This is a site about systems for trend trading and so scanning for chart patterns means primarily looking for them in a trend. Thus the question for the trading system designer is: Timing the trend entry with the help of chart patterns or by other means?
Betting on chart patterns alone, without them being embedded in a trend, is not so wise. It depends of course on the pattern, but more often than not there is a real price driving force missing.
Breakout patterns have a small trend, the breakout, on their own. They are somewhat better than patterns based on support and resistance like the double top or bottom. Embedded in a trend a double top would always be the potential signal for a trend resumption for me and not the opposite, a trend reversal.
A double top could that way be interpreted as a loose base. Chartists like to see it as cup with a handle, when time has drawn a bit more of the future into their chart. The question for them is just whether it stands upside down or not. But, the real question should be, which direction the surrounding trend has and not the small handle.
Looking for pattern based entry points like this restart after some sort of base in a trend is probably the best pattern scanning method for trend trading. Interpreting a breakout to the downside of a base in a trend as a trend reversal is a horrible strategy. Sure, there are occasions where indeed the trend changed its direction and went the same long way down that it came once up, but there is no specific reason a market should behave like this.
After breaking out to the anticipated reversal the long-term trend is probably still intact. So, we are missing the deeper cause for trading the trend reversal just on a minor disruption of the global trend. Unless you are from the overbought-oversold camp of swing traders who don’t believe in deeper reasons, you should find this trading style unreasonable.
Patterns embedded in the chart of a longer trend are interesting, more or less depending on the pattern. But – this pattern trading system has a severe problem. It is more a waiting than a trading system. There is a trend, but you can’t get onto it, because your favorite entry pattern doesn’t show up.
The alternative would be to scan a large trading universe, presumably of stocks, to find enough that are right now showing some tradable chart formation and are also in a trend. That would be a purely technical system and most likely would leave the trader with an account full of penny stock trades.
A better alternative is timing the trend without waiting for a chart pattern . The simplest version to enter a trend by timing is to enter it immediately as soon as it got recognized. Timing could then be done by a trading system that has some quality criteria for a trend and as soon as a “trend score” reaches a certain threshold, the entry point has been found. Combine that with some sensible preselection of trading candidates and a stop loss system and you will arrive at a trading system “near the virtual optimum”.
Another method or a finetuning of the above could be done in the stock market with a comparison of an individual stock to the whole market. Relative strength comes to mind, on either a short term scale, meaning intraday, or over a time span of some days.
Many black box trading software systems use some sort of autocorrelation tool pack. The most simplistic version would be using the MA, the moving average. Build an indicator and have a traffic light that shows you a green or red signal, or perhaps a 3 phase version, buy, sell and hold or wait.
This is the space of the mythical trend switching or swinging system, the place from where the magical trading formula comes. Perhaps the magic could be made by combining it with the above idea of entering the trend as soon as the scanner system has identified it as such. Who knows, perhaps this magic indicator exists and Penny Stock Alerts will finally find it for the lazy beach traders of this world…
