Merely stating a technical observation does not elevate it to the status of eternal truth. Yet, distilling our observations into strict rules also has its drawbacks; fixed rules inevitably fail to address the exceptional cases. The conceptual model offers a possible middle ground. It attempts to remove some of the subjectivity involved in chart pattern analysis while still permitting flexibility.

The model is useful, even if it is not always an absolute indicator, if it helps us to understand the nature of the relationship between trending and non-trending markets, and how changes in volatility reflect changes in overall supply and demand. We have seen how higher volatility coincides with the early stages of chart pattern development and declining volatility with the later stages.

This has a logical basis: A more active market attracts and supports more participants, and hence more gross supply and demand – or total investor interest – than does a less active market. Any sudden changes in supply or demand in a less active or “quiet” market can result in sharply higher or sharply lower quotes due to a sheer lack of available buyers or sellers, hence resulting in what we commonly refer to as a pattern “breakout.”

In the case of the structure component, we have seen examples of how chart patterns, regardless of whether they be reversal or continuation patterns in “classical” terms, can be set apart from trends by their characteristic periodicity and wave structure. If we accept the idea that classical chart patterns can be broadly characterized by general conditions, rather than by a variety of pattern “shapes,” then perhaps classical chart patterns are truly not the products of wishful or delusional thinking as some critics allege.

Unlike UFOs, we can point to evidence that supports chart pattern existence in the form of the volatility and structure components. In addition, we can utilize this “template” view of chart pattern construction to help us locate and trade patterns without debating over myriad chart pattern definitions and their directional significance.

By Daniel L. Chesler, CMT, CTA

Next: Thanks and References

Summary: Index