This article on Day Trading Chart Patterns is the opinion of Optimus Futures. Stats presented have not been verified across all Futures contracts, and should only provide a rough guide as a reference.
- Reading trading patterns and being able to distinguish a solid setup from a fake one is critical to successful day trading and swing trading.
- When it comes to identifying “fake” day trading chart patterns, it’s not the patterns you should be looking at but the underlying conditions which can easily “turn” patterns from reliable to unreliable.
- To deal with disrupted patterns, it helps to know the odds with regards to failure rate, pullback rate, target success rate, and average return.
You are probably wondering, “how many fake patterns are out there?” Based on our count, at least 400 of them. Meaning, every single chart pattern under the sky can, under certain conditions, turn on a dime, shifting from a real trading prospect to a “fake” opportunity.
Want proof? No pattern works every single time. The trick is understanding how often a pattern fails and succeeds and what to do in either scenario.
Reading Day Trading Chart Patterns Is Like Trading Half Blind Unless You Know the Odds
Trading is an odds game, as you probably know all too well. Traditional chart patterns are so “general” in that every trader sees them and strategizes around them. Given this context, wouldn’t it help you to know what the odds are (based on historical performance) so that you can plan what to do if a pattern works or doesn’t? It would also help you determine which patterns might be more favorable to larger position sizes.
Let’s go over a few basics. Here’s what you need to look out for:
1 – Breakeven Failure Rate
You see a chart pattern on your screen. What percentage has this pattern failed to cover even the cost of the trade? If you knew, such knowledge might help you not only determine your position size but also anticipate a “plan B,” exploiting the failure, if such an opportunity is tradeable.
2 – Average Rise or Decline
If your pattern works out, how well has it performed on average? Did it rise or fall in the single or double digits?
3 – Pullback Rate
Price moved favorably following your chart pattern setup. So, how often does it pullback?
4 – Percentage of Reaching Traditional Price Target
And finally, based on “traditional” profit target methods, how often does it reach its target after a breakout?
Knowing these four metrics can help you become a better oddsmaker when assessing trades. Not knowing them means you’re trading partially blind to the tendencies of a given pattern. Who would argue that it’s better to be ignorant of these odds, despite the reality that some trades may undershoot or overshoot their averages? In short, it is better to know them.
Day Trading Chart Patterns with the Odds Stacked in Your Favor
We published an article on 10 chart patterns that every trader should know. True, it’s important to know these (mostly reversal) patterns. But it’s even better if you know the odds surrounding the most critical aspects of each pattern. So, let’s cover each one, this time focusing on the four key metrics outlined above.
Note: from this point on we’ll cite updated data from the classic book Encyclopedia of Chart Patterns by Thomas Bulkowski.
Double Tops (sharp tops)
We covered double tops in the aforementioned article, so if you’re unfamiliar with it, do go back and read the explanation as to how this pattern works. The same can be said of every pattern we touch upon in this piece. So, how reliable are double tops?
The following data is based on 1,719 trades.
- How often has it failed, exceeding trading costs? The breakeven failure rate stands at 27%, meaning that the number of trades on average that have failed and whose loss exceeded their trading costs stands at 27% which is quite low.
- What’s the average decline? Considering its a bearish reversal pattern, it stands at 14%, so keep your stops relatively tight once it reaches half this level.
- What’s the pullback rate? It pulls back 63% of the time, so expect the price to rally back to the breakout price on a frequent basis.
- How often does it meet its traditional target price? That stands at 45%, almost 50/50, so be sure you’re aware of traditional price target estimations and keep your stops tight should it exceed its target.
V Tops and V Bottoms
V-tops and bottoms are tricky patterns to catch, as the reversals–bearish or bullish–tend to be sharp. Before you know it, the trend just reversed on you, and oftentimes, it’s easy to miss.
Let’s take a look at the stats for each one:
The following data is based on 2,416 trades.
- How often has it failed, exceeding trading costs? Breakeven failure occurs 29% of the time, a fairly low number.
- What’s the average decline? If price breaks downward, the average decline is around 15%, a pretty decent return, don’t you think?
- What’s the pullback rate? This bearish reversal pulls back around 56% of the time to its breakout level as bullish traders are hoping for a continuation in the uptrend (allowing you to enter the trade if you missed it the first time).
- How often does it meet its traditional target price? Expect to hit your target 37% of the time only, so keep your eye on your stops. Note that the traditional target is at the bottom of the pattern formation.
Disclaimer: The placement of contingent orders by you or broker, or trading advisor, such as a “stop-loss” or “stop-limit” order, will not necessarily limit your losses to the intended amounts, since market conditions may make it impossible to execute such orders.
The following data is based on 1,997 trades
- How often has it failed, exceeding trading costs? 19% which is a relatively low percentage.
- What’s the average rise? The average appreciation is 39%, which is a relatively solid distance.
- What’s the pullback rate? Here’s the downer–the pullback rate is 55%, meaning that more than half of the trades will pullback to the breakout price (but that also allows you a late entry).
