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An introduction to Bar or Candlestick patternsBar patterns consist of one, two or few bars. Their usefulness lies in the fact that they can trigger signals at a relatively early stage in the development of a new trend and usually offer good benchmarks for traders to place low-risk stops. Overall, when considering these patterns, one key factor in determining their significance is the size of the pattern. Note this please because it is very important. Among other characteristics, this helps one to distinguish a high probability from low probability pattern. But size is measured relative to the preceding bars. These patterns are quite impressive to study because although they act short-term in influencing or moving price, they are quite reliable in their ability to signal short-term trend reversals. Even when a trend is long-term, they can develop at the final points in the trend just when it wants to reverse. One fact you should note is that not all of these patterns are created equal. By evaluating the criteria for the validity of these patterns, you should be able to distinguish between high probability signals from low probability ones. Only take high probability valid signals when you see them on a chart. General principles of bar pattern interpretation: Some of the general principles for interpreting these patterns are outlined below: 1. For these formations to be effective there must be something for them to reverse. That means top reversals should be preceded by a meaningful rally, and bottom formations should be preceded by a sharp selloff. As a general rule, the stronger the preceding trend, the more powerful the effect of the bar price pattern. This chart, a EURGBP chart, shows an example. 2. The formations generally reflect an exhaustion point. In the case of an uptrend, such patterns develop when buyers have temporarily pushed prices up too far and need a rest. In the case of a downtrend, there is little if any supply because sellers have liquidated their positions. That is why these patterns are always associated with a reversal in the prevailing trend. In the EURGBP chart above, notice how the momentum of the sell-off has dropped significantly and each bar had low volatility before the pattern appeared. 3. Not all patterns are created equal. The presence of one of these patterns on a chart does not necessarily guarantee a quick, profitable price reversal. Some patterns show some of the characteristics in a very strong way while others in a mild way. Therefore, you need to apply common sense to their interpretation. Take only patterns that show a high probability which some have called 5-star patterns. The USDCHF chart below shows a bullish pin bar that failed because it was trading into a barrier, resistance, when it should be trading away from a barrier. 4. Occasionally, it is possible to observe some form of confirmation closely following or even during the development of these patterns. Some examples could be the pattern being a large pattern, the violation of a trendline, or its formation at a support and resistance zone. These increases the odds that the pattern is a valid signal as well as significant. Relationship to Japanese candlestick patterns: Although these patterns were discovered when bar charts were widely used and hence the name, you could use candlestick charts for their analysis since bar charts and candlesticks share the same data presentation which is the same open, high, low, and close (OHLC) of price within a specified time. They also share a relationship to traditional Japanese candlestick patterns that are widely used for centuries. Anyone familiar with Japanese candlestick patterns would readily see the similarities and be able to use these bar patterns quickly. If you want an overview of Japanese candlesticks patterns you can read the classic book by Steve Nison on the subject titled “Japanese candlestick charting techniques.” So, when you see bar in subsequent notes, you can replace it with candlestick. Note: Make sure these patterns form tops and bottoms, that is, swing highs and swing lows, before trading them.
Education
by Emekadavid
3
Understanding the Significance of a TrendlineWe want to trade trendlines, but not all trendlines have equal importance. Whether price has touched a trendline or violated it, we should act based on whether the trendline is significant or not. The following three factors are usually considered when evaluating the significance of a trendline: the length of the line, the number of times it has been touched, and the angle of ascent or descent. 1. The length of the line: Since a trendline measures a trend, the longer the line the longer the trend it is monitoring and the more significant the trendline. 2. Number of times the trendline has been touched or approached: The larger the number of touches or approach to a trendline, the more significant is the trendline. Note that because a trendline represents a dynamic area of support and resistance, each touch or approach increases the significance of that trendline because it better represents the underlying trend. Some traders tend to ignore a move close to the line, that is, an approach, but this is as significant as the actual touch. This USDZAR trendline has two factors working for it. One, it is long, extending from March 13 to April 2 and has a good number of touches. 3. Angle of ascent or descent: A very sharp trend is difficult to sustain and liable to be easily broken by a short sideways movement. Flatter trendlines or lines with smaller angles of ascent or descent then are better in reflecting price. Since steep trendlines are likely to be violated much easily, the violation of a particularly steep trend is not as significant as the violation of a more gradual one. That is why the penetration of a steep trendline usually represents a continuation rather than a reversal break. The following chart shows a steep USDTRY (dollar Turkish lira) trend that resulted in a continuation of the prevailing trend. Measuring implications: Trendlines have measuring implications when they are broken. The measurement is calculated as the maximum vertical distance between the price and the trendline. The distance is then projected in the direction of the new trend from the point of penetration. This is known as the measuring objective. It should be noted that measuring objectives in trendlines are sometimes misleading because when a trendline violation turns out to be a reversal, objectives are usually reached and exceeded. Therefore, you should take the measuring objective as more of a minimum expectation. The chart below shows how the measuring objective can be calculated for a GBPUSD uptrend, taken from the maximum vertical distance between the price and the trendline.
