Diagonal VS Horizontal Trading Patterns

By | December 22, 2015

Over the years I’ve become a bigger and bigger fan of horizontal chart patterns in the detriment of the diagonal ones. It took some time until I was able to articulate to myself why the former are superior to the latter, but now it’s all crystal clear in my mind.

In books or on various websites, formations like symmetrical triangles, wedges, flags and so on look wonderful. Just buy the break-out of the diagonal resistance or support and more than likely you’ll hear the cash register ring. :) Well, in my experience, things are not as easy as they seem. I found the failure rate of such patterns to be inordinately high. To add insult to injury, in many cases, the price will just go far enough to take out your stop loss, consolidate a little bit, and then move without you in the correctly anticipated direction.

Nevertheless, some of my biggest winners (risk-return wise) have involved diagonal patterns, a fact which delayed my identifying the issues with them. But now, that I’ve carefully gone through a lot of my trades to research this aspect, I can say the following: in the majority of successful past trades involving a diagonal chart pattern, a horizontal pattern was also present. Only that for one reason or another, the trigger in those cases was represented by the diagonal formation.

Below is one of my most perfectly executed trades to date: a pyramid on EUR/USD in January 2013. While the most visible and the reason at that time for entering the second pyramid level was the break of the resistance (the first level was entered at the supporting trendline), there are two ‘hidden’ horizontal patterns here.

graff

EUR/USD diagonal patterns

You can see in the picture below the double bottom (coinciding with the trendline) and the break out of the consolidation (coinciding with the break of the diagonal resistance)

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EUR/USD horizontal patterns

I like to keep things simple in trading – I pay attention only to what the price does – the highs and lows of the price bars give you all the objective information there is about where the market has been. Anything else on the chart is either a derivative of the price (indicators for instance) or random lines (Fibonacci for instance). Now, here lies the big difference between diagonal and horizontal patterns:

AUDUSDH1

Horizontal support/resistance on AUD/USD

EURAUDH11

Symmetrical triangle on EUR/AUD

We can see in the first picture how the support turned resistance and then support again is determined by the highs and lows of the price. In the second picture though, both trigger points (blue areas) are not created by the highs and lows of the price itself. In other words, we have only chart pattern confirmation, without price confirmation – this is a very important difference, hence the bold.  The price should have reached a point higher than the previous swing high and conversely a point lower than the previous swing low in order to confirm either move.

What I hope to make clear is that price is the most objective (although far from 100% correct) trade trigger there is. And in many cases, it gives different signals to what a diagonal formation might give. Ignoring the price in these instances will usually turn out to be a costly decision.

3 thoughts on “Diagonal VS Horizontal Trading Patterns

  1. Christopher

    Hi Vlad
    Thanks for the article.

    I have recently started pyramiding profits myself. It’s a much more rewarding way of trading and enables one to achieve rewards of 1:30,40 & 50 far quicker than just having one position. Also when you pyramid, your success rate can be less than 40% and you can still make good returns, as opposed to having to be right 70-80% of the time with a 1:2 1:3 risk reward like most traders are taught and aspire too ( lol what a sad joke that is ).

    I am having a problem with it though.
    I haven’t been able to get the math right when working out how many extra positions to add on with the current floating profit when there is an opportunity to do so. For example

    If I was long 1 contract on gbp/cad, 120 pip stop and had an opportunity to add on when my first position is in 430 pips profit but with a 80 pip stop on the second position, how or is there an easy way to work out how many extra contracts I can add with the current profit and new stop loss? Is there a simple formula you use yourself?

    Any thoughts would be much appreciated
    Cheers

    Reply
    1. JLTrader Post author

      Hi
      I don’t have a fixed formula for pyramiding levels. The only hard rule is that in case the stop loss is hit, you shouldn’t lose more than your usual risk (let’s say 0,5% of capital). Other than that, it’s all a matter of how aggressive you are (normally I’m more aggressive when in a winning streak).

      In your example, assuming 1 standard contract, your initial risk is 120p X $7.18/pip = $862. You have 430p profit, that means 430p X $7.18/pip = $3087. So the most you’re willing to lose is $862 + $3087 = $3949. With a 80p SL, that means the max value per pip is $3949/80p = $49.36/$7.18 = 6.87 contracts. So the most you can add is 5.87 contracts. (6.87 – your existing contract).

      I hope this helps.

      Reply

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