself is where the pattern is forming in the current market. That’s a very critical aspect of picking which pattern works and which pattern doesn’t work. What I call that is the market context.
Within the market context, you have to define structure, and then you find the pattern, and those are the patterns which I trade.
Can you find this same pattern in different time frames, and does that give you stronger confirmation?
Absolutely, absolutely. Patterns have a couple of concepts. Patterns within the patterns and also patterns on a higher time frame.
In fact, higher-time-frame patterns are much more successful, but when you drill down to a smaller time frame when you’re trading, if you see a confluence of a single pattern forming in the higher time frame than the lower time frame, it adds to the success.
Can you use this for intraday trading, swing trading, and long-term trading?
Absolutely, patterns work in all time frames and also in all instruments. Any instrument which has the basic data like open, high, low, close, and of course, the time stamp, it’ll work in that.
It also works in range bars and different types of alternating chart types.
See video: Gain an Edge Using Range Bars
The recognition of it, is it just by practice, practice, practice?
Well, actually there’s two concepts. One is that recognition is visual because if you have to see thousands of orders in order to practice it, but the other way is to detect automatically.
You can write algorithmic programs to detect it, then you can also write rules to see where and how you enter into the trade.
Then, as I said, the patterns are superior because you know the risk and are far ahead of it. Patterns also give you multiple opportunities to get into that trade, because even though patterns are forming, as long as the pattern has not failed, you can enter into that pattern multiple times.
So that’s the biggest advantage about the pattern theory.