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.
by Alan Farley (Author of Master Swing Trader)