Chart pattern failures occur frequently, confounding the expectations of traders.
Due to the high frequency of these failures, it is important for you as a trader to know how to trade them.
When a chart pattern fails, most traders end up with a losing trade.
The failure itself may also fail, creating a second entry, which is considered to be a more reliable signal.
This means that for an astute trader, the failure may present an alternative trading scenario.
In this article, I will be showing you how to trade chart pattern failures profitably.
Let’s start…
What are Chart Pattern Failures?
A chart pattern failure is said to have occurred when a particular chart pattern does not materialize as expected and it cannot achieve its potential.
Due to this, the price action moves in an opposite direction than it is expected.
In most cases, this results into triggering of stop losses, and it can open a new trading opportunity for traders.
Consider the chart given below…
The above chart shows the occurrence of a chart failure.
The image shows the formation of a Double Bottom chart pattern.
This has been shown using the blue lines on the chart.
The magenta line running horizontally is the neckline for the chart pattern.
It acts as a confirmation signal for the chart pattern.
From the chart, it is very clear that the price action managed to break through the neckline.
This occurs at the point of intersection between the blue line and the magenta line.
This acts as a confirmation for the bullish potential of the chart pattern.
The expectation by most traders is that this bullish trend will continue for a long time.
Due to this, most traders will enter a long position.
However, the bullish trend doesn’t continue for long.
It makes a sudden reversal and begins to move in a bearish direction.
This will catch many traders on the wrong side of the market.
The bearish trend continued for a long time.
This has been shown by the long, red arrow running downwards.
Such a reversal in the price action can easily wipe out your trading account.
This is the case for traders who don’t protect their trades using tools like stop loss orders.
However, I will be showing you how to profit from such a reversal.
Keep reading!
Failure Patterns and Trapped Traders
For you to succeed when trading a technical analysis pattern failure, you have to understand why failure patterns happen on charts.
In this section, I will be helping you know why failure patterns occur in Forex.
The fact is that there is always something bigger behind every failed pattern.
In most cases, you will realize that your failed pattern develops into another pattern.
This can happen on your trading timeframe or on a higher degree timeframe.
Consider the chart given below…
The above chart also shows a failed chart pattern.
A double bottom chart pattern is first formed.
This has been shown using blue lines.
However, if you look at the chart pattern closely, you will realize that the failed Double Bottom chart pattern turned into an Expanding Triangle.
This has been clearly marked using two black lines.
The two black lines mark the upper and the lower levels of the Expanding Triangle.
This appears to be the real pattern of the chart, meaning that the double Bottom chart pattern can easily be forgotten.
The Double Bottom chart pattern was confirmed, but the price action returned to create another bottom on the lower level of the formed Expanding Triangle.
This means that the black horizontal support is of great importance when it comes to accessing future price development.
So, once the price action breaks through the lower level of the Expanding Triangle pattern, it gives a sufficient evidence that the new bearish move is most likely to continue.
This can act as an opportunity for you as a trader to go short.
The chart shows that after the occurrence of the breakout through the black horizontal support of the Expanding Triangle, the triangle reached its full potential.
Types of Chart Pattern Failures in Forex
Basically, there are two types of failed chart patterns in Forex.
These can be classified depending on how far the price action goes into the creation of the pattern.
You can have a formed and confirmed chart pattern that still fails, or you can have a formed and non-confirmed chart pattern that still fails.
Let’s discuss these two to know where the difference sets in…
Non-Confirmed Chart Patterns that Fail
These are patterns that form on the chart, but a breakout through the actual trigger line of the chart does not happen.
The further price action proves that the expected pattern is false and the price action begins to move in an opposite direction than it was expected.
The impact of this type of failed chart pattern on traders is less severe compared to the next failed chart pattern that we’re about to discuss.
But why?
Because since the price action does not breakout through the trigger line to confirm the pattern, traders are less likely to have entered the trade before the pattern failure occurs.
Due to this, no traders are caught on the wrong side of the market.
Confirmed Chart Patterns that Fail
These are chart patterns that manage to breakout through the trigger line of the chart.
