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Forex Stock Exchange Forum  » Forex and Stock Trading English Forum » Forex School » Chart Patterns

Chart Patterns

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1attention Chart Patterns Mon Oct 31, 2016 1:52 pm

Yuri

Yuri
Moderator

Trendlines

Trendlines are a valuable tool to recognize bullish, bearish or sideways trends. Draw a bullish trendline by connecting significant lows in a market that is making higher highs and higher lows.
Bullish Trend Chart:
A bearish trendline connects significant highs in a market that is making lower highs and lower lows. Two parallel lines connect the highs and lows in a sideways market. Trendlines are usually applied to charts in three time frames, including intraday, daily and weekly.
Bearish Trend Chart:
Some long-term traders also use monthly charts. The longer the market has been in a trend, the more significant the trendline. Bullish trendlines (moving upward) should be viewed as support until broken.

Likewise, trendlines moving downward should be viewed as resistance until broken. Many traders use trendlines as part of their risk-management strategy, placing sell stops below trendline support and buy stops above trendline resistance.

How far above resistance or below support you place your stops may depend on the market’s volume and volatility. Your RJO Futures broker can help you decide on the appropriate distance to place your stops.

Change of Trend

Identifying true trend changes can help improve your entry and exit timing. The most important signals include:

• Close above the resistance trendline or below the support trendline.
• Close below the most recent low or a close above the most recent high.
• Increase in volume as a trendline is broken.
• Moving average changes direction or the lines cross over each other.

The number of contracts changing hands in the market is useful information about the trend. When trendline support or resistance levels hold and are accompanied by high volume, that indicates the trendline is significant.

The simple moving average, which averages the closing price over a set number of periods, can signal a change in trend when it turns or crosses over.

The most common set of moving averages include the 9-, 21-, 50-, 200 -day periods. However, you can use moving averages on any chart from short-term intraday charts to longer-term monthly charts. Sometimes, of course, the market fakes you out.

To help determine if the change in trend is real, experienced traders use these common rules of thumb. On long-term trends, they wait for price to move 3% in the new direction. On shorter-term trends, they look for at least a 1% price move or for the breakthrough to hold for two trading days.

Channels

Channels are simply a pair of trendlines moving in the same direction that identify both support and resistance. Channels are commonly used nby more aggressive traders who want to capture near-term or countertrend market swings.

However, they also are commonly used as a warning to an approaching trend change because as a trend has run its course, the market struggles to reach the channel lines.
Channels Chart:

Continuation Patterns

Probabilities are higher that a market trend will continue in the same direction upon completing a continuation pattern, which can look like a flag, pennant, triangle or wedge. Traders often use these patterns to project the distance of the price move that follows the breakout.

Flags and Pennants

Flags and pennants are created as a result of a sharp, high-volume market move and the need for the market to take a breather. Both formations usually last one to three weeks before the longer-term trend resumes, and may be on the shorter end in bear markets. Once the flag and pennant formations have completed, the market typically resumes the original trend with higher volume.The flag is a parallelogram that countertrends the longer-term trend. The pennant resembles a symmetrical triangle, with a much larger rally or sell-off than the flag upon breakout.

Bullish Flag Chart:
Bear Flag Chart:
Pennant Chart:


Triangles

Traders like to see prices form symmetrical, ascending or descending triangles on the chart because they reveal clues about when and which way the market will make it’s next move. The longer the market trades in the triangle, the greater the odds a breakout is approaching because it should occur before prices reach the triangle’s apex.As prices break out of a triangle pattern, volume typically increases.

Symmetrical Triangle Chart:
Symmetrical triangles typically represent a pause in the bigger trend. Typically, both the lower and upper boundaries of the symmetrical triangle converge equally on decreasing volume.

Traders expect the market to break out of the symmetrical triangle in the direction of the longer-term trend. Once price breaks out of the triangle, look for a market movement equal to the distance between the widest points of the triangle.

]Ascending triangles:
Ascending triangles are considered bullish patterns. The top of the triangle is flat and is connected to a bullish trendline. The distance between the bottom of the bullish trend and the top of the triangle is used to estimate how far the market will move upward after it breaks out.

