Technical Analysis, Continuation Chart Patterns

All chart patterns reviewed until now were reversal patterns. But, there are also patterns that signal the continuation of the prevailing trend. These patterns are important to understand since they generate trades in direction of the prevailing trend thus generating low risk trading opportunities.

Symmetrical Triangles

These types of patters are formed by two converging trendlines:

Symmetrical Triangles

[Image 6]

Symmetrical triangles indicate consensus, new highs or lows are reached, the price makes a series of lower highs and higher lows, these points connected make two converging trendlines. As the price approaches the apex, supply and demand reaches a temporary equilibrium. The pattern is completed when either the support or resistance trendline is broken.

Bullish Symmetrical Triangle in Action

[Chart 3]

In this 4H EURUSD chart a symmetrical triangle is formed during an uptrend. The market eventually breaks the resistance-trendline and the target price is reached. (Please see below rules for placing target for all triangles).

Bearish Symmetrical Triangle in Action

[Chart 4]

This bearish triangle in the EURUSD 5 min chart is completed when the market breaks the support-trendline.

Commonly target used for symmetrical triangles

Measure the height of the triangle in terms of pips and add/subtract the same amount of pips from the eventual breakout level.

Ascending Triangles

Ascending triangles are formed in an uptrend, after the prices rallied to new highs:

[Image 5]

At this point the bears come in play attracted by the higher prices and start selling at such highs making the price pull back to a support level where the bulls take control again of the market making the prices rally to test previous highs. A second decline is followed to the support-trendline (higher lows). At this point, the bears realize there is not enough supply to take the prices lower, as they close out their short positions; bulls take again the command of prices making them rally to new highs. The pattern is completed when the trendline-resistance line is broken.

Ascending Triangle in Action

[Chart 4]

Commonly used target for ascending triangles

Measure the height of the triangle in terms of pips and add/subtract the same amount of pips from the eventual breakout level.

Descending Triangles

Descending triangles are formed in a downtrend after new lows have been reached:

[Image 6]

At this point the bulls come in play attracted by the lower prices and start buying at such lows making the price rally to the resistance level where the bears take control again of the market making the prices reach lower levels to test previous lows. A second rally is followed to the resistance-trendline (lower highs). At this point, bulls realize there is not enough demand to take the prices higher, as they close out their long positions; bears take again the command of the market making it rally to new lows. The pattern is completed when the trendline-support line is broken.

Descending Triangle in Action

[Chart 5]

Triangles are among the most reliable chart patterns of technical analysis, as changes in supply and demand are very well defined.

Commonly used target for descending triangles

Measure the height of the triangle in terms of pips and add/subtract the same amount of pips from the eventual breakout level.

Bullish Rectangles

Bullish rectangles are periods of consolidation that appear after a sharp move:

[Image 2]

These types of rectangles or channels are periods of consolidation (after a sharp rally) where supply and demand meet. At this period of indecision, investors and traders try to digest the recent sharp move. In a bullish rectangle, bulls prefer to take partial profits, and wait for further pull backs so they can make their move again. This pattern is completed when the resistance is broken.

Bullish Rectangles in Action

[Image 9]

Bearish Rectangles

Bearish rectangles are periods of consolidation that appear after a sharp decline:

[Image 10]

In a bearish rectangle, bears close most of their short positions and wait for further rallies so they can sell again at higher prices. Although the sentiment is still strong in favor of the prevailing trend, traders and investors prefer to take a rest. The support must be broken in order for the pattern to be complete.

Bearish rectangle in Action

[Chart 6]

Bears take a little rest after the sharp decline. When the market breaks the support zone the pattern is completed.

Remember again, once the price breaks an important support/resistance zone, it becomes an important resistance/support zone. As in the chart above, the resistance became an important support line where the price bounced off to reach new highs.

Rectangles commonly used target levels

Measure the height of the triangle and add/subtract it to the point of the eventual break out.

Technical Analysis, Reversal Chart Patterns

Double Top

The double top is made up by two extreme peaks like the illustration below:

[Image 3]

After the first peak, there must be a decline of no more than 25% of the uptrend. (This decline makes up a support that must be broken for the pattern to be complete). Then the price rallies again to the resistance made by the first peak. Highs should be roughly equal. Then the price falls back down from resistance to support, and finally breaks the support (yellow box).

This type of patterns can be used during trending markets signaling a possible reversal or during trendless markets, to signal a possible change in the direction of the market.

Double Top in Action

[Chart 1]

See top #1 and top #2 have similar highs. The pattern is not valid until the market breaks the main support which happens in the yellow box. Notice also how the support zone becomes a resistance and stopped the market from reaching higher levels.

