Pattern
Failure
Patterns appear at the end of thrusting
price movements. They are characterized by constricted swings between key
support and resistance levels. Pattern development completes when a new
trend leg breaks through this wall into directional price change. This new
thrust may be in the same or opposite direction as the previous one. A
pattern between adjacent price moves in a single direction continues
that trend. Alternatively, when a breakout turns and retraces the last
trend leg, the intervening pattern reverses the prior move.
You can categorize most patterns by
their tendency toward continuation or reversal. This familiar bias
underlies the predictive power of these structures. By their repeating
nature, a well-marked chart landscape can be drawn to profit from the
expected breakout. Use classic observation and well-chosen technical
indicators to examine patterns as they develop. Their bullish or bearish
nature can often be identified well before completion and exact entry
points chosen where new price momentum will likely erupt.
But sometimes patterns won’t do what
the crowd expects.
One of the most powerful signals in
pattern analysis flashes when a setup fails to act according to its
tendency. This pattern failure often triggers sharp
price movement in the opposite direction from the formation’s natural
bias. Have a contrarian entry system based on this reversal waiting in
your trader’s toolbox. But first exercise sound risk management as you
recognize this event in progress and wait for ripe opportunity to appear.
Probability underlies all prediction.
Through skilled observation or system-driven signals, technicians
anticipate future price movement and enter trades they hope will profit
from it. But the most common price patterns often fail to act as expected.
Look to the edges of these rogue formations to identify trigger points
where price signals a break in the low-odds, high-profit direction. One
obvious example can be seen in the unexpected Tellabs rally after it drew
a recognized reversal formation.
The classic Head and Shoulders reversal
has been subject to intensive study over the last century. In fact, one
popular investigation discovered this well-known pattern works only 79% of
the time. While this figure lies well outside random outcome, it
illustrates just how wrong you might be the next time you sell short at
the H&S neckline.
