Saturday, June 24, 2017

Profitable Forex Chart Patterns Part 2

Chartists have long held the belief that patterns can predict future price movement. These assumptions are largely based on the interpretative analysis of the trader or technician that happens to be looking at it. Often times, two traders can be looking at the same chart and have two entirely different opinions.

It’s this sort of subjective, opinion based analysis that can easily lead to a bad trading decision. However, there are a number of patterns that have been identified and catalogued for many years by chart readers. These patterns have withstood the test of time and by virtue of their lengthy history can provide us with sufficient statistical data for traders to base their assumptions on.

These well known patterns, despite the fact that they are used by thousands of traders every day, will always work within the confines of any well planned strategy. Some will argue that their very appearance creates a sort of self professed strategy, and to some degree there may be some truth to that.

However, once you learn the underlying reasons for their formation, you’ll begin to understand the very foundation upon which chartists base their belief in a price pattern’s predictive powers. The reason for this is because a good chart pattern’s very formation is born out of two conditions that will never change.

The first condition is psychological. The human condition will always possess varying degrees of fear, greed and uncertainty, even, and especially when it comes to trading! We all know that money can have a big effect on the behaviors exhibited by most people. As you will see by the examples below, chart patterns do an excellent job of revealing these behaviors.

The second condition is the natural presence of supply and demand. Buying and selling also has a story to tell as it prints it’s data onto your screen. When you start studying these charts you’ll begin to see the very logical reasons for some of these formations and how to interpret them. Once you are able to recognize the convergence of psychology with supply and demand in one of these patterns… now you’ve really got something to begin building a trading system around.

Double Top or Double Bottom Formations

Currency pairs that have been in a long term up trend will often see a double or triple top formation occur before the trend reverses direction and begins trading lower. Conversely, down trending currency pairs will often show a double or triple bottom before changing direction and trading higher. Multiple tops and bottoms are classic reversal patterns.

As the predominant trend weakens, buyers and sellers begin to do battle resulting in what initially appears as a classic pullback and continuation pattern. However, with any multiple top formation, if the buyers become fearful and choose to take profits once price has reached the previous high… then a sell off ensues sending the chart into a new downward trend. The reverse of this is true with a multiple bottom formation.

Bull And Bear Flags

Flag formations are considered trend continuation patterns and are among the most reliable of all patterns to trade. A bull flag forms when the currency pair has been in a strong uptrend and price then trades in a range bound sideways pattern. The resulting pattern looks like a flag at the top of a flag pole.

Traders that recognize this set up will place a buy order just above the previous high of the flag with the expectation that the trend will continue. The reverse is true when a bear flag formation occurs.

With this pattern we see a dramatic increase in price (the pole) with some normal and expected profit taking (the flag). However, demand (in the case of a bull flag) is greater then supply despite the profit taking which has created this temporary sideways action. High demand, combined with confidence by traders causes price to break out of it’s consolidation and the trend resumes.

Triangles

The triangle pattern is another very reliable charting formation and is considered a consolidation pattern. Triangles begin with a fairly wide yet defined sideways movement in price that over time tends to have lower highs and higher lows until the price points are trading within a very narrow range. This gradual narrowing of highs and lows creates an apex with the resulting pattern looking like a triangle.

What sets triangles apart from other side ways patterns is that once a break out occurs beyond the crudely drawn lines of the triangular shape, these break outs can often be explosive and the beginning of a new trend. This occurs because we can see very little conviction from buyers or sellers as price drifts slowly sideways into the point of the apex. However, at the beginning of this consolidation, the triangle’s wide point proves the potential and likely magnitude of price once it is a confirmed break out or break down.

Psychology + (Buyers and Sellers)= Profitable Patterns

Double tops, double bottoms, bull and bear flags, and triangle formations are among the most heavily watched  and traded patterns in the world. They are, and always will be extremely reliable because they represent the merging of human behavior, supply and demand in a way that is identifiable and logical.

The descriptions of each pattern in this article are very basic. There are many other considerations  required before attempting to trade them. The point in all of this is so that as you become a student of technical analysis, and chart patterns in particular, that you will understand the importance of being able to visualize the fear, greed, uncertainty, and confidence that causes many of the buyers to sell and the sellers to buy.

This knowledge is what will set you apart from the whimsical amateur  who thinks that patterns are magical ATM machines to be followed blindly. It also is what sets apart the charted results from a coin flip versus a currency pair that involves human beings and real money.

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