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Understanding Chart Patterns Trading vs. Indicators

October 15, 2020 by Daniels Trading| Futures 101

Chart patterns trading is often equated to buying and selling at the direction of technical indicators. However, although chart patterns are considered to be technical tools, they differ in many ways from indicators. If you’re in the process of becoming a market technician, then it’s important to understand the functionality, pros, and cons of both chart patterns and indicators.

What Is a Chart Pattern?

A chart pattern is a formation that represents the former path of price itself. Chart patterns are constructed directly from market data that has been filtered with respect to periodicity and type. Popular intervals are tick, minute, hour, and day, and common chart types are candlestick, OHLC, and line. A few traditional formations are morning and evening stars, dojis, pennants, head-and-shoulders, wedges, and hammers.

Chart patterns trading strategies may be applied to any market using any periodicity. In fact, legions of active traders do so daily, searching for those with positive forecasting capabilities. Although chart patterns are valuable technical tools, it’s important to be aware of their unique benefits and shortcomings.

Pros

Perhaps the biggest advantage of chart patterns is that they are user-friendly. Patterns are presented in a visual context, right on the pricing chart. There’s no guesswork in identifying a pattern―it’s either there or it isn’t.

Chart patterns also function well in a predictive capacity. Distinct formations may be used to project trend extension, market reversal, or a pending breakout. Further, the chart pattern itself is frequently viewed as the basis for stop loss and profit target locations. In this fashion, traders may optimize risk vs. reward in live market conditions.

Cons

On the flip side, chart patterns trading falls short in a few areas. The main disadvantage of patterns is that they disregard a market’s prevailing state. Given that they are visual constructs, information such as traded volumes and order flow are ignored. Overlooking these factors enhances the probability of being “faked out” by a signal likely to lack any conviction and follow-through.

Also, buying and selling futures contracts in reference to patterns can be expensive. Stop losses are often sizable, especially when larger chart periodicities are being referenced. Although it’s possible to reduce risk by using charts with smaller intervals, the forecasting capabilities of most patterns generally break down.
Ready to think like a technical trader? Download our free guide to learn how to identify chart formations and take action when the time is right.

What Is an Indicator?

An indicator is a technical device that is mathematically derived from pricing data. Once the calculations have been completed, the indicator may then be plotted on the price chart as an overlay or in a corresponding window. Indicators come in many varieties, including support & resistance levels, oscillators, and pivot points. A few of the most common are moving averages, Fibonacci retracements/expansions, stochastics, and moving average convergence/divergence (MACD).

Like chart patterns trading, futures market participants apply indicators to various types of periodicities and charts every day. Through their use, the direction of price may be either confirmed or challenged, prompting the development of new trade ideas. Nevertheless, indicators have a few key upsides and downsides to be aware of.

Pros

One aspect of technical analysis where indicators excel over chart patterns is in quantifying trend strength. For instance, the MACD uses two moving averages to measure the momentum behind directional price action. If the MACD’s moving averages converge, the trend’s momentum is weakening; if they diverge, the trend is gaining steam.

Also, indicators lend themselves well to managing open positions on the fly. As an example, support & resistance levels, such as Fibonacci retracements/projections, may be used as guides for stop loss and profit target locations. Methods like this offer traders a clear-cut way of managing positions in fast-moving markets.

Cons

Unfortunately for active traders, indicators have a multitude of drawbacks. One pitfall is the tendency for indicators to become “cluttered” on the pricing chart. Because indicators are calculated automatically and routinely applied, it’s easy to use too many. The result is analysis paralysis as a result of conflicting and jumbled indicators hampering decision-making.

Although there are “leading” indicators, most are classified as “lagging.” Because they are derived from price data, indicator values reflect where price was, not where it may be going. The same can be said about chart patterns trading, but patterns suggest that a specific scenario is likely to unfold; the predictive capabilities of indicators are limited because the data is subject to interpretation.

What Will It Be: Indicators or Chart Patterns Trading?

If you’re confused about the concepts of chart patterns and indicators, don’t worry. Daniels Trading’s free how-to guide 10 Rules for Technical Futures Trading is designed to help you begin thinking like a technical trader. Download your copy today!

Ready to think like a technical trader? Download our free guide to learn how to identify chart formations and take action when the time is right.

Filed Under: Futures 101

About Daniels Trading

Daniels Trading is division of StoneX Financial Inc. located in the heart of Chicago’s financial district. Established by renowned commodity trader Andy Daniels in 1995, Daniels Trading was built on a culture of trust committed to a mission of Independence, Objectivity and Reliability.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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