Upbeat music plays throughout.
Narrator: Price patterns are an important and helpful part of technical analysis. However, there's a few pitfalls that can stop you in your tracks if you're not careful. We'll look at three: impatience, inflexibility, and tunnel vision. Let's start with impatience.
Technicians are often eager to label a pattern as soon as it starts to form. However, continuation patterns can fail and become reversal patterns. Reversal patterns can fail and become continuation patterns. The fact is, you won't know if a pattern is a continuation or a reversal pattern until the price breaks support or resistance. That's where patience comes into play. Let me explain.
Animation: An uptrending line climbs to a peak and slightly pulls back. It climbs to the previous peak and turns down again falling to the same level as the first pullback. A downtrending dotted line appears with a box labeled "short entry."
On-screen text: Disclosure: Past performance is not guarantee of future results or success.
Narrator: After a stock has been uptrending for some time, it's human nature to try and call the top. As soon as the stock creates a second equal high, new traders often assume it's a double top pattern and enter the trade.
Animation: The solid line turns higher and rises back to the same level as the previous two peaks before turning lower settling nearly the previous two lows. A new downtrending dotted line appears with a new box labeled "short entry."
Narrator: However, say support doesn't break, the stock rallies, and a third equal high forms. These traders are out of luck, but undeterred, they may become convinced it's a triple top pattern.
Say the stock breaks higher and the pattern turns out to be a rectangle, which is a continuation pattern. These traders are out of luck again. Alternatively, when the first pattern started to emerge, they could've waited for the signals to confirm the pattern before entering. This could've led to a more successful trade.
Another common occurrence is seeing a triangle pattern and expecting it to be a continuation pattern. While triangles are commonly categorized as continuation patterns, until price breaks support or resistance, nothing is for sure. Be patient and wait for the signals.
The next pitfall is inflexibility. Some traders have a plan for a certain pattern, and if that pattern doesn't play out, they're stuck. A flexible trader waits for the pattern and adjusts her plan accordingly.
If, for example, you're waiting for a resistance break, but support breaks instead, qualified traders could consider making the short trade instead of the long trade. Remember, one of the benefits of technical analysis is the flexibility to trade in any market condition. So, learn to be flexible, as you learn to be patient. Don't let an unexpected move throw off your game.
The final pitfall is tunnel vision.
Basically, this means getting so caught up in identifying and labeling price patterns that you stop paying attention to price. You don't need to be dogmatic about the names of the price patterns or if the price pattern performed exactly how you expected. Remember, price patterns are just another way to look at support and resistance. And one way to trade support and resistance is to consider trading whichever breakout occurs first.
So, as you incorporate price patterns in your investing plans, remember to watch out for these pitfalls: impatience, inflexibility, and tunnel vision.
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