Chart Patterns vs. Indicators: Which Makes You Richer?

Some say that learning a specific analytical method is a superior approach. Numerous types of technical indicators provide a variety of insights into the specifics of any given market situation. On the other hand, using chart patterns is a much cleaner way of making forecasts for the near future and long-term predictions.

Making the right choice when comparing different methods of making price action predictions is not an easy task as it requires substantial experience with both methods. While the combination of the two usually produces the most optimal results, it is important to take into consideration the lack of practice and knowledge that often handicaps novice retail traders. Sticking to something that you understand well and can apply to real market conditions is a superior choice for newcomers.

What are chart patterns?

A pattern is a sequence of price action changes that can be repeatedly identified on a chart where it is graphed. In general, practitioners of this particular discipline assume that all the necessary information about market dynamics is already represented in price action. Decisions of traders move the graph in certain directions creating an environment where you can deduce and introspectively predict market fluctuations based on how participants of the market habitually react to certain events.

Here are several examples:

• When a price suddenly surges up, analysts often expect so-called retracements or corrections. The logic behind this expectation is that the initial reaction of the market is often driven by panic and the fear of missing out. The asset must be returned back to the true value of an asset once emotions calm down and traders aggregate at a certain level.
• Several corrections in a row often suggest a dramatic shift in market sentiment. People who know how to use TA techniques heavily focus on searching for repeating shapes formed by sequential and easily recognizable fluctuations. In theory, these are frequently caused by temporary uncertainty that should resolve eventually. A variety of types of different line formations try to predict trend changes based on the length, amplitude, number, and direction of corrections.
• Long periods of inaction may also be indicative of potential reversals or trend strengthening depending on the context of the sideways movement. Some of the shapes account for prolonged stretches of time where nothing of note happens and strong trends do not form. Analyzing markets with little activity can be challenging when using only this method without insights produced by volume indicators.

Some retail traders spend years searching for the best chart patterns for day trading and other strategies. However, many experts believe that these tools are insufficient on their own and require additional analysis to generate reliable trading signals.

The benefits of using chart patterns

Despite the notable downsides of exclusively using price action reading to produce forecasts, they still can have immense value for a retail trader. People enjoy visual clarity and avoid cluttering their terminals with unnecessary noise, conduct holistic analysis incorporating a variety of data points, apply identifiable shapes to all types of assets, and make predictions based on timeless principles like psychology and behaviors or market participants.

These are all valuable advantages but you should also consider the following:

• High accuracy. Some academics claim that using this approach is a method of making forecasts with incredible precision. Thomas Bulkowski known by many for its magnum opus “The Encyclopedia of Chart Patterns” states that his research revealed an impressive 86% correct market direction forecasting when using the “Head and Shoulders” formation. The result is higher compared to many technical graphical tools.
• Avoiding false positives. In trading automation, the issue of false positive trading signals is quite challenging as it often causes erratic behavior in bots. Neely et al. (2014) compare the performance of various visual shapes with popular analytical instruments across several different asset classes. Simple formations like triangles and rectangles produced reliable predictions and less noise than 3MA or MACD.
• Understanding the market sentiment. Investor psychology plays a huge role in the process of forecasting. In 1999, John R. Nofsinger and Richard W. Sias, two acclaimed researchers in the field of financial analysis, demonstrated that easily recognized forms like “Double Tops and Bottoms” do reflect market sentiment and make correct predictions about the fallout of fluctuations in most cases.
• You can interpret them easily. The vast majority of retail traders prefer using this methodology due to their relative simplicity and clarity of signals. The famous analyst John Murphy surveyed his peers and learned that over 80% of investors consider reading visual cues based on the changes in the graph superior because of the factors mentioned above. Many believe that technical tools are more complex and may enhance subjectivity.

Some foundational work on the field in question was done in 1948 by Edwards and Magee, but their research was based on already existing approaches to analyzing asset evaluations. The historical significance of the method and its modern evolution should not be underestimated! Millions of investors use these time-tested ideas to identify opportune moments to enter the market.

What are technical indicators?

It is a mathematical formula (or several) represented visually as a graphical overlay, oscillator, or another form. The formula may calculate a variety of factors including the history, volumes, momentum, time, and more. Since calculations may interpret any inputs, it is possible to create a chart pattern indicator that will use standard approaches to building graphical overlays.

The TradingView platform allows users to create sophisticated systems that may incorporate a variety of market data and even receive external inputs (numbers, statistics, or social media sentiment). Modern analytical instruments come in all shapes and colors allowing everyone to build complex strategies.

While strategies based on using a combination of these instruments may indeed be more complex than just looking for familiar shapes, contemporary investors have to learn them for several reasons:

• The prevalence of automation. Without running powerful automated trading systems, it is hard to achieve success in the long run and build a strong portfolio. A typical crypto trading bot is capable of producing profits systematically, trading around the clock, and making decisions without succumbing to emotions. The effectiveness of algorithmic trading is what makes it important for retail traders to deploy bots which usually receive trading signals from strategies based on various analytical tools.
• Low entry barrier. If you use default settings which are quite easy to deploy and read making them attractive to newcomers, you’ll be good at analysis even without any prior experience. A graph cluttered with graphical overlays can be very hard to interpret, but standard combinations like RSI/Moving Averages or MACD/Stochastic are time-tested instruments providing clear readings if you don’t tinker with the settings. Novice analysts find it easier to work with tools like the Relative Strength Index, Bollinger Bands, and Volumes.
• The abundance of information. While many of these tools may have some difficulties making predictions when used with default parameters, experienced analysts make them work by carefully testing different combinations of settings for specific time frames and assets. Learning this mastery takes a long time and dedication as well as good mentorship from a professional. Thankfully, the internet is full of good educational materials.

