Continuation Patterns: Flags

A flag is another continuation chart pattern. It can be bullish or bearish, depending on what kind of move was before the pattern formed. If the move was down you would expect a bearish flag and if it was up you would wait a flag to be bullish. Technical analysts argue about the length of time that would validate the pattern, but most would agree that it could be from a couple of days, to a couple of months. Key components of a flag A flag pattern should have a sharp move that precedes consolidation or a range. This strong move forms a shape of a flagpole, which distance has to be measured from the area where the move started to the point where the move stalled. After the move is over and price starts ranging it forms a rectangular sloping channel that does look like a flag. If previous move was up, the sloping channel should be down. If previous move was down, the sloping channel should be up. If you draw the trend lines through the highest and the lowest points of the pattern you will be able to see the shape of a flag clearly. How to trade a flag Sooner or later a breakout occurs and in most cases a bullish flag is broken upwards through the trend line of the upper channel and a bearish flag is broken downwards through the trend line of the lower channel. So, if you spotted a bullish triangle and expect a break up, you need to place a buy stop order a few pips above the upper trend line and with a stop loss a few pips below the most recent support. In most cases that would be around 50 pips. If you defined that a flag is bearish you have to place a sell stop order a few pips below the lower trend line of the pattern with a stop loss order a few pips above the most recent resistance (usually some 50 pips). An easy way to calculate your take profit target is to measure the size of a flagpole and add that amount of pips to the breakout point (up or down depending which direction price breaks). Below is the example of a bearish flag that formed in eur/usd pair when it was in a sharp downtrend. It took only one week for the pattern to form. Bearish flagpole was 300 pips and that was our minimum target. Stop loss was around 50 pips. Our target was reached and we were happy to make hundreds of pips....

Continuation Chart Patterns: Ascending and Descending Triangles...

I want to continue talking about most popular chart patterns, but this time start analyzing continuation patterns: ascending and descending triangles. There might be more combinations of triangles, but most of them will have the same attribute: narrowing range. This is expressed by another attribute: two lower highs and two higher lows, which clearly indicates contraction in volume and a narrowing range. This eventually leads to a breakout up, or down. If you connect those lower highs with a trend line and higher lows with another trend line you should get a shape of a triangle. Eventually price breaks either up or down and price moves strongly, usually in the direction of previous trend. If the previous trend was up, we would expect an upward breakout and if it was down, we would expect price to break downwards through the lower trend line. How to trade these patterns These technical patterns are best traded using breakout trading strategy. In case of an upward break we would place a buy stop above the second point of an upper trend line with a stop loss a few pips below the most recent support level. In case of a downward break we would place a sell stop below the second point of a lower trend line with a stop loss a few pips above the most recent resistance level. Minimum expected target How to calculate how far the price is going to travel? Well, nobody knows that for sure, but in most cases a formula that helps to calculate minimum expected target often works. You simply have to measure the base of the triangle or distance from the highest point to the lowest point and add the distance to the breakout point. When price eventually breaks up or down, that’s the minimum distance you expect price to go. If the base is 400 pips, that’s how much you expect (at least) price to travel from the breakout zone to your take profit target. In most cases it will go much more and if you trade with a few or more positions you will be able to accumulate a lot more pips. Below is an example of a small bearish (descending) triangle in eur/usd pair that was only a breather in a huge downtrend. Two high and two low points are clearly visible in the chart. You simply had to place a sell stop below the number 4 point in the chart with some 40-50 pip stop loss and when the breakout occurred you could have made thousands of pips, had you traded with a few...

