Trading is all about pattern recognition and the setups you trade are patterns with unique characteristics that allow you to put the odds in your favor by reading market clues. Your job as a trader is then to make sure that you can reliably identify your setup patterns and differentiate between high probability and low probability setups.
Pattern recognition is a skill and you can train your brain to process information in better and more efficient ways so that you are able to recognize patterns fast and accurately.
Intuition. Skilled chart readers who have developed the ability to recognize patterns can often see if there is anything worth trading within seconds of looking at a chart. Of course, this does not mean that you look 2 seconds at a chart and then decide whether or not to buy or sell.
Speed vs Quality. Pattern recognition is not primarily about being able to recognize a specific chart pattern faster, but being able to interpret your patterns more efficiently. A good chartist knows the subtle differences between a good and a mediocre setup because he has trained his eyes and his mind to recognize the nuances and tells of good chart patterns.
The famous awareness test, which has been used in psychological studies, shows that if we are too focused and absorbed, we can’t process all information that are present. In terms of trading, this means that if a trader has to look too hard for a pattern, he might miss other important clues given by his price chart. A skilled chartist sees patterns right away, he can tell whether it’s a good or a bad setup and he is able to put everything into the right context.
Consistency. Especially the way traders arrange their charts, set up their charting programs and monitor the markets can make a huge impact on their ability to make consistent decisions about the markets and their trades. Almost no one is aware of how significant the differences between price charts can be if a trader falls for one of the following mistakes.
Trading is pattern recognition. Things that influence perception:
— Tradeciety (@Tradeciety) 25. Februar 2016
Problem I – Chart arrangements, zoom level and the space available
This can have disastrous effects on a trader’s perception of chart patterns and the way he interprets price. Traders who view multiple charts vertically or horizontally split on one screen suffer from this problem the most. Charts that are split vertically show only very limited information and the way price is displayed is very distorted because charting platforms scale price to fit it into the space available. Horizontally split screens often make trends seem smaller than they are and ranges appear much more visible.
You don’t need multiple screens, I personally trade from just one laptop, but you need to be organized. I use chart profiles and organize my trading with watchlists, trading plans and alerts to stay on top of things. I only look at full-screen charts so that I can see the whole picture and don’t make my trading decisions based on just a small snapshot. By the way, I highly discourage trading from a phone or a small tablet for those reasons as well.
Problem II – Chart platforms
I personally use Tradingview.com for charting and MetaTrader for placing my orders. In the beginning, when I had identified a trade on Tradingview and then switched to MetaTrader to place my order, I was always hesitant because the charts looked slightly different and it often made me question my previous analysis on Tradingview. It even got so far that I did decide not to take a trade after what I saw on MetaTrader, even though it looked like a valid setup on Tradingview.
Nowadays, when I have identified a trade, I don’t even look at any MetaTrader charts; I just place my order and then close the platform again. This also helps with many other problems such as constantly watching the P/L or babysitting trades.
Problem III – Colors and our wiring
We have been brought up to automatically react to certain signal colors; green means go and red means stop. Casinos use our hard-wiring to get us to gamble more by carefully arranging the colors in the casino to motivate our risk appetite.
I keep my charts neutral and don’t use bright red or green colors at all. I am not 100% sure that it makes a difference, but if you can eliminate potential sources for errors, you have to do it.
By the way, switching between barcharts and candlesticks can also mess with your pattern recognition. Even though you might not be aware of it, your brain will process the information differently, especially if you are used to candlesticks and then suddenly switch to barcharts. Everything has a learning curve.
Improving your pattern recognition abilities
Pattern recognition is a skill where experience trumps everything. Nowadays, I can go through 50 markets in less than 2 hours and pretty accurately tell which charts need to be on my watchlist. Here are some tips that can help you develop your pattern recognition skills:
(1) Screenshots and pre-session routine
This is probably the single best exercise for enhancing your pattern recognition skills. Always grade your setups by quality of the signal, not only based on the outcome. Then, file your screenshots in a physical folder so that it’s easy to review them. Before you start your trading session, review your playbook and go through your charts. Remind yourself what your setup looks like and what makes a setup a great setup.
Your checklist should contain a few screenshots of textbook setups, along with a list of entry criteria. You should place your checklist next to your monitor where you can see it at all times. When you are about to take a trade, go over the checklist and cross-check if the setup is really matching your criteria. There is a reason why airplanes have a low failure rate; no plane ever takes off without double-checking the same checklist.
(3) A consistent approach
In order to get consistent results, you need a consistent approach. Don’t rearrange your charts too often and don’t change the way you analyze charts. And if you make any changes, be sure to track the impacts they have and be aware of how it influences your trading. The ability to read charts, recognize patterns and notice details is what allows traders to make consistent and well-informed trading decisions.