This sends a confirmation signal of the chart pattern.
After such an occurrence, most traders gain the confidence of pursuing the potential of the chart formation.
However, the price action makes a sudden reversal and the chart pattern fails.
Due to this, many traders are caught on the wrong side of the market.
This means that the impact of this type of failed chart pattern on traders is severe compared to the previous failed chart pattern.
How to Trade Chart Pattern Failures
In most cases, before you can trade a failed chart setup, you will have already made a loss from the initial false breakout.
However, you have to accept this as normal.
What should save you from making a severe loss is by adhering to a strict risk management strategy.
One of the ways to achieve this is by using a stop loss order.
This will protect your trading account from being wiped out in case the market moves against you.
After realizing that a particular chart pattern is a false breakout or a fakeout, you should prepare yourself to trade in the opposite direction in order to catch the real price move.
I now want to give you the rules that you should follow when trading chart pattern failures.
So, let’s start!
How to Enter a Failed Pattern Trade
For you to enter a failed pattern trade, you should begin by identifying the point of failure in the pattern.
Normally, you will see a weak breakout and a follow through, which is followed by a quick return to the breakout point.
You will see the price action beginning to return to the critical level of the pattern on a stronger momentum compared to its momentum during the initial breakout.
When you see this happen, there are high chances of having a failed chart pattern setup.
The best time to enter a failed pattern trade is after the price action breaks and closes beyond the original breakout level, but in the opposite direction.
This way, you will benefit from the market reversal.
How to Set a Stop Loss on a Failed Pattern
You cannot leave your failed pattern trade setup without protecting it.
Doing so will expose your trading account to being wiped out.
Whenever you are trading any chart formation, make sure that you protect your trades using a stop loss order.
This is not different when trading a failed chart pattern trade setup.
Always keep in your mind that nothing is 100% certain in Forex.
Failed patterns can also fail.
So, it will be good for you to take risk management measures in advance.
But, what is the ideal place to set your stop loss?
Place your stop loss order beyond the critical level.
This is the level that was used as a trigger line for the original chart pattern and before the failure.
If the price action reverses, the stop loss order will be triggered, and it will close the trade.
This means that your profits won’t be wiped out.
Take Profit Target
It is of great importance for you to use price action rules when trading and managing chart pattern failures in Forex.
When trading a failed pattern, the first thing that you should do is to check whether the price action is likely to evolve into a new chart pattern.
When this happens, just follow the take profit rules of the newly created pattern to exit your trade.
However, the price action may fail to create a new chart pattern.
In such a case, you should use your price action knowledge to determine how to exit carefully.
This can be channel breakouts, ascending/descending price moves, breakouts from resistance/support levels, other candle or chart patterns, etc.
When you realize that the Forex pair is beginning to stall, keep on looking out for reversal signs and continually monitor swings highs and swing lows for potential exit opportunities.
In the next section, I will be showing you how to trade chart pattern failures.
Chart Pattern Failures Trading Example
Consider the graphic given below…
The above chart shows how you can take advantage of Forex chart pattern failures to trade them profitably.
From the image, you can tell that the chart begins with a price decrease.
This is followed by the formation of range.
The range has been marked by two black lines running horizontally and marked as Range.
A range is formed when the price action moves in a sideways direction.
From the above figure, you can tell that the price is moving sideways.
The price action is also swinging in between the two black horizontal lines.
The upper line can be seen as the resistance while the lower line can be seen as the support for the range.
After some time, the price action managed to breakout through the lower line of the range in a bearish direction.
This creates an impression that the price action is resuming the initial bearish move.
Traders who don’t know how to trade a chart pattern failure will sell their Forex pair.
The reason is that they think the bearish move will continue for some time, which is a nice opportunity for them to go short.
However, this bearish move does not continue for long before the price action reverses into a bullish direction and manages to get back to the lower horizontal line of the range.
So, the bearish breakout through the lower level of the range was a false signal.
That is why this position has been marked as Fail.
Note that this happens at a very strong momentum, which acts as an indication that the bullish move may continue for some time.
