LEARN TO TRADE FOREX
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Introduction
Chart patterns are well documented phenomena in technical analysis literature and are said to be based on psychological phenomena that occur between the buyers and sellers of financial instruments in liquid markets. They include but are not limited to head-and-shoulders, channels, triangles and wedges.
Pattern formations do not form a trading system, but rather provide an indication of the potential future trend as the security's price breaks key psychological barriers in the form of support and resistance lines.
Identifying chart patterns and using technical analysis does not guarantee success in the off exchange foreign currency market. Trading in this market is risky and only suitable for the sophisticated investor.
Pattern Recognition System
What is PRS?
At the core of any successful trader's technical analysis there lies the ability to spot forming and completed chart patterns. It is no secret that price consolidation in many forms almost always precedes the strengthening of trends, or the reversal of price directions. For over a century now traders have been looking for ascending and descending triangles, rising and falling wedges, and flags and pennants as a means to recognize price consolidation and to prepare for price breakouts.
How Does it Work?
The PRS scans multiple currencies and time frames looking for price consolidation patterns. When a forming pattern is identified, traders using the PRS will be alerted. Completed patterns offer traders a look at where the price direction is most likely to head, thus offering a potential take profit region. The PRS can be used to spot potentially strong trades, or to confirm the strength of current positions held.
Pattern Types
There are numerous types of patterns, all named according to the shapes that the price graphs form between the support and resistance lines. The general types of patterns include Triangles, Channels, Wedges, and Head-and-Shoulders.
Triangles
A triangle is formed between converging support and resistance lines. A negative sloping resistance line indicates a reducing level of profit taking or more uncertainty about the value of the stock. With a positive sloping support line the price levels are squeezed into a corner. Once the support or resistance line is broken, pressure that has built up as a result of uncertainty is released and a certain amount of momentum is added to the price change in the direction of the breakout. There are specific variations of triangles that can occur, namely ascending and descending triangles. An ascending triangle has a horizontal resistance line and a descending triangle has a horizontal support line.An ascending triangle usually occurs as a continuation of a bullish trend, while a descending triangle usually occurs as a continuation of a bearish trend.
Channels & Rectangles
A channel is formed between parallel support and resistance lines. This pattern usually indicates a relatively strong trend (up or down) with the price staying within the lines until breakout. A breakout from a channel indicates either a reversal in the trend or a change in the slope of the current trend. Similar to a channel, a rectangle is a pattern formed between horizontal support and resistance lines.Rectangles and Channels are sometimes referred to as Flags and Pennants depending on the slope of the initial trend and the slope of the breakout. A Flag would be defined as a Bullish Continuation Channel Down, or a Bearish Continuation Channel Up. A Pennant would be defined as a Bullish Continuation Triangle, or a Bearish Continuation Triangle.
Wedges
Wedges are similar to triangles in that these patterns are formed between converging support and resistance lines. However, where the support and resistance lines in a triangle have one positive and one negative slope, the support and resistance lines of a wedge would both have either a positive or negative slope. Wedges with positive slopes are called Rising Wedges and ones with negative slopes are Falling Wedges. The most common wedges are found as breakouts in the opposite direction of the wedge. That is, bearish breakouts in a rising wedge, and bullish breakouts in a falling wedge.
Head & Shoulders
A Head and Shoulders pattern describes a share price movement that depicts the head and shoulders of a person. Head and Shoulders is a reversal pattern from a bullish trend to a bearish trend. The pattern starts when the price graph crosses the support line upwards before formation of the left shoulder, and is completed once the graph crosses the support line downwards after formation of the right shoulder. An Inverse Head and Shoulders is similar in shape except that it is upside down and indicates reversal from bearish to bullish trend.
Trends & Breakout
An important measure of the quality of a pattern is the trend that precedes it. It does not matter whether the trend is bullish or bearish, but the consistency and duration of the initial trend partly determines the well-formedness of the pattern.
The pattern is said to have "broken out" once it has crossed either the support or resistance line. If the pattern broke out in the same direction as the preceding trend, it is called a continuation pattern. If breakout is in the opposite direction, it is called a reversal pattern. For example, a pattern described as Bullish Reversal Triangle would mean that it is a bullish signal, that is, the breakout was through the resistance line, upward. Because it is a reversal pattern that means the preceding trend was in the opposite direction as the breakout, that is, the preceding trend was bearish.
2. Trading Strategies
2.1 General comments regarding Technical Chart Patterns Almost all literature about technical analysis (both printed and online) has a chapter about Technical Chart Patterns. Refer to this literature to learn how to make PRS work for you. As with any trading tool there is no 100% correct way to trade it; chart patterns are notoriously subjective. In general, the longer patterns are more reliable, so trade the 60min, 240min and End-of-Day patterns - the 15min and 30min give a lot of noise. Adjust the minimum quality indicators to insure that you only receive opportunities of the highest quality.
2.2 How do I trade emerging patterns? Charting theory states that the pattern should only be traded once a breakout has occurred; not prior to the breakout. The breakout is the confirmation of the reversal or continuation of the preceding trend. If one follows the theory, then the emerging patterns should only be used as a "watch list" - a list of currency pairs to watch more closely for a breakout.However, many users find that PRS is most useful when both complete and emerging patterns are taken into account during the trading process. You can think of emerging patterns in two ways:1) As patterns that may break out in the near future. 2) As an indication of where the next turning point is going to be. When trading them as (1) above, they provide an advanced alert of a breakout; giving you ample time to watch the stock in your own trading / charting platform. When trading them as (2) above, they can provide you an indication of when the next turning point in the price can occur.
2.3 Where should I set my limits and stops? PRS is an automation of existing chart pattern technical analysis techniques. Providing exact stops and limit levels is impossible because the theory of charting does not cater for this. Chart pattern theory does however provide expected range for the price to reach; this is displayed visually on the PRS application via the grey block on the chart. It is the responsibility of the user to decide whether the pattern is of a high enough quality to enable it to reach the desired objective.
2.4 Does PRS provide risk/return ratios? Chart theory is not a trading system. It only provides an entry into the market (either long or short), but no exact exit time is provided. Therefore, it is not possible to calculate exact risk/reward ratios.
2.5 Can you provide history for the trading success of PRS? Unfortunately it is not possible to measure the trading success of PRS because of the fact that it does not stipulate when to open and close trades. That is, PRS is not a trading system, but rather an ideas or opportunities identifier. The proof of the value of PRS lies in what you see. By showing you the pattern on a price graph, it allows you to see exactly what you get. It is not hidden inside a "black box" that just gives signals.