HOW TO PROCEED FROM HERE
Now that you have a solid understanding of the different patterns, a very common mistake that can lead to loosing money is trading those patterns individually using the conditions explained for each of them. Understanding the patterns is an important step, but it is not the only one.
Below we will go through the thought process of creating a money management plan for a trading cycle based on the patterns covered in this book, to illustrate that process we will breakdown -most- of our own strategy for trading using some of the patterns in the Forex market.
Please understand that we are not providing you with a “ready-to-use” trading strategy, what works for us might not work for you, the purpose of providing this information is to show you how to build your own profitable strategy for trading the standard chart patterns.
STEP 1: determine which patterns suits your trading style
The patterns in this book have different characteristics, it would be very hard and confusing to build a trading strategy around all of them, therefore the first step is to eliminate the patterns that aren't compatible with your trading style. Below is how we filtered our own list of patterns to trade:
- We prefer trading continuation patterns, thus (head and shoulders, inverse head and shoulders, double tops, double bottoms, triple tops, triple bottoms) are removed from the list of patterns we trade.
- The second trading preference is trading patterns that occurs more frequently in the market, that removes the cup and handle from our list.
- Since wedges can be continuation or reversal patterns, we only trade rising wedges when the prior trend is downwards, and falling wedges when the prior trend is upwards.
- That leaves us with the following patterns list:
- Symmetrical triangles
- Ascending triangles
- Descending triangles
- Wedges (continuation variants only)
STEP 2: setup a strategy for trading the selected patterns
Once you have the list of patterns you are willing to trade, it is time to build a strategy for trading them. This strategy must include how to enter a trade, how to calculate take profit target, and how to calculate stop loss. Below is a -simplified- list of the conditions we use for the patterns we filtered earlier:
- Trade entry: at the closure rate of the candle after the breakout candle.
- Take profit target: default measurement for each pattern.
- Stop loss: each pattern have its method(s), discussed thoroughly below in the next topic.
STEP 3: Backtest, thoroughly!
Now that we have the list of patterns to trade and the strategy for each of them set, it is time to manually backtest our plan by going through the different charts searching for all the patterns from our list that can be found, and precisely do the calculations for each finding using the strategy we have set. Of-course, the larger the backtesting sample, the more reliable the results will be. We recommend finding at least 10 of each pattern, it can be a boring and exhausting process that might take days or weeks to complete, but it lays the foundation for months or even years of successful trading to come.
STEP 4: Calculate your edge and build a money management plan around it
Using the data collected from backtesting, calculate R:R and W/L for all the backtested trades to calculate your average R:R and W/L (your edge over the market) and see if trading using those conditions will be profitable or not.
STEP 5: Be consistent
If completing the previous steps resulted in a profitable calculation and gave you the confidence to use that strategy in a real trading cycle, always remember this: “You backtested the pattern and know its performance, you have a money management plan for a trading cycle, you created your set of rules to be used in trading, now please stick to them!”.