Double top commonly used target

Measure the amount of pips from the first peak to the support line (where it bounced back up to the second peak). Subtract the same amount of pips from the support line. This last quote will give us the target price.

Double Bottom

The double bottom pattern is made up by two extreme lows like the illustration below:

[Image 3]

After the first low, there must be a rally of no more than 25% of the downtrend. (This rally makes up the main resistance that must be broken for the pattern to be complete). Then the price drops again to the resistance made by the first low. Lows should be roughly equal. Then the price rallies again from the second low to the main resistance, and finally breaks the main resistance zone (yellow box).

This type of pattern can be used during trending markets signaling a possible reversal or during trendless markets, to signal a possible change in the direction of the market.

Double Bottom in Action

[Chart 2]

Lows #1 and #2 have similar levels. The pattern not considered valid until the market breaks the main resistance zone. Notice how the resistance zone becomes a support zone preventing prices from falling below those levels.

Double bottom commonly used target

Measure the amount of pips from the first low to the resistance line. Add the same amount to the resistance line; this last quote will give us the target price.

Both patterns reflect changes in supply and demand. In a double top, it reflects the inability of buyers to take the prices to new highs and trade above them. In a double bottom, the inability of sellers to break the lows and pull the prices further down.

Remember: The resistance/support made after the first peak/sell off could act as a support/resistance after the price breaks the zone.

Triple Top

The triple top is similar to double tops, but has three peaks (instead of two):

Triple Top

[Image 6]

Same mechanics are followed here. A prior trend has to be reversed, three peaks reasonably equivalent to each other, and an important support to be broken in order to complete the pattern. In this pattern the changes in supply and demand take a little longer to change the perspective of traders about the markets.

Triple top in Action

[Chart 3]

Three peaks form the triple top, the pattern becomes valid when the market breaks the main support area. Notice how the market retraces back to the resistance zone (previously a support zone) to test it.

The mechanics to get the target price for these patterns are the same as the double top and bottom.

Triple Bottom

The triple bottom is similar to double bottoms, but has three troughs (instead of two):

Triple Bottom

[Image 8]

Same mechanics are followed here, a prior trend has to be reversed, three troughs reasonably equivalent to each other, and an important resistance to be broken in order for the pattern to be complete. In this pattern the balance in supply and demand take a little longer to change the perspective of traders and investors about the markets.

Triple Bottom in Action

[Chart 4]

This triple bottom becomes valid when the market breaks through the main resistance area (yellow box).

The mechanics to get the target price for these patterns are the same as the double top and bottoms.

Head & Shoulders Top

The pattern is formed by three successive peaks:

[Image 4]

The second peak or the “head” must be the highest peak. The two other peaks or “shoulders” should be roughly equal. A support is made by the first and second bounces from the first and second peaks; this is commonly named as a neckline. The pattern is completed after the neckline is broken through and the price trades below it. The neckline becomes an important resistance once it has been broken.

Head and Shoulders in Action

[Chart 5]

This is a head & shoulders pattern under development, the market has not been able to break the neckline, thus it isn’t a valid head and shoulders pattern yet. Why did we use this one? Because it is important to track them when they are forming (not after the fact, when we know what happened) and see how they look like. This is the GBPJPY weekly chart, so if this pattern proves to be valid, it has a potential of more than 2,000 pips.

Head and shoulders top commonly used target

Measure the amount of pips from the highest peak (head) to the neckline. Subtract the same amount from the neckline; this final price will give you the target price.

Head & Shoulders Bottom

This pattern is made off three consecutive lows.

The second low is the deepest low (head), while the other two lows are roughly equal (shoulders). The pattern is considered complete when the neckline is broken.

Head and Shoulders in Action

Notice here the neckline is similar to a trendline (instead of a resistance).

Head and shoulders bottom commonly used target

Measure the amount of pips from the lowest low reached (head) to the neckline, and add this amount to the neckline to get the target price.

Technical Analysis, Major Candlestick Reversal Patterns 2

5- Engulfing Reversal Pattern

In the image below, engulfing patterns are represented by the last two candlesticks of the illustration.

 
Formation

Engulfing patterns consist of two candlesticks. The first one is usually a small candle, and must be in direction of the prevailing trend (in an uptrend the short candlestick must be white and in a downtrend the candlestick must be black) while the second candlestick must be against the prevailing trend and is usually a long candlestick. Candles should have little or no shadows at all. The body of the second candlestick must cover or embrace the body of the first candle (shadows are not taken into consideration).

