Question Everything... Really!
As we began our trading careers, we were initially introduced to chart patterns and found them fascinating. Head and shoulders patterns, ascending wedges, pennants, the king's crown, triangles, flags, etc. We found that the famous M's and W's had been documented in 1971 by Robert Levy and later by Arthur Merrill in the 1980, and again by John Bollinger, and we studied them in depth. We were taught that these patterns reflected the aggregate results of market sentiment – the combined push and pull of supply and demand, the bulls and bears tug-of-war.
We went on to study Japanese candle patterns, learning that the shape of even a single candle can tell you so much about the market. Fascinating stuff. And we spent another fortune in classes and webinars learning Fibonacci patterns called gartleys, crabs, butterflies and the like. The more we studied, the more interesting it all was. Profitable? Hmmm...
So it's no wonder that the day we read the following key parts of Larry Williams' book Long Term Secrets to Short Term Trading we literally stopped dead in our tracks and said "Whoa! Wait a minute! We've been duped again!"
Good trading to you all, Evelyn & Mindy...
What's This Chart?
Larry showed this chart with a perfect head and shoulders pattern (which we show in green):
Is it the EURUSD? Is it grain or cattle or a particular stock? No. It's the weather! It's the daily highs and lows. How arbitrary is that?!
How about this next chart which could be interpreted as perfectly showing the behavior of the reputed market makers who are manipulating the market by accumulated contracts (in yellow) followed by a vicious stop hunt (orange arrow). What market is this? Which currency pair and time frame?
Well, this is a chart we just generated based on 150 random coin flips. Yep, heads or tails. Talk about a wake-up call!
We found an Excel spreadsheet to easily generate charts like this on a web site by Timothy R. Mayes, PhD, who is the author of Financial Analysis with Microsoft Excel 2007. Visit his site, or download his Excel spreadsheet here. As you open the spreadsheet up, enable macros, and then you can click the Flip Coin button and see for yourself. Do this and prove it to yourself. Generate several random charts and see how many patterns you can recognize from the results. Pretty amazing, isn't it? Can you recognize gartleys or fib retracements? Can you find the 'Three pushes to a top' in operation? Can you count levels or recognize Elliott Waves? Sure you can.
But do they really mean anything? Are they telling you about market psychology? Nope. They tell you about as much as the patterns you see charting a random bunch of coin tosses, or any other random behavior.
Fulfillment of Expectations
If you can't rely on chart patterns, does that mean you can't make money trading Forex? Is that the conclusion we want you to make? Far from it.
What's going on with chart patterns is the tendency of the eye to recognize only that which works and conforms to our expectations. When you glance at a chart, your eye sees the 'head and shoulder' that goes down, but totally misses seeing the 3 other times that were starting to shape up as a head and shoulder pattern and never carried out your prediction and would have failed horribly. This is human nature and it's unavoidable. Want proof for yourself?
Here's how. If you use the Forex Tester and go candle by candle then your charts will look just like they do in real time. You won't be able to see what's coming next; there's actually blank space on the right edge, just like real life. Do this and start looking for your trade criteria. It's the only way you can be honest with yourself and avoid seeing only the trades that work. We know you're not intentionally cheating when you look back at your broker's charts and try to read them - but you can't help the kind of unconscious cheating we all do when we look at a complete finished chart and cherry-pick our perfect pattern or see a glimpse of what's coming next on the right edge of the chart. You can download a free trial and start using the Forex Tester now: click here. We also have a webinar recording on that page if you want to see the Tester in action.
After we sent out Newsletter Two about keeping things simple, one of our readers wrote back: “Great advice. You continue to be a light in the murky depths of the forex jungle.” (PS - we love to get your feedback). Because we're not selling you a strategy, and because we're registered CTA's, we're in a rare position to sit back and tell it like it is. So we wanted to share this alternate view about magic chart patterns with you. Question Everything... REALLY!