Fundamental Analysis and Position Trading: Evolution of a Trader

CHAPTER 20

Ten Factors Make Chart Patterns Work

Trading comes in two basic styles: discretionary and system. Discretionary trading relies on intuition and experience to determine when to buy and sell. System trading follows a mechanical setup for trading signals. I am a discretionary trader, but sometimes having systems available that point the way are the trader's equivalent of a GPS (global positioning system). In the pages that follow, I describe a scoring system that helps select winning chart patterns, or more importantly, avoid weak ones.

Novice system traders often compile a list of rules that could fill a page. “If the MACD histogram shows bull divergence, and RSI was oversold but has moved above 30 with price above the 200-day SMA, with the ADX showing a strong trend, and it is raining on Monday. . . . ”

One novice showed me his list of rules, and it was 21 items long. My guess is he would get one signal every decade, and it would probably fail anyway. Pros know better. They have boiled down their setups into as few rules as possible. Simplest is best.

Try this experiment. Plot all of your indicators on the same chart. If the indicators peak as price peaks and they make valleys as price bottoms, then why not just eliminate them and use price alone? Price tells all. Everything else is just a derivative (distraction?). Are they acting like a busload of kids all yelling to turn right at the next intersection, confirming what the GPS is saying?

• To increase the odds of success, ...