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by Emekadavid
Forecast: Highly probable break of support at 1.0786 for a shortPrice has touched that 1.0786 support about 4 times within three weeks. Therefore, the sellers have been testing the resolve of the buyers, showing the buyers are getting weaker each time. This reasoning is confirmed by the descending triangle that is forming at that support. So, it is highly probable that price will break that support when trading resumes next week. Look out for short opportunities on the short term.
Short
by Emekadavid
Trendlines and how to trade themTrendlines are one of the simplest tools in technical analysis and about one of the most effective for price patterns since they form the building block for pattern identification and interpretations. What is a trendline? – A trendline is a straight line connecting a series of ascending swing lows in a rising market or the top of descending series of swing highs in a falling market. The trendlines that are constructed by joining swing lows are called upward trendlines and those connecting swing highs are called downward trendlines. How to draw trendlines: A downward trendline is constructed by joining the first swing high in a downtrend with another swing high. When price breaks above the trendline, a trend change signal is given. The upward trendline is drawn by joining the first swing low in an uptrend to another swing low. When the trendline is broken, a trend reversal signal is given. Notice how the trend reversed when the trendline above was broken. We have said that in order to be a true trendline a line must connect two or more swing highs or lows, otherwise it is not significant. This is a fundamental point because a true trendline is a graphic way of representing the underlying trend. Trendlines can be primary trendlines or secondary trendlines. The primary trendline connects the first top or bottom with the next swing point. If price then moves sharply, this could create a second trend within the primary trendline. Then we connect the first two swing points again to form the secondary trendline. Trendlines can alert you to changing market conditions. How? By paying attention to the steepness of the trendline. If the trendline is getting flatter, it means the market is moving into a range condition. If the trendline is getting steeper, it means that the trend is getting stronger (or possibly going into a climax). Thus, you can be able to adjust your trading strategy accordingly. Also, note that trendlines are not always diagonal. There are also horizontal trendlines and these are seen in the case of some price patterns such as head-and-shoulders pattern or the upper and lower boundaries of rectangles. When these lines are penetrated, they usually warn of a change in the trend as would the violation of upward or downward trendlines.
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by Emekadavid
How to determine if a support or resistance will holdWhen price goes to a key level, that is, a support or resistance level, it will either hold and reverse price or it will break and be violated. There are no hard and fast rules for determining if a key level will hold and reverse price but I can give you some guidelines on what to look out for that would increase the odds that a support or resistance would hold. 1. The greater the speed and extent of the previous move, the more significant the support or resistance will be. In this case, watch out for big candles leading up to the key level. Consecutive big green candles in an uptrend or consecutive big red candles in a downtrend shows that the move has speed or momentum. Also, the candles have high volatility or the ranges are large. This big move towards the key level shows that the buyers or sellers in the previous move are overextended and they might be getting exhausted, and so would be lacking enthusiasm to continue their move at that key level. 2. Examine the amount of time elapsed. By looking at when the market touched that key level in the past and the general market conditions, it could tell you whether the market is likely to regard that key level as important. The longer the price has been away from that key level, the more significant it is that the level would hold as support or resistance because other traders who trade in higher time frames would be attracted to that level. 3. Look for strong price rejection. The presence of rejection candlesticks at a key level, like pin bars and also rejection patterns like two bar reversals, three bar reversals and engulfing bar patterns is a high probability sign that the level will hold. When you see strong price rejection at a key level, you should be confident that the level would hold as support or resistance. Some reversal strategies are based on this effect.