Psychology behind the Shooting Star and Examples

In a downtrend or downside movement where bulls have control over the markets, a bullish engulfing pattern indicates that bulls finally took total control over prices, they were attracted by the lower prices (and intend to sell back at higher prices) and pushed the market up above the open price. This could signal a trend reversal, a correction or a consolidation period.

In an uptrend or upside movement where bulls have control over prices, a bearish engulfing pattern indicates that bears finally took total control over the market; they were attracted by the higher prices and pushed the market down below the open price. This might signal a short-term reversal pattern as clearly bears or sellers have taken control of the market. .

Bullish Engulfing Patterns are signals to go long!

Bearish Engulfing Patterns are signals to go short!

Bullish Engulfing in Action

In the 5 min EURJPY chart a bullish engulfing pattern appears at the bottom of the range signaling a possible change in direction. The market goes up because of the bullish sentiment at lower prices. Bears notice bulls are really confident at those levels.

Bearish Engulfing in Action

In the AUDUSD 5 min chart, an engulfing pattern appears at the top of the range signaling a “change in direction”. Remember that reversal pattern not always forecast trend reversals, correction or consolidation periods are always a possibility.

6- Piercing Reversal Patterns

In the image below, piercing patterns are represented by the last two candlesticks of the illustration.

* The bearish piercing pattern is also called “Dark Cloud Cover”. For the sake of simplicity, in this course we will always refer to this pattern as bearish piercing pattern.

Formation

Piercing patterns, as engulfing patterns, are also made from two candlesticks. Both candlesticks should have long bodies and small or no shadows. The first candlestick must be in direction of the prevailing trend and the second against it. The further the second candle goes against the trend the more significant the pattern is. Candlesticks could have small or no shadows at all.

Psychology behind Piercing Patterns and Examples

In a downtrend or downside movement where buyers have control over the markets, a bullish piercing pattern indicates that buyers finally took total control over prices, they were attracted by the lower prices and pushed the market up near the highs of the day. This could signal a trend reversal, a correction or a consolidation period.

A bearish piercing pattern, or most commonly called dark cloud cover indicates that bears liked to sell on those higher prices, gaining temporary control. If the move is strong enough, bulls will close their longs making the price sell off. The close price of the second candle must be below the midpoint of the first candle body.

Bullish Piercing Patterns are signals to go long!

Bearish Piercing Patterns are signals to go short!

Bullish Piercing in Action

Hey, forget about the red box! We will get to that a few lines below. The bullish piercing pattern at the yellow box illustrates what the balance of supply and demand in this scenario: bears make a final push down, but bulls take command of the market pushing them up again.

What’s the red box?

It was the result of the Interest rate announcement from Canada. Consensus was no change but the Bank of Canada decided to cut .25%, it’s a 100 pip 5 min candlestick.

Bearish Piercing in Action

This is a valid bearish piercing pattern at the GBPUSD 30 min chart. Small shadows, first candle in direction of the movement and second candles against it. This pattern marks the end of the retracement. 

7- Morning Star & Evening Star

In the image below, morning and evening stars are represented by the last three candlesticks of each illustration.

Formation

Morning and evening stars are made from three candlesticks. The first candlestick is always in the direction of the trend or current direction, the second candlestick could be a black or white one while the third must be against the prevailing trend or direction. Usually candlesticks in these formations have small or no shadows at all.

Psychology behind Evening and Morning Stars and Examples

The morning star pattern begins with a long bearish candlestick or big sell off (in direction of the prevailing trend). At the second candle, the bears are not sure anymore about the downtrend continuing its path. At this point, the buyers feel a little stronger than before. Buyers take total control of prices on the next candle making the market rally. The closer the candlestick closes from the first candlestick open price, the stronger the pattern.

Evening stars begin with a long white candlestick in direction of the prevailing trend. At this point, the bulls are still confident about the uptrend. At the next candle though, the bears start selling attracted by the higher prices. This candle represents a short period of indecision or a fierce battle between bulls and bears. On the third candlestick, bears take total control of the situation making the price sell off. The larger the third candle is, the stronger the reversal.

Morning Stars are long signals.

Evening Stars are short signals.

Morning Star in Action

In this USDCHF 1 min chart we see two morning stars patters that finally capped the downside movements. The trend wasn’t reversed, at least there some support is found around those levels.

Evening Star in Action

GBPJPY 1 min chart, the evening star at the beginning of the chart makes the market head down to reach lower levels. Bearish pressure is self evident: bears start selling and bulls take profits (sell back), this makes the market drop like a rock.

8- Harami Reversal Patterns

In the image below, Harami patters are represented by the last two candlesticks of each illustration.