- How often does it meet its traditional target price? Another plus is that this pattern tends to hit its target–the left side of the pattern’s “top”–around 52% of the time.
Head and Shoulders
A classic bearish reversal pattern, let’s see how well it has performed.
The following data is based on 2,800 trades
- How often has it failed, exceeding trading costs? It has failed 19% of the time, again, quite low.
- What’s the average decline? The average decline isn’t that great, but it’s 19%.
- What’s the pullback rate? 68% is quite high, so expect rallies back to the breakout from the neckline.
- How often does it meet its traditional target price? At least it hits its target around 51% of the time based on historical data.
Pennants can go either way, up or down. So, we’ll include both upside and downside breakout data.
The following data is based on700 to 900 trades
- How often has it failed up/down, exceeding trading costs? The numbers are 54% (up) and 56% (down).
- What’s the rise/average decline? 7% up (not much) and 6% down (even less).
- What’s the pullback rate? 57% up and 63% down, meaning expect frequent pullbacks and potential re-entry opportunities.
- How often does it meet its traditional target price? 34% up and 30% down; not a great probability in terms of historical performance.
Cup and Handle
The classic IBD William O’Neil pattern. Of course, his version is fundamentally driven. Not the case for most short-term futures traders.
The following data is based on 912 trades
- How often has it failed, exceeding trading costs? The failure rate here is impressive, a mere 5%, making this pattern fairly reliable (especially if fundamentals agree).
- What’s the average rise? The average rise is also high, at 52%.
- What’s the pullback rate? However, it does tend to pull back 62% of the time, sometimes disrupting the pattern formation.
- How often does it meet its traditional target price? The good news, however, is that it reaches its price target 62% of the time, fairly high, considering the other patterns we covered above.
There are many triangle formations but in the last piece, we covered symmetrical triangles, which is a neutral pattern (it can go up or down).
The following data is based on over 1,000 trades
- How often has it failed up/down, exceeding trading costs? Upward, it fails 25% of the time; downward, it fails 37% of the time (making the upside more favorable).
- What’s the average rise/decline? Again, the upside is favored with a rise of 34% and a decline of only 12%.
- What’s the pullback up/down rate? Very similar, it pulls back from the upside 62% of the time and from the downside 65% of the time.
- How often does it meet its traditional target price up/down? The upside is favorable, meeting its target 58%; downside only 36%.
The following data is based on hundreds of trades
- How often has it failed up/down, exceeding trading costs? Upside failure is 10%, and downside failure is 8%.
- What’s the average rise/decline? It rises 10% on average; for “shorts” it falls 8% on average.
- What’s the pullback rate? Pullbacks on a bullish bias occur 53% of the time; pullbacks on a bearish bias rallies back 60% of the time.
- How often does it meet its traditional target price up/down? Upside targets are hit 53% of the time downside target, 60% of the time.
Ross Hooks do not have any available data. They occur almost everywhere, on every time frame, and they form frequently. They are what, in price action terms, define a given trend (higher highs and lows for an uptrend, and lower lows and highs for a downtrend).
The pattern is reliable, and when they’re violated, it often signals the end of a trend–from micro to macrotrends depending on the time frame you are looking at.
Rectangles are trading ranges. How well they have performed or failed varies depending on whether they take place within a bull market or bear market.
Let’s take a look at each.
Rectangle (bull market)
The following data is based on hundreds of trades
- How often has it failed, exceeding trading costs? The upside failure rate is 15%; the downside failure rate is at 24% (it’s a bull market, so naturally, downsides may tend to fail more often).
- What’s the average rise/decline? Given the bullish environment, upside returns have been greater–47% average rise; 26% average decline.
- What’s the pullback rate? 65% on the upside and 66% on the downside (you can see the slight upside bias here).
- How often does it meet its traditional target price? Upside targets have been met 78% of the time; downside targets, 56% of the time.
Rectangle (bear market)
The following data is based on 500 trades
- How often has it failed, exceeding trading costs? The failure rate is 15% on the upside and 34% on the downside.
- What’s the average rise/decline? 51% on the upside and 13% for downside targets.
- What’s the pullback rate? Similar to the previous example, it’s 66% if price moves up, and 65% if price moves down.
- How often does it meet its traditional target price? Interestingly, even in a bear market or a “topping” pattern, upside breakouts reach their targets 78% of the time; downside targets 54% of the time.
Channels are subject to be broken on a regular basis, but a violated channel doesn’t always mean that the pattern has failed; a new channel might have to be redrawn. For that reason, we don’t have any data on channel failures, simply because channels are dynamic and therefore subject to constant adjustment (a kind of “failure” but not really). However, this is something you should be aware of, should you be trading a channel for entries, re-entries, or countertrend opportunities.
The Bottom Line
This was originally intended to be an article about “fake patterns.” Well, now you know the secret. All patterns–given the dynamic situation–can end up faking you out. So, if you want to be a successful trader, you’d better be prepared to deal with them when they” turn.” Otherwise, you will be stuck with a static approach to an otherwise dynamic scenario.
There is a substantial risk of loss in futures trading. Past performance is not indicative of future results.