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FRONT RUNNING THE PATTERN

https://vantagepointtrading.com/anticipating-chart-pattern-breakout-direction/

Front-running a chart pattern increases the reward:risk of the trade significantly, gives us more options for a profitable exit, and leaves us less exposed to false breakouts compared to the traditional chart pattern trading approach.

Trading chart pattern breakouts is one of the first strategies I learned when I began full-time trading back in 2005. Even though it took time to determine which ones to trade, which ones to leave alone, and which ones were high probability, if you’ve read my eBook Forex Strategies Guide for Day and Swing Traders you know that I like chart patterns.

Always looking for ways to improve on trading methods, predicting chart pattern breakout direction–I call it “front-running”– is an advanced technique for trading these types of patterns. It’s recommended you have trading experience before attempting these methods and have a good sense of market direction and strength. Basic directional guidelines are provided below.

Use this strategy on triangles, ranges, and consolidations. Consolidations may not have a particular shape, but are still a pattern in that they are identified by a lack of volatility relative to the price moves around them. While the pattern occurs less frequently, we can also front run head and shoulders continuation patterns.

Instead of waiting for a breakout, which is the traditional approach to trading chart patterns, if we’re able to read the price action and come up with an expectation for the direction of the eventual breakout, we can greatly reduce risk and increase potential profit by getting a better entry price.

The method generally applies to all markets and time frames, as the examples below show.

Once the pattern is drawn, the traditional method requires waiting for a breakout. In this case we enter when the price breaks below the lower trendline of the triangle. A stop loss is placed just outside the opposite side of the triangle, and a target is achieved by taking the height of the triangle (widest point) and subtracting it from the breakout price (add it in the case of an upside breakout).

This method is fine, but we don’t always need to wait for the breakout. Figure 2 shows another triangle in Apple. The stock was in an uptrend and the price was rallying aggressively prior to the triangle forming. Therefore, we can anticipate the trend will continue and the triangle breakout will be to the upside.

Based on the prior rally, as soon as we can draw the bottom line of the triangle (need two connection points or more) we have an approximate entry area. Since we’re anticipating an upside breakout and the price isn’t moving lower (it is bouncing off support), we go long near the bottom of the triangle. Our stop loss is still placed just below the triangle–although give it a bit of a room.

Using this method we get a better price than if we waited for the breakout. Our risk is reduced (difference between entry and stop loss) because the stop loss is in the same spot as using the traditional method, and our profit potential has also increased (difference between entry and target) because the target is still based on the breakout point (traditional target method).

Figure 3 shows a head and shoulders continuation on a 1-minute EURUSD chart. There’s a strong price run leading into a head and shoulders pattern. The head and shoulders pattern is commonly considered a reversal pattern, but if you look closely, you will often see small head and shoulder patterns that act as continuation patterns. The price rallies, forms a small head and shoulders continuation, and then moves to the upside

With front-running, we are only concerned with buying near pattern support in uptrends, or selling near pattern resistance in downtrends. Therefore, the false breakout that is typically going to result in a loss, and potential opportunity, is when the price breaks through these levels and then quickly moves back in our expected direction.

In order to predict chart pattern breakout direction, there needs to be a strong trend underway that the chart pattern is a part of. We expect the breakout will occur in the direction of the trend. As a general rule, I want to see trending movement prior to any chart pattern–whether I end up trading it in a traditional way, or front-running it. Without a strong move prior to the pattern, there’s no evidence that traders care about the price, and therefore, breakouts are more likely to fail or not reach the target(s).

For the entry, we want some minor confirmation of our expectation. In the event of a predicted upside breakout, we want to see the price hold above the support of the pattern, as it did in the examples above. In the event of a downside breakout, we want the price to hold below resistance of the pattern. I then typically wait for the price to start moving up off pattern support before buying or wait for the price to start moving lower off pattern resistance before shorting.

To front-run a pattern, it should be relatively small compared to the waves around it. Look at all the examples. There were strong price waves followed by the patterns…and the patterns were smaller than the price wave leading into them. This is key. Very big patterns (relative to the waves around them) signal too much indecision. Smaller patterns indicate the trend traders are just pausing. That’s a big difference in psychology. The more you watch price action, and the more charts you look at, you’ll get a feel for what an ideal front-running pattern looks. We certainly won’t be right all the time, but because our reward:risk ratios can be so big, we don’t have to be. Pattern size, in this case, must only be measured against the waves around it. It is a relative measurement, not an absolute one.

Sometimes we can’t front-run. The market doesn’t give us the opportunity. Refer to back to figure 1. By the time we draw the triangle (we need at least two price swings) the price breaks lower before pulling back to the top of the triangle. Therefore, sometimes trading chart patterns in the traditional way is the only option.

Use traditional targets, Fibonacci targets, or “active trade management.” Fibonacci targets provide multiple prices to look for an exit at. The traditional method for calculating a target only gives one, and doesn’t account for strength prior to the pattern (it only factors the height of the pattern).

Active trade management is an advanced technique which involves adjusting your stop loss (only reduce it, never expand it) and/or target level once a trade is underway. The benefit of active management is that if the price goes to breakout in your direction, but fails, you can still get out with a small profit. For example, you could create a front-running rule that if the price tries to break out in your expected direction but it doesn’t happen, then you exit right there for a small profit. You still capture the profit of the price moving to the other side of the pattern. With the traditional approach, this is not a possibility.

Just because the trend was up prior to the chart pattern doesn’t mean the breakout will be in that direction. Consider other factors, such as strong support and resistance levels, whether the trend is slowing down, or if the price is bucking up against trend channel support/resistance.

Like any strategy, this one takes time to get good at. It requires analysis skills, because it is those analysis skills which aid us in determining which chart patterns to front-run. Not every chart pattern is created equal.

Predicting Chart Pattern Breakout Direction – Final Considerations

No matter how we trade, losing trades will occur. While some may argue that waiting for a breakout is safer, breakouts can fail and result in losses too. With this front-running method you may have a few more small losses, but the reward on the winners more than makes up for it. Anticipating chart breakout direction reduces the size of the stop loss required, and increases profit potential (relative to the traditional method).

Learning how to read the market will take time. This method is recommended for advanced traders. If you try the method and find that your expectations are often wrong, or you’re unable to capitalize on the opportunities that come along, more practice is needed on reading price action. This is only a strategy, and like any strategy it must be combined in an overall trading plan for it to be successful. It’s your trading plan and analysis that will help you determine which trades to take and which to leave alone.

WATCH US CARRY OUT A SIMPLE TA