Excellent observation. I wrote point #6 to cover the “fade the majority” principle, as the more times I have observed a ‘perfect’ pattern and tried to trade it, the less accurate my results and the greater my frustration. This seems to be true in terms of the notion “If it seems too good to be true, it probably is.”

In my observation, most retail traders who react to an pattern do so in the obvious and expected way and expect the pattern to work without fail. They place their orders in and place their stops at the ‘proper’ levels which creates an enormous pool of liquidity of literally ‘low hanging fruit’ for professionals and ‘fade-traders’ to exploit, and if they can drive the price to those pools of liquidity (where the price should NOT go), then the stops will be triggered, and a false break will occur, or a pattern that was seeming to work will suddenly fail.

This, combined with the sense that if everyone sees something, the more nimble traders will exploit it before the mass public can take advantage of it, and thus ‘destroy’ a pattern before it can complete perfectly.

There is sort of a disconnect that should be noted when actually trading patterns, as opposed to visually inspecting patterns that occurred in the past. In other words, it helps to be objective and inherently suspect when ‘everything lines up’ perfectly.

Now, regarding volume, not all patterns have volume characteristics, but the examples I mentioned do.

The inherent patterns – especially the ones developed by Shabacker and Edwards & Magee – were more likely to ‘work’ because there weren’t mass computer programs exploiting volatility and order flow over 50 years ago. The volume was literally created by psychological reasons and supply and demand.
The head and shoulders example is classic in that the left shoulder represents optimism of the ‘unsophisticated’ traders and the start of ‘distribution’ by the sophisticated ones. The ‘head’ rally further confirms the enthusiasm of the public against the distribution tactics of the insiders, and the rally occurs on lower volume, and the final right shoulder rally – should it occur on lower volume – means the pattern now has high odds of working (in other words, we can count on a break of the neckline to produce a minimum price objective and we can trade this pattern and place stops appropriately.

However, now, with speed of execution and algorithmic trading, as well as a much higher level of sophistication of the professionals, if they anticipate a price break downwards, they may begin shorting before the proper ‘neckline break’ and thus ‘bust’ the pattern before it completes, or alternatively, if a huge proportion of stops are placed once the neckline breaks downwards (the stops would be placed above the neckline break), then if the downward move stalls and price creeps upwards seeking the liquidity pool of those stops, then should the market get there, shorts would cover and price would rally, busting the pattern. The eventual resolution may be to the downside, but not before that pool of liquidity – those massive pocket of live orders – are filled.

I suppose my main point is nothing is perfect. A pattern is likely to fail if volume characteristics are radically different than what is expected (if price rallies and then pulls back creating a flag, we would expect volume to be lighter during the flag, or else the flag becomes suspect. Further, we would expect price to eject upwards in a bull flag.)

I hope that helps.

Thanks! Corey

The accurate volume pattern would be part of the ‘perfection’ or textbook-ish-ness. But in that case it doesn’t add to reliability? Or does it only add to the reliability of the reversal or direction (as opposed to strength) – thanks

I’ve been busier than normal lately getting everything prepared for the Chicago trip and the Chartered Market Technician Exam Level 1 this Saturday. I will resume educational posts in greater frequency in addition to the market observation posts.

Thank you for stopping by!