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by Emekadavid
8
Rules for determining Potential Support and resistance. 1. Swing points: Previous highs and lows These points are intelligent points where one would expect support and resistance. They are high probability points because sellers and buyers made decisions on these points in the past and it is more likely that when price gets there again, due to people’s psychology being constant, they would tend to act on these points. Buyers who bought at the lows have a tendency to take profits at the highs, and vice versa for sellers to take profits at the lows. Sometimes though, price will not respect these zones and would just break through them. That is why they are pointers or intelligent places to expect support and resistance to be. 2. At round numbers: Support and resistance often form at round numbers because these serve as psychological points on which traders base their decisions. They are often referred to as psychological levels and market orders used to be formed around these numbers. It is the human tendency when talking about numbers, to gravitate towards round numbers and this is no different for the forex market. For most of these numbers, price would tend to end in two, three or four zeros like 1.3200, 109.00, 110.00, and 1.0000. 3. Trendlines and moving averages. These are dynamic levels of support and resistance. I usually use trendlines and avoid moving averages although many price action traders use moving averages. The number of times a trendline has been touched, the more reliable it will be. That is a rule in trendlines. To draw a valid trendline though, it has to touch at least two swing highs for a downtrend, or two swing lows for an uptrend. You buy or sell at these points again if price touches them another time. 4. Gaps Gaps represent emotional points on charts. They are formed when there is a substantial difference between the closing price of the previous candlestick and the opening price of the next candlestick. They are formed when there is a strong shift in sentiment about the market, and usually due to fundamental news. Gaps can occur over the weekend or intraday. Weekend gaps are more common than intraday gaps. It is noticed that the market tends to fill the gaps that were formed, and when these happens, the gaps tend to act as support and resistance levels. 5. Fibonacci levels To every action, there is a reaction. So when price moves upwards, it usually has a correction. The same goes for price move downwards. When these corrections happen, the Fibonacci retracement tool can be used to measure where this will end for the underlying trend to continue. This tool was taken from the famous Fibonacci sequence of numbers such as 1,1,2,3,5,8,13,21,34,…. If any number in the sequence is divided by its successor, what you get is a ratio, 0.618, which is called the golden ratio. The golden ratio appears widely in nature and market participants believe that this golden ratio can be used to measure how much price will make a correction or counter trend before returning to the dominant trend. The levels are defined as percentages and many price action traders believe that the 61.8% and 50% fib retracement levels are very significant, although other levels are also important.
Education
by Emekadavid
Understanding Support and ResistanceSupport and resistance are points on a chart where the probabilities favor at least a temporary halt in the prevailing trend. Support is experienced when demand concentrates around a zone as price is in a downtrend and price finds it difficult to break below that zone. This is because traders have placed a high number of buy orders at the zone, preventing prices from going lower. Resistance acts like a ceiling on prices when prices are on an uptrend. Prices find it difficult to go above that level because traders have placed a high number of sell orders at that zone making it difficult for an upward thrust beyond that zone. This USDZAR chart illustrates areas of support and resistance on a chart. Although they are plotted as lines on a chart, we should not think of them as specific price points but as zones. A support zone represents a concentration of demand, and a resistance zone represents a concentration of supply. We need to emphasize the word, concentration, because supply and demand are always in balance, but it is the relative enthusiasm of buyers compared to sellers, or vice versa, that is important because that is what determines trends. If buyers are more enthusiastic than sellers, they will bid prices higher until their purchasing demands have been satisfied. Also, if sellers are the more anxious, then they will be willing to liquidate at lower prices, and the general price level will fall. These are the three principles to follow when analyzing support and resistance zones. Principle 1: A previous swing high or low is a potential resistance or support zone. Therefore, to identify a potential support, look for previous lows. In the case of a potential resistance, look for previous highs. Principle 2: Support can reverse its role to resistance on the way up after a violation of the zone. Some elementary psychology will be used to explain this. At the previous support, some buyers went long thinking that price will rise but eventually, price violated or broke the support zone. Now, since no one wants to take a loss, they held on to their positions with the belief that price will rise up again. When price eventually rose to the previous support zone, they closed their positions so as to breakeven, thereby creating sell orders at that zone that made the zone now resistance. Principle 3: Resistance can reverse its role to support on the way down after it has been violated. Principles 2 and 3 are what traders call support and resistance flips. Take note of these principles because they are important in the price patterns we are going to trade.
Education
by Emekadavid
Which is better: Arithmetic or Logarithmic scale charts?A market chart has two axes, the x-axis and they-axis. Where the x-axis registers the date, the y-axis registers the price. The y-axis has two methods for plotting it: an arithmetic scale or logarithmic scale. Whichever you chose will have implications for your trading. Arithmetic scale: On an arithmetic scaled chart, the spacing between price levels is equal. If price rises, like from 1000.20 to 1500.20 and 1780.20 to 1980.20 for gold, the grid spacing on the chart does not change. This is a gold chart illustrating arithmetic scaled chart. Logarithmic scale: The log chart is scaled based on percent moves. A hundred percent move or change in prices will have a larger space than a fifty percent move or change in prices because the spacing reflects differences in percentages. The same gold chart illustrating a logarithmic scale. The differences in both scales are not readily noticeable when charts are plotted on short periods of time because price fluctuations are relatively subdued. However, you begin to notice considerable differences with large price fluctuations. Because my trading is in the short term, I use the arithmetic scale. But position traders who deal on the longer term would consider using both arithmetic and logarithmic charts for their trading. That way they see both the price level moves as well as how that scales in percentage terms.
FOREXCOM:XAUUSDEducation
by Emekadavid