Forex Trading Articles - Pattern Recognition

Cognitive Pattern Recognition in FX Trading

Nov 11 • Forex Trading Articles • 4210 Views • 3 Comments on Cognitive Pattern Recognition in FX Trading

A single euro coin has eight sides; heads, tails, edge side, outside, inside, top side, bottom side and inner wall. We often use popular phrases such as “there’s two sides to every coin”, or “there’s two sides to every story” and accept without question these statements as received wisdom. Issues and problems have more than “two sides” and yet this acceptance is so unconscious that people forget that an everyday object such as a coin has an obvious third side, the edge or rim.

As in all areas of life we (as traders) must constantly question assumptions or wisdom that’s delivered to us from what appears to be an authoritative platform of success or expertise. It’s imperative that people question assumptions and see beyond the surface of the reality and understand the fundamental physics.

Using the coin as an example, in order to see all eight sides why not (with your mind’s eye) enter the coin and look around or “become” the metal inside the coin and find your boundaries. How many more sides are on the inside, is the fact that the coin is solid important, if the coin was hollow would it stop being a coin, is the material in a coin insignificant? Since inception the value and cost of certain constituent parts of the euro have rocketed, are the producers using less copper, zinc or silver in their production, where does the real value of this euro coin come from?

People with dominant objective reasoning will identify with the concept of thinking in terms of probabilities. It’s difficult to accurately identify a shape with a cognitive function as each function operates from two perspectives. Pattern recognition and awareness can be applied to exercising and improving cognitive performance. Recent work suggests that people are actually thinking, at an unconscious level, about the solution even prior to actually solving the problems with insight.

I often look at charts and think of what’s displayed in several dimensions and not simply the flat information delivered to me on the chart by way of my monitors. I consider the activity that has led to the creation of that chart, both the human interaction and the technology. Literary hundreds of thousands of trades have been placed as you’ve read this last paragraph. In the time taken to read this article billions of trades will have been made, on a myriad of exotic securities, by hundreds of thousands of traders on millions of pieces of software and technology. To think that all that effort, all that human action and interaction, even that performed by quants programming their algorithms, is then concentrated and reduced to a decimal figure on a chart is often worth contemplating. We are one of several billion contributors helping or attempting to move a market in a certain direction.

I often ‘meditate’ on the vastness of our internal trading universe shortly after taking a trade, once the trigger is pulled the contemplation that you’re now at the mercy of the market, created by the billions of parts of action and interaction, promotes the right degree of humility. That all that concentrated effort produces a ‘footprint’ on a chart for us to then consider making a decision on is mind blowing at times; all that human emotion, all that energy and intelligence eventually produces some random dots and dashes leading to a pattern.


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Similar to indicator based strategies pattern recognition technique is often a target for the naysayers. However, as with all: indicator based methods, price action, tape reading, trading off fundamentals, or using key levels pattern recognition ‘works’ in as much as all methods work in the right hands. The importance of pattern recognition to trading success should never be overlooked.  Whether traders focus on chart configurations, technical indicators, or shifting bids and offers from a Level II screen, they are extracting patterns from markets that are associated with future price movement.  Much of trading expertise consists of seeing so many variations of these patterns that they become internalized, a trader develops a feel for the market.

Success in trading is less about personality and more about screen time. Traders need to see enough examples of patterns to create what psychologists typically refer to as implicit learning. This is the type of learning that characterises athletes, fighter pilots, chess masters and other trained professionals.  A hallmark of implicit learning is that the performer’s knowledge cannot be verbalised and communicated but can result in exemplarily performance. For example, how often do we remark that a brilliant footballer reads the game well, he has the ability to find time and space to accept the ball in the right areas of the pitch, he creates his own high level of probabilities of success in doing so.

There can be two critical success factors that hold back expertise developing within a trader; firstly a lack of screen time. Traders who watch the markets on a part-time basis, or who attempt to trade without live data cannot possibly develop the intimacy with patterns that are the characteristic of full-time traders who constantly review their market.

Secondly information overload. Traders who watch too many patterns can internalize few of them. A high level of cognitive focus is needed for implicit learning. If the trader jumps from chart to chart, indicator to indicator, pattern to pattern then traders create what researchers call interference effects. Information obtained before and after the occurrence of a key pattern interferes with the processing and internalizing of that pattern.

There is much to be said for advice to maximise screen time, but it’s essential to focus on a small set of core, tradable patterns that the trader can readily identify and that makes sense to that trader. Having watched charts for some years I am now familiar with the patterns of, for example, breakouts, reversals, and trending days. In short I have acquired intimacy with a small set of patterns as I have done with a certain small set of indicators which I favour.

However, the specifics of market indicators and chart patterns is actually less important than the process of observing and internalizing these over time. Practice makes permanent. In part two of this article next week we’ll focus on the most popular chart patterns to look out for.

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