This means that every trader who had entered a short position is now on the wrong side of the market.
Now that the market is in a bullish move, it provides you with a nice entry point.
The best time to enter the market is when the price action breaks through the upper level of the range in a bullish direction.
This is the position pointed to by a green arrow marked as Buy.
Now that you have entered a trade, you cannot leave it unprotected.
You need to add a stop loss order that will protect your account in case the price action reverses into a bearish direction.
The ideal position to place your stop loss order has been shown by a red horizontal line marked as Stop Loss.
This is just below the lowest point of the range.
Remember the two types of failed chart patterns that we discussed earlier, the confirmed and the non-confirmed failed chart patterns.
So, where does this range fall?
It’s simple!
The range was formed, confirmed, and then failed.
So, it belongs to the category of confirmed chart patterns that fail.
The range reversed its bearish direction into a bullish direction after confirmation, that is, after breaking out through its lower level.
The price action maintained the bullish move for some time.
This doesn’t go for long before the price action begins to make some high and low swings.
These swings led to the formation of a Rising Wedge chart pattern.
This has been shown using two blue lines.
The Rising Wedge chart pattern is well-known for having a very strong bearish potential.
When trading this chart pattern, you should exit the trade immediately the price action breaks out in a bearish direction.
Furthermore, the breakout will coincide with a trend line breakout, which gives you an even stronger exit signal.
However, the Rising Wedge pattern did not break the downside as it was expected.
The good thing with this is that the Rising Wedge chart pattern failed before sending a bearish confirmation, giving traders no reason to exit the trade.
Note that a bearish confirmation could have occurred if the price action broke through the lower level of the Rising Wedge, that is, the lower blue line.
This did not happen.
So, this Rising Wedge chart pattern falls under the category of non-confirmed chart patterns that fail.
Since traders did not exit the trade, they will not be caught on the wrong side of the market.
Instead, the price action continued to move in a direction that favors traders who are in a long position.
The bullish trend resumed immediately after this.
The price action makes a very strong bullish move before a price correction happens.
This price correction forms a pattern that resembles an Ascending Triangle.
The Ascending Triangle has been marked using two red lines.
This pattern manages to break the trend line in a sideways direction.
The trend line is the long green line running diagonally from the bottom to the top of the chart.
According to the price action clues, it is not wise at all to close the trade at this time, when the price action is making a breakout through the trend line.
Instead, we should hold the trade until the triangle breaks downwards.
The price action manages to breakout through the lower level of the triangle in a bearish direction.
This generates a very strong exit signal.
It means that most traders will exit their long positions and short the currency pair.
This has been shown clearly on the chart by marking the position as Close.
However, the bearish move doesn’t go far before making a sudden reversal into a bullish move.
It also managed to move above the triangle.
So, the bearish trend was a false signal or a fakeout.
That is why the formation has been marked as Fail.
All the traders who had entered a short position will be caught on the wrong side of the market.
Since the price action has managed to break out through the upper level of the red triangle in a bullish direction, it is safe for you to reopen the trade.
This position has been pointed to by a green arrow marked as Reopen.
Now that you have reopened your trade, you cannot leave it unprotected.
You must use a stop loss order to protect your trade.
This will protect the profits that you have earned so far from being wiped out in case the price action reverses into a bearish direction.
But, where should you place the stop loss?
Let me show you.
The ideal place to set your stop loss order is the position below the lowest point of the red Ascending Triangle.
This is the position shown by a red horizontal line marked as Stop Loss.
After the breakout through the upper level of the triangle, the price action made another strong bullish move.
This acts as a confirmation of resumption of the previous bullish move.
Many are the times that the price action attempts to breakout through the trendline in a bullish direction.
Remember that the trend line is the green line running diagonally from the bottom to the top of the chart.
These attempts don’t bear fruits, and the price action never manages to break through the trend line.
The trend line is now acting as a resistance level.
The two instances at which the price action attempts to break through the trend line in a bullish direction have been shown using two black arrows marked as Resistance.
