There are certain limitations associated with using chart patterns to trade that traders should be aware of.
The 6 limitations of using chart patterns are:
- Chart patterns can fail
- Traders can draw the chart patterns wrong
- Chart patterns can have many false breakouts
- It can create a bias for traders
- Traders can misjudge where to place price targets
- Chart patterns can cause some traders to overtrade
Below are the problems and limitations of chart patterns discussed in more detail.
Some of these chart pattern limitations are particularly problematic with newer traders.
1. Chart Patterns Can Fail
The first limitation of chart patterns is they can and will fail.
Essentially, a failed chart pattern is when the chart pattern breaks out or breaks down and fails to continue in the direction of the trend and instead reverses and stops traders out.
From our chart pattern data, no chart pattern has a 100% win rate. On the contrary, most chart patterns have a low win rate meaning they fail quite often.
For example, a rounding bottom pattern has a very low win rate of 35% in the forex market.
This is not a problem if the reward-to-risk ratio is high to offset the losses.
However, new traders get caught out by this because they believe that chart patterns have very high win rates which causes them to make oversized trades.
Every trader should plan for chart patterns to fail by placing stop-losses in the market and managing risk on a trade.
2. Traders Can Draw The Chart Patterns Wrong
The second limitation with chart patterns is traders can sometimes draw the wrong chart patterns.
From the image above, there is a great example of drawing a chart pattern wrong (on the left) and the right way to draw it (on the right). This is from the exact same price chart at the exact same time.
Drawing the chart pattern wrong can be very problematic as one trader could be shorting a market and another trader could be buying the market based on the pattern they draw, a perfect example of this being the image above.
This limitation becomes less of a problem when a trader gets more experience with drawing the chart patterns.
3. Chart Patterns Can Have Many Failed Breakouts
The third limitation with chart patterns is they can have many false breakouts before the real breakout occurs.
This can cause a trader to get frustrated as they attempt to capture the breakout only to be continually stopped out of the trade before the real breakout happens.
From the image above, there is an example of a chart pattern failing to break out on multiple occasions before the actual breakout occurs (labeled "1" and "2" on the chart).
A useful tip to help with this limitation is to only trade the chart pattern when there is an increase in volume on the breakout.
This does not guarantee success but it helps filter out some lower probability trades.
4. Chart Patterns Can Create A Bias For Traders
The fourth limitation of chart patterns is they can create a bias for traders.
For example, if a bullish chart pattern forms, it can cause a trader to have an overly bullish bias in the market and a bearish chart pattern can cause a trader to have an overly bearish bias in the market.
This can cause traders to not think objectively and instead they only see what they want to.
This can be problematic if the trader does not manage their risk appropriately to protect their capital.
5. Traders Can Misjudge Where To Set Price Targets
The fifth limitation of chart patterns is traders can sometimes misjudge or make an error when setting price targets based on chart patterns.
Every chart pattern has rules on setting price targets but new traders sometimes calculate their price targets wrong.
There can also be confusion about how to calculate the price targets of different chart patterns.
From the above price chart, there is an example of a trader setting the wrong price target on a trade. This results in the trader missing the profit level and turning a winning trade into a losing one.
6. Chart Patterns Can Cause Some Traders To Overtrade
Chart patterns when drawn incorrectly can cause traders to overtrade. A trader may think there are more signals from a pattern than there actually is.
As a result, they may be constantly attempting to buy breakouts and short breakdowns from patterns.
Overtrading can cause commissions and losses to add up. This is why it's so important to ensure a trader knows how to identify a chart pattern correctly.
This will only come with experience.
Frequently Asked Questions About The Limitations Of Chart Patterns
Below are frequently asked questions about the limitations of chart patterns.
Do Chart Patterns Have Any Downsides?
Yes, chart patterns have downsides including they can be misinterpreted by traders, they can create many false signals, they can fail and they can cause a trader to overtrade when used incorrectly.
Do The Limitations Of Chart Patterns Mean They Are Unprofitable To Trade?
No, the limitations of chart patterns do not mean they are unprofitable to trade.
The limitations of chart patterns are only limitations depending on the individual trader. For example, professional and experienced traders are more familiar with chart patterns and do not suffer from some of these limitations like a novice trader might.
Is It Difficult To Overcome The Limitations Of Chart Patterns?
Overcoming the limitations of chart patterns is not difficult to do. However, this will depend very much on the individual trader and their discipline and ability ot learn.
Some traders can figure out how to fix these limitations much faster than others and there is no set time it takes a trader as everyone is different.