Formation

Both, bearish and bullish harami are made from two candlesticks. The first one is always a large candlestick in direction of the trend or current move and the second one against the direction of the trend or current move. Candlesticks could have small or no shadow at all. The body of the second candlestick must be inside the body of the first one.

Although the size of the body of the second candlestick is smaller than the size of the first one, it should be “larger” than usual.

Psychology behind Bearish and Bullish Harami and Examples

In the bullish harami, bulls stop bear dominance and take temporary control over the market. The first candlestick of the bullish harami is the final push of bears while the second one means bears are feeling more confident about further upside movements.

In the bearish harami, bears step in after a high volume bull push. Prices are high enough to start opening their short positions. The closer the second candlestick closes to the open of the first one, the stronger the short sentiment.

Bullish Harami are long signals

Bearish Harami are short signals

Bullish Harami in Action

As we have mentioned before, reversal patterns not only signal trend reversals, they also signal possible retracements and consolidation periods. In this case, the harami pattern signals a correction period. Now, take in consideration this is a weekly chart, from the top of the pattern to the bottom of the retracement there are around 500 pips.

Bearish Harami in Action

In the USDCHF 4H chart above, a bearish harami pattern appears after the retracement. It could signal the end of the retracement; traders could resume their short positions.

Technical Analysis

As we have already stated in the previous lesson, technical analysis tries to determine the future performance of any financial instrument based in the study of historic prices (price behavior).

By studying the price behavior and technical analysis we are actually analyzing the behavior of all traders involved in a certain market. Traders and investors are behind every price movement; after all, they all drove the price to a certain level. The price moves based on traders’ expectations; on what they think the future price of any given instrument should be.

Most of the time traders are driven by their emotions (fear, greed, hope, etc.) and these emotions are visible on the charts as repetitive price patterns. The outcome of these specific patterns is what technical analysis tries to forecast.

Technical analysis is based on the Dow Theory which has three main principles:

Price Discounts Everything - All information available is already reflected in price, it reflects the knowledge of everyone involved, including fundamentalists.

Price Behavior is not Random - Although there are periods of trendless or random behavior, the price tends to trend. Our job as technicians is to identify those periods where the price is trending and profit from them.

The “What” (or “Where”) Question is more Important than “Why” - The “What question” refers to where is price and what is its historical behavior. Those questions are to be answered by technical analysts. Why is price at certain level? This one is of concern of fundamental analysts; they look for reasons behind certain price movements.

And here we go with Technical Analysis...

This will be  in the following way:

   

1-Types of Charts - We will review the most common types of charts used by technical analysts.

2-Support and Resistance - We will review one of the most important concepts of trading; we will see what makes support and resistance and how to identify them.

3-Support and Resistance FAQ’s – Here you will find common questions about support and resistance zones. 

4-Trends and Range Bound Conditions - How to identify a trend and a range market. We will also see how to measure its intensity through trendlines.

5-Candlesticks Intro - We will review the most popular type of charting used by technical analysts.

Candlestick charts

Candlestick charts
Candlestick charts show the same information as a bar chart but in a graphical format that is more fun to look at. Candlestick charts indicate the high and low of the given time period just as bar charts do, with a vertical line. The top vertical line is called the upper shadow while the bottom vertical line is called the lower shadow; you might also see the upper and lower shadows referred to as “wicks”. The main difference lies in how candlestick charts display the opening and closing price. The large block in the middle of the candlestick indicates the range between the opening and closing price. Traditionally this block is called the “real body”.
Generally if the real body is filled in, or darker in color the currency closed lower than it opened, and if the real body is left unfilled, or usually a lighter color, the currency closed higher than it opened. For example, if the real body is white or another light color, the top of the real body likely indicates the close price and the bottom of the real body indicates the open price. If the real body is black or another dark color, the top of the real body likely indicates the open price and the bottom indicates the close price (I used the word “likely” since you can make the real body whatever color you want). This will all become clear with an illustration:
Now, here’s the same EURUSD daily chart that I showed you in line and bar form, as a candlestick chart. Note that I have made the candles black and white, you can pick whatever colors you want, just make sure they are friendly to your eye but also that they convey bullish and bearishness to you. Bullish candles are the white ones (close higher than open) and bearish candles are the black ones (close lower than open):
Candlestick charts are the most popular of all three major chart forms, and as such, they are the type you will see most often as you trade, and they are also the type I recommend you use when you learn and trade with price action strategies. I use candlestick charts in my Forex trading course, and I recommended all my members use them when posting up charts in the members’ forum, because their visual pleasantness and simplicity make it easier for everyone to learn from.