Double Bottom Reversal Pattern

This is the third blog post on the series of basic chart patterns. If you haven’t read previous ones, be sure to do it. I am still covering the first big group of the patterns: reversal ones. Today I want to discuss double bottom formation and clarify how you can trade it. It is basically the same structure as double top, except inverted, in the same fashion inverted head and shoulders pattern (bullish) is to head and shoulders (bearish). So, let’s define it! It is a bullish reversal pattern that is often found at the end of a bearish trend and when validated it often results in a big uptrend. This technical structure consists of two bottoms that are relatively equal in terms of place they form. So, firstly, there has to be a bearish move before the pattern forms. At some point price reaches important support level, where the first through (bottom) forms and then it starts going up rapidly. After some time price reaches important resistance level and forms the first peak. It entices bearish traders to step in and continue selling as they assume the downtrend will continue. Price collapses back to previous support (through) and fails to break it convincingly. In most situations this bottom will be slightly higher than the first one, in other situations price can break previous bottom by some 3-15 pips and then a sharp reversal will take place. When that happens we can be sure that the second through (bottom) is in place. Price will start rising again till previous resistance level where it stopped and rallied to form the second bottom. It may linger there for a while, but double bottom pattern is really validated when price breaks up through that resistance and continues going up. How do you trade it? One of the best ways to trade the pattern is to place a buy stop order above the first resistance level where price came and then collapsed to form the second bottom. You may wait for the level to be hit second time, retrace a little and then if it starts going up again, place a buy stop order above the resistance with a stop loss order below the most recent support. When the resistance is broken, pattern is validated and you should be in the game of buying. Where to take profit? It is not difficult to calculate a minimum expected target. You can do that by calculating the distance from the bottom to the resistance and adding it to the breakout level. If the distance is 500 pips, this is the minimum distance you expect price to go from breakout level upwards. I want to illustrate how it works by attaching a weekly chart of gbp/usd with a double bottom pattern. When the structure was confirmed after resistance was broken price rallied more than 1400 pips before reversing. The minimum target for the move was measured to be 938 pips. You could have taken that easily and many more had you traded with a few...

Double Top Reversal Chart Pattern

We continue the series of articles on best known chart patterns in financial markets. Last time I wrote on head and shoulders (don’t forget to read that one). May I remind you that these patterns are usually placed under two categories: continuation and reversal. It would be best for us to look at reversal category first and then go on to continuation patterns. So, let’s talk about double top today. It is a bearish reversal pattern that is often found at the end of a bullish trend and when validated it often results in a big downtrend. This technical structure consists of two peaks that are relatively equal in terms of place they form. So, firstly, there has to be a bullish move before the pattern forms. At some point price reaches important resistance level and starts going down rapidly. After some time price reaches important support level; which entices bullish traders to step in and continue buying. Price rallies back to previous top and fails to break it convincingly. In most situations this top will be slightly lower than the first one, in other situations price can break previous top by some 3-15 pips and then a sharp reversal will take place. When that happens we can be sure that the second top is in place. Price will start falling again till previous support level where it stopped and rallied to form the second top. It may linger there for a while, but double top pattern is really validated when price breaks lower through that support and continues going down. How do you trade it? One of the best ways to trade the pattern is to place a sell stop order below the first support level where price came and then rallied to form the second peak. You may wait for the level to be hit second time, retrace a little and then if it starts coming down again, place a sell stop order below the support with a stop loss order above the most recent resistance. When the support is broken, pattern is validated and you should be in the game of selling. Where to take profit? We need to have a minimum target. You can do that by calculating the distance from the peak to the support and adding it to the breakout level. If the distance is 500 pips, this is the distance you expect price to go from breakout level downwards. As the picture is worth a thousand words I have attached a weekly chart of eur/usd with a double top pattern. When it was confirmed after support was broken price went down more than 3000 pips before reversing. The minimum target for the move was measured to be 750 pips. You could have taken that easily and many more had you traded with a few...