This acts as a confirmation that the bullish trend has come to an end.
After the price action fails to break through the trend line, it begins to form a new bearish trend.
This has been shown using the two blue lines at the end of the price action.
This gives you a further reason as to why you should exit the trade.
That is why this position has been marked as Close.
That is how you can profitably trade chart pattern failures in combination with price action analysis.
In the figure, we had three chart patterns that failed.
These were the range, the Rising Wedge and the Ascending Triangle.
The range and the Ascending Triangle were confirmed chart patterns that failed.
They both sent exit signals to the traders, but the bearish move failed.
Instead, the price action reversed and begun to make a bullish move.
The Rising Wedge was an unconfirmed chart pattern that failed.
Instead of the price action breaking out in a bearish direction, it resumed its bullish move before the pattern was confirmed.
How to Trade Chart Pattern Failures using the Volume Indicator
The use of price action analysis is an effective way of trading Forex failure patterns.
However, I want to show you an indicator that you can use to confirm a pattern failure.
This is the volume indicator.
To trade using the volume indicator, you have to follow these two basic rules:
The above two rules can help you distinguish between real and fake patterns.
By use of the volume indicator, you can avoid or reduce the number of cases in which you find yourself trapped inside a failed chart pattern.
Again, if a pattern fails, it will be easier for you to identify it and position yourself where you can take advantage of the actual move afterward.
Now, I want to give you an example that demonstrates how to trade failed chart formations using the volume indicator.
A combination of these two can help you trade with accuracy.
Consider the chart given below…
The above chart shows the occurrence of a chart pattern failure.
The bottom of the chart shows the volume indicator which helps us gauge the market conditions.
The price action begins by making a price consolidation.
This price consolidation takes the shape of a Symmetrical Triangle, and it has been shown using two blue lines.
The price action manages to breakout through the upper level of the Symmetrical Triangle in a bullish direction.
At the same time, the volume indicator shows a time of decreasing volume.
This has been shown using a red line on the volume indicator section.
Once the price action breaks the upper level of the symmetrical Triangle, it forms a top and then it reverses into a bearish direction.
The price action manages to move below the original breakout level of the Symmetrical Triangle.
At the same time, the volume indicator shows a very big bar.
This bar manages to break the red line on the volume indicator showing a decreasing volume.
This acts as a confirmation for the price decrease, creating a nice opportunity for you to short the currency pair.
This has been shown on the chart by a green arrow marked as Sell.
This is a nice opportunity for you to short the trade.
However, you can’t leave your trade unprotected after shorting the currency pair.
You need to protect the trade using a stop loss order.
The best place to set the stop loss order is just above the top that was created after the price action broke out through the upper level of the Symmetrical Triangle.
This position has been shown using a red horizontal line marked as Stop Loss.
The chart shows that this was followed by a drop in the price of the currency pair.
The decrease shows a very sharp trend compared to the previous price action, making it easy for us to distinguish it.
After some time, the price action slows down and begins to consolidate, leading to the formation of a new pattern.
The pattern becomes a Falling Wedge, and it has been marked using yellow lines.
The Falling Wedge chart formation is known to have a very strong bullish potential.
So, as a trader, when the price action breaks out through the upper level of the Falling Wedge in a bullish direction, you should exit your short position.
But is it a true or a false Falling Wedge chart pattern?
The volume indicator can answer this question.
If you look at the volume indicator keenly, you will realize that the volume is high and increasing at the time when the price action breaks through the upper level of the Falling Wedge.
This is a clear indication that the formed pattern may be real and there can be a good follow through.
So, this breakout should act as a signal for you to exit the trade.
Notice that after the formation of the wedge, the price action reverses sharply.
So, the volume indicator has helped us make decisions during three breakouts.
The first breakout occurred at a time of decreasing volume, which was an indication of a false breakout.
The second breakout occurred at a time of high volume, which is an indication that the breakout is most likely to be real.
The third breakout occurred at a time of increasing volume, which is an indication that the breakout is most likely to be real as well.
Conclusion:
This is what you’ve learned in this article…