Before we get into the chart patterns themselves, we must understand something even more deep-rooted. The key to consistent trading is good psychology.
- One of the keys to good psychology is having a trading plan. Trading without a plan is tantamount to amateur gambling.
- The key to a good trading plan is a clear set of rules.
- The key to a clear set of rules is an easily definable chart pattern that identifies clear areas of support and resistance for entry, exit, stop placement, and profit management.
- If you’re clear about all that and can stick to the rules, then you’ll win—pure and simple. I’ve trained people with no experience whatsoever, and they’re now “boringly” consistent traders who understand the virtue of being patient and take only the prime opportunities on offer.
So let’s review our requirements for finding a tradable chart pattern. It must provide us with easily identifiable areas of
- Stop placement
- Profit management
These are all critical elements. If you only trade when you have these elements in place, your trading results will soar in the right direction, whether you’re trading options, stocks, or futures.
A Common Mistake
Have you ever traded a stock where you were in a winning position? Have you seen your paper profits start to increase as the stock rose in your favor? What did you do? Did you have a plan for taking profits, or did you stay in too long? Did you stay in too long? Did you stay in as the stock started to fall? Did you stay in until your profits were all wiped out and you then had a loss-making situation? Did your winner end up being a loser?
Most people who have invested in the markets have been through this type of situation...on multiple occasions.
Why is it that traders stay in a position too long? Why is it that traders don’t take their profits when the signs are that the stock is about to reverse?
Well, I can only go by the countless interviews I’ve conducted with traders and investors, plus my own early experiences. The fact is that most people don’t have a consistent method of identifying suitable candidate stocks regularly in the first place! So when they suddenly find themselves in a winning situation, they tend to hang on too long, as if it’s the only opportunity they’re ever going to find. Does that ring a bell? Because if you did know how to find good opportunities on a regular basis, then you wouldn’t need to hang around in an existing position if all the signs said “sell.”
There’s another key, one that I’ve already alluded to. That is to have a clearly defined trading plan. Most traders have no idea what a trading plan is. They go to seminars and read books, but they are never taught how to enter or exit their trades. A trading plan outlines your entry and exit points so you know exactly what to do in any circumstance ahead of time. In other words, every trade has a business plan attached to it.
So we need to address two disciplines in this chapter:
- How to find stocks
- How to create a trading plan