A recent think-or-swim publication extolled the trading platform's new "Pattern Finder," a tool that can be applied to price charts to identify patterns. Patterns such as head-and-shoulders, double tops or bottoms and others used to be big stuff back in the late 90's, but aren't we kind of over patterns? Aren't they so
1999? Do they even work any longer in the age of dark pools and high-frequency trades?
Daily Chart of MO through March 5:
Please ignore the grammatical mistake on the annotation and notice instead that almost classic wasn't good enough for this head-and-shoulders pattern. Price broke to the upside and not through the neckline. I've seen plenty of head-and-shoulders or other patterns that were classic, fulfilling all pattern requirements, including volume considerations, and then failed to break as expected or predict the next price target.
However, is it possible that patterns still can prove their worth? Sometimes we seek a general understanding of where the markets might be in their cycles: whether they appear ripe for a rally, a pullback or a consolidation. Whenever we trade directional trades, we need stops as much as we need potential profit targets. What tells us when our trade isn't working as expected? In our MO example, the trader with a bearish trade knows on that first full-bodied white or green candle on the far right side of the H&S formation that this trade isn't acting as anticipated. Depending on whether the trader had entered a bearish trade at the last peak or when MO hit the supposed neckline, the bearish trade might have set a stop just above 50 or nearer 52. The head-and-shoulders pattern didn't predict the next direction, but it certainly helped the trader set up a scenario for determining when the trade was going wrong.
Most online brokerages provide you with tools to draw trendlines, channels, triangles, rising and falling wedges and such patterns. If the trader doesn't know much about such patterns, StockCharts provides a free section on chart patterns under their "ChartSchool" section. FinViz goes one better: when you call up an equity chart on that site, FinViz slaps any chart patterns it finds on the chart for you. It's of course up to you to determine whether you agree or disagree with that pattern or whether you feel it's a tradable one, of course.
FINVIZ Daily Chart of MO as if March 5:
Sizing requirements for publication rendered this chart a little fuzzy, but I think you can see that the predominant pattern chosen here is a rising price or regression channel. I can't determine from looking at it whether regression analysis was used. I also can't be sure whether it was already showing that rising channel back early in 2015, when MO was dipping down to test the trendline of a supposed rising price channel. If a trader had seen that the neckline of the H&S formation from the first graph was going to roughly coincide with a rising price channel's support line--or just with a roughly drawn rising trendline--that might have discredited the idea that prices would break down through the neckline of a trader-drawn H&S formation. The trader who still believed that a breakdown would occur might have risked less in the trade or set a tighter stop, for example.
For the utter newbie with drawing price patterns, an old book titled Stikky Stock Charts is a great primer, demonstrating "8 major chart patterns used by professionals" in a much illustrated workbook form. Traders can still find the book for sale: I checked before recommending the book. More sophisticated traders might turn up their noses at the simple format, but I think it serves a great purpose if traders remember that patterns should not be used as guarantees that something is about to happen but rather as a guide to what might happen. More importantly, patterns can be guides to where profit targets and stops might be placed.