Step-by-Step Guide to Using Technical Patterns for Trading

The initial phase is all about gathering context. You must understand the market environment before you commit to any signal.

A chart pattern is meaningless without the backdrop of the larger market trend. Is the stock on a rocket ship, or is it grinding down?

• The Trend Filter Rule: Use a high timeframe chart (e.g., daily or weekly) and a long term moving average (like the 200-period EMA). If the price is above the 200 EMA, you are in an uptrend; if it is below, you are in a downtrend.
• Practical Application: In a strong uptrend, treat reversal patterns with caution. They might only lead to a small pullback. Prioritize continuation patterns (like Bull Flags) that align with the dominant direction. In a ranging market, reversal patterns (like Double Tops) become highly reliable.

Once the trend is known, accurately classify the pattern to correctly interpret its message.

• Reversal Patterns: These signal a shift in the trend’s direction. Examples include the Head and Shoulders, Double Top, Double Bottom, and Wedges. Their completion means the buyers have been defeated by the sellers (or vice versa).
• Continuation Patterns: These signal a pause, or consolidation, before the trend resumes. Examples include Flags, Pennants, and Triangles (most often). They offer ideal, low risk points to join a move already in progress.

Misclassifying a Continuation Pattern as a Reversal (or vice versa) is one of the quickest ways to lose capital. Be sure the price action strictly conforms to the established rules of the pattern.

This is the most crucial phase, as it is where you commit to risk management and filtering false signals. Never enter a trade without completing these three steps.

A pattern is not complete until the price breaks through the pattern’s boundaries (e.g., the neckline of a Head and Shoulders or the trendline of a Triangle). Crucially, the breakout must be confirmed.

• The Signal: Wait for a decisive close outside the pattern boundary. A spike or a shadow that touches the line is not a breakout.
• Volume Confirmation for Breakouts: High quality breakouts are always accompanied by a significant surge in trading volume. This tells you that institutional money is moving in the direction of the breakout. A low volume breakout is often a bull or bear trap—a false signal designed to lure in inexperienced traders before reversing sharply.

Your stop loss is the single most important rule in your technical patterns trading strategy. It is a predetermined exit that protects your capital.

• Placement Rule: Place your protective stop loss order at a logical point on the chart that invalidates the pattern’s structure.
  • Example: For a Double Bottom, the stop goes just below the lowest point of the two bottoms. For an Ascending Triangle, the stop goes just below the ascending support trendline.
• The R:R Rejection Rule: Calculate your potential loss (the distance from entry to stop loss). If the potential profit (measured move, calculated in Step 5) does not provide at least a 1:2 or 1:3 Risk to Reward Ratio (R:R), reject the trade. A low R:R setup is a low quality setup, regardless of the pattern.

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Every valid chart pattern provides a way to calculate a reasonable measured move target — the area where the new trend is most likely to find profit taking or resistance.

• Calculation Rule: Measure the height of the pattern (from its highest point to its lowest point) and project that distance from the point of the breakout.
  • Example: For a Head and Shoulders, measure the vertical distance from the Head to the Neckline. Project that distance downward from the breakout point of the Neckline to find your profit target.
  • Example: For an Ascending Triangle, measure the height of the triangle’s base and project that distance upward from the resistance breakout line.

This final phase focuses on the discipline of trading—the art of execution and the necessary step of post trade review.

Once Steps 1 through 5 are complete and the R:R is favorable, the trade is ready for execution.

• Entry Strategy: The safest entry is usually a retest entry. Wait for the price to break out (Step 3), then allow the price to pull back to the broken trendline or support/resistance level (which now acts as new support/resistance). Enter on the rebound from this retest. This offers a higher probability of success and a tighter stop loss.
• The Failed Breakout Strategy: If the breakout fails (i.e., the price closes immediately back inside the pattern after breaking out), the pattern is invalidated. This failure is often a strong signal for a move in the opposite direction. Be prepared to quickly reverse your bias and look for a short-term entry in the other direction, placing a new stop loss just beyond the original breakout level.

Your work is not done once the order is placed. Discipline requires management and learning.

• Management: Once the trade moves in your favor and has achieved an R:R of 1:1 (i.e., the profit equals the amount risked), move your stop loss order to the break even point. This secures the trade, guaranteeing you cannot lose money. Consider taking partial profits (e.g., selling half your position) once the target is reached to lock in gains while letting the remainder run with a trailing stop.
• Review: Maintain a trading journal. Log every pattern you traded, noting the timeframe, the initial R:R, the confirmation type (or lack thereof), and the final result. Systematically reviewing these patterns is the only way to improve your personal technical analysis process and gain confidence in your strategy.

Trading based on technical patterns is not an art; it is a systematic, repeatable process. By following this seven-step step by step guide to trading patterns, you move away from subjective guessing and adopt the disciplined approach of a professional trader.

The core of this process is not merely recognizing a shape on a chart; it is in the risk control applied during Phase 2—the mandatory check for volume confirmation, the calculation of the measured move target, and the stringent requirement for a favorable Risk to Reward Ratio. 

Adopt this blueprint, practice it diligently in your journal, and you will secure the essential foundation for long term success in the markets.