The benefits of using these time-tested tools

A variety of contemporary analytical instruments have been in active use since the beginning of the 20th century. Some of these tools are used without any changes by this day. We often compare charts vs indicators but many analysts use both types of instruments to conduct holistic analysis of the market. These tools have differences and some can be beneficial in certain scenarios.

Here are some reasons to focus on using them:

• Quantitative metrics. Many of these instruments work on predefined formulas leaving little room for subjective interpretation. Issues start appearing when retail traders start tinkering with settings too much making them highly specialized or erratic. A research paper published by Lo et al. in 2000 says that algorithmic strategies that utilize different tools for reading the market based on quantitative approaches consistently outperform many other strategies.
• Impressive adaptability. The method relies strongly on recorded historical market movements and do not incorporate any other, potentially relevant data. Contemporary adaptive RSI and Moving Averages produce good results even in chaotic markets often experiencing high levels of volatility. These arguments are backed by the research of Chan et al. in 2013.
• Statistically provable. In 1992, a group of traders led by an academic Brock found that RSI and Stochastic were better at predicting the market than random strategies that made decisions without taking market data into consideration. The results were not surprising yet revealed the statistical advantage of using standard instruments for financial forecasting.
• Automation. As discussed previously, automated trading systems are prevalent in traditional and crypto markets with over 65% of all retail traders using it to at least some degree and over 99% of institutional investors employing automation for most of their trading operations. 70% of all institutions heavily use algorithmic trading according to Greenwich Associates.
• Personalization may add subjectivity to the interpretation of readings. However, Menkhoff, a recognized academic in the field of finance, notes that successful retail traders often employ different types of TA tools and their settings based on their risk tolerance and asset types. This diversity allows all investors using different instruments to discover and come up with unique analytical methods that often outperform standard models.

How to develop a technical analysis strategy

Comparing different tools that analyze volume or trend vs pattern analysis is not the right approach to creating a functional strategy. You should choose instruments based on personal preferences, available tools, risk style, and many other factors that may change from one investor to another. It is hugely important to consider them when building a strategy that works perfectly using common practices.

Below are some useful tips for people who want to build a robust analytical system and cannot decide between standard indicators of trend vs pattern analysis:

• Pick the right tools. Advanced instruments like MACD, RSI, Bollinger Bands, Fibonacci Retracement, and more can be quite useful. Combine them with time-tested price action line forms like triangles, head and shoulders, flags, and others to conduct a holistic analysis. A good combo of tools will help you identify trends, momentum, volatility levels, and proper entry points.
• Be mindful of the crypto market specifics. Many assets in this industry are highly volatile due to their speculative nature. Traders engage with the ecosystem around the clock and have to be aware of massive value changes caused by social media sentiment, news events, and more. Accounting for unpredictability is crucial.
• Do not forget about testing. TA work is all about achieving the most optimal, statistically provable performance from your strategy. Automation platforms like WunderTrading offer their users a variety of ways to backtest and validate any strategy. Whether you use the whole available arsenal of instruments and other means of procuring signals. You can and should test them!
• Employ appropriate risk management practices. If you want to learn how to use various TA tricks properly, studying and using robust risk management instruments like delayed orders, trailing stops, smart position sizing, strategic order placement, and diversification can be extremely useful and save you a lot of money!
• Use multiple timeframes. Switching between different views of the chart and trying to find correlations between market sentiment on different time scales should be a habit for any contemporary retail trader. Signal alignment on multiple timeframes was proven to be an effective approach by John Murphy in his 1999 book “On Chart Analysis” where he used the combination of 4-hour and 1-hour charts to a great success.
• Consider tolerable risk-reward optimization. Personal risk style and asset management preferences play a key role in any invetment strategy. Maximizing gains while reducing losses leads to better short- and long-term outcomes for retail traders. Searching for the sweet asymmetry between potential losses and profits is a skill that one must master.

Finding the right balance between vastly different instruments for financial forecasting is quite important if you want to build a high-performance strategy without glaring weaknesses. You must be flexible and adapt to changing market realities by learning new tricks, practices, and tools.

Chart patterns for price action vs indicators: which is better?

What works best for any particular retail trader is defined by personal preferences and risk tolerance. Even the best technical indicators for swing trading will fail to deliver a good performance when used by someone who does not understand them and can accept a high level of false positive signals. The right tools for the job can be quickly identified if you practice systematically and try to statistically prove the efficiency of your trading strategies.

Work with reliable service providers like WunderTrading, use the most sophisticated tools like TradingView, and trade on reputable crypto exchanges like Binance or Coinbase. With enough practice and patience, you will create a robust system capable of delivering consistent results.