Descending Triangle Chart:
Descending triangles are considered bearish patterns. The upper part of the triangle is a bearish trendline while the lower part is flat. Like the ascending triangle, the distance between the upper and lower parts of the triangle is used to project how far the market might move once it breaks out of the pattern. Note in the example below that the market made a false breakout to the upside before ultimately breaking down as it violated the bottom of the triangle.


Rectangles are similar to the symmetrical triangle except that the upper and lower trendlines are parallel (like a short-term sideways market.) Rectangles are considered a continuation pattern because the market often breaks out in the direction of the longerterm trend.
Rectangle Chart:
However, it is not unheard of for the rectangle to act as a reversal pattern. Volume in rectangle formations, which can last as long as one to three months, usually is higher than during the formation of triangles due to the wide price swings. Even so, volume still increases on a breakout.

Volume is key to predicting which way the market will likely breakout. If volume is higher on the up-trending swings vs. the down-trending swings, the market will likely break to the upside and vice versa.

Wedges

Wedge Chart:
In a wedge pattern, both sides of the triangle are headed in the same direction. A falling wedge is considered bullish and a rising wedge
is considered bearish. It is not uncommon for prices to break out of a wedge much closer to the apex than in other triangles. Like other triangles, expect relatively low volume as the pattern forms and an increase upon breakout. Wedges are most commonly seen as a continuation pattern of the longer-term trend. However, they are found occasionally in trend reversal situations.

Reversal Patterns


Everyone who trades wants to know when the market is going to change course. Although there is no crystal ball, some patterns provide hints that a reversal is in the making.

Head & Shoulders

This pattern gets its name from the picture it makes on the chart—that of a head between two shoulders. Technicians measure the distance from the top of the head to the neckline as an indication of the minimum amount the market will move once it breaks out of the formation, often on high volume and with a gap in prices.
Head-and-Shoulders Top Chart:
A head-and-shoulders top starts with a high (left shoulder), correction and then a rally to a higher high (head). The ensuing correction finds support in the same area as the previous correction, forming a neckline.
Head-and-Shoulders Bottom Chart:
The market rally from this support often falters near the left shoulder, creating the right shoulder. An inverted head-and-shoulders is a bottomforming pattern. The left shoulder is the first low, the head is a new, lower low and the right shoulder is a low in the area of the left shoulder.The two corrective moves in between these three lows mark the formation’s neckline.

Double Tops & Bottoms
Double Top Chart:
Double tops and bottoms are an excellent indicator of a market that is ready for a trend change. Although a double top/bottom pattern is a common sign of a reversal, the market always could be forming a triple top or triple bottom, so wait to see how the market unfolds before jumping on the new trend.
Double Bottom Chart:
In tops, volume should be lower on the second leg up and should increase when the low between the peaks is broken. The opposite is true for a double bottom. Volume should decrease on the second leg down and increase when the high between the valleys is broken.

Islands

Island Top Chart:
Island reversals usually occur when there is a major trend change, leaving a set of prices isolated as if they were on an island. After an initial gap (later to be seen as an exhaustion gap), the market trades in a sideways channel for a short period of time. Then, there will be a “breakaway” gap that leaves behind what appears to be an island.
Island Bottom Chart:

Retracement Objectives with Fibonacci

When analyzing the markets it is also important to address how far a market will move in order to identify profit objectives and manage risk. Often the minimum objective of each move is based on its pattern, for example the distance of the channel, the widest point of the triangle or the distance between the head and neckline in the head-and-shoulder formation. In addition, Fibonacci retracements are commonly used to establish target points for reversals or corrections.

They are named for the Italian mathematician who identified the price series in which each number added to the one before it creates a new one related by a ratio of 61.8%, e.g., 0, 1, 1, 2, 3, 5, 8, 13, 21, 34, etc.

Thus, traders commonly look for markets to retrace 38.2% (the inverse of 61.8%), 50%, 61.8% or 100%. Traders look for stronger trends to correct just 38.2% and weaker trends to correct at 61.8%.
Fibonacci Retacement Chart:

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