Head and Shoulders Reversal Pattern

Head and shoulders is a bearish reversal pattern that often forms at the end of a bullish trend or a short term swing. It also predicts a possible downturn in price if the pattern is validated. This technical structure is probably the most famous one among technical traders, because when validated it is usually followed by mega bearish trend. Like any other pattern it has its specific characteristics, rules for trading as well as filters that might negate the pattern. The structure The pattern consists of three consecutive peaks: left shoulder, the head (it is the highest peak), and the right shoulder. Some technicians say that it is better when the shoulders are relatively the same in size and form in the same length of time, but even if that is not the case most of these patterns work out pretty well. In an uptrend the left shoulder forms first. When this point is reached, price sharply reverses and starts going down (usually quite dramatically). After some time price stops falling, consolidates and makes another rally upwards by exceeding previous high (left shoulder) and forms the head of the pattern. After some consolidation price starts going down again and reaches relatively the same area as in the first case when it went down from the first peak. It finds support again and makes another attempt to reach previous high (the head), but fails. That’s the level where the right shoulder forms. Price consolidates the last time and starts falling like in previous times. Now, if you draw a trendline from the low of the first decline through the low of the decline from the head you will get a neck line. The neckline acts as key support level of the pattern. If broken downwards, the pattern is validated and the downtrend confirmed. How to trade head and shoulders Trading rules are really simple. A trader has to place a sell stop order below the neckline (some 5 or 10 pips) and when price reaches the level the order is automatically opened. The reason for placing the order at that spot is obvious: price gathers momentum when falling down and a lot of traders expect the momentum to continue when the neckline is broken. In most cases that’s precisely what happens. The general rule for placing stop loss is putting it above the right shoulder (some 5 or 10 pips). Why? Because, if price breaks the neckline and then comes back and goes above the right shoulder, the pattern is invalidated. Take profit The minimum take profit zone is calculated by measuring the distance from the top of the head to the neckline. When breakout occurs that is the minimum distance we expect price to go down. Of course, in most cases it will go further, but you can always lock in some profits by doing these calculations. In the example below you can see usd/cad pair that was in a prolonged trend for a number of years. However, in 2001 it started showing signs of exhaustion. In a matter of two years it formed a head and shoulders pattern and the uptrend was finished when price broke through the neckline on the last week of February, 2003. In this case minimum target was 1100 pips. The level was reached in a matter of a few months, while price continued falling for the next four years till 2007. It collapsed more than 6000 pips....

How to Trade Inside Candle Pattern

We are going to continue the series on Japanese candle formations in the post. Last time we discussed pin bar pattern and what you can expect when it is formed on various time frames. Today I want to look at another very powerful and popular candle pattern and that is inside candle. What is inside candle pattern? Inside candle is simply a candle that forms within another candle. The candle that it forms within is usually called mother candle. Needles to say that mother candle is bigger than an inside one. In itself it does not indicate whether it is a bearish or bullish pattern. Price may go either way when it finally breaks out within the confines of mother and inside candles. Inside candle Despite the fact that the pattern might be neutral in itself, traders do monitor price areas where they form. It is usually accepted that if this formation happens around important support level, there is a much higher chance for price to go up, than down. If this formation happens to be around important resistance level, there is a much higher chance for price to go down, than up. How to trade the pattern? The best way to trade it is to wait for a break of a mother candle and go in the direction breakout occurs. If the mother candle is broken upwards, you buy, if it is broken downwards, you sell. In the example below you can see a daily chart of eur/usd pair. On the 12th of March, 2014 the pair ran into important resistance level. A sharp reversal took place and a mother candle formed. The next three candles formed within the mother candle. On the 18th of March a break downwards finally occurred. Price went down for over 150 pips before reversing. Now, you could have traded the break by placing a sell stop order a few pips below the mother candle (the low for that candle was 1.3844). So, you could have put a sell order at 1.3840 with some 50 pip stop loss and 100 or more take profit target. The trade would have played out well and you would have made more than double of what you had initially risked. You would have done the opposite had the pattern formed near important support level. You would have bought a break of mother candle upwards. eur/usd daily chart (inside candle pattern:...