Technical Analysis, Technical Indicators, Time-Frames

There are different periods in which a currency pair could be charted: monthly, weekly, daily, hourly, 30-minute, 5-minute, etc.

Each timeframe has its unique trend; this is the reason why there is no absolute trend for any currency, take the following charts for example.

EURUSD Hourly Chart

[Chart 30]

EURUSD Daily Chart

[Chart 31]

In these charts, a swing trader focusing in the 1H chart could assess: well there is no trend (ranging market) right now for the EURUSD while a long-term trader could assess: the trend for the EURUSD is clearly up. Which trader is wrong? No one, both of them are correct. Both of them have effectively determined the trend in the timeframe they are focusing on.

Of course, the market condition in the 1H chart is most likely to continue for the next couple of days while the market condition in the daily chart is likely to continue for the next month or so.

The same goes when we use indicators. Sometimes the same indicator could be signalling the opposite signals on the same currency pair on different time frames.

Take for instance the following charts:

GBPJPY 15 Minute

[Chart 32]

GBPJPY 4H

[Chart 33]

On the first chart (15min) the stochastics are in an oversold situation however, at the same time, in the 4H chart the stochastics did give a sell signal (crossing from the overbought territory to the neutral territory). The reason for this simple, remember all indicators go back n-periods to make a calculation, in this particular case, the 7 period stochastics in the 15 min chart went back 8 candlesticks to complete its calculation (1.75 hours). The stochastics in the 4H chart also represent 8 candlesticks but those 21 candles represent around 1.5 days worth of data. The market conditions are completely different during those periods.

Obviously, it is better to trade when many timeframes indicate the same market condition (i.e. both, the 15 min and the 4H chart indicate an oversold condition). When this happens, the probability of success of the given signal increases enormously.

Is important to realize that the longer the timeframe the more impact it will have in the market. For instance, an oversold condition in the 4H chart is more important than an overbought condition in the 15 min chart. More important because the “signaled market condition” will last for a greater time in longer time frames than in the shorter time frames.

Which timeframe should I use?

When trying to decide which timeframe to trade in we must take in consideration two important factors: the time dedicated to your trading and your personality.

How much time a day/week are we going to dedicate to our trading? Obviously if you have a day job and do not have the possibility to monitor your trades, then it would be better to focus on the 4H or 1H chart, and even daily charts can work out. If there is a possibility to monitor your trades then you can use the 30 min charts.

On the other hand, if you are a full time trader, then you have the possibility to trade shorter timeframes such as the 5 or 15 min charts.

However, we must almost consider that when you are a full time trader there is a chance that trading shorter timeframes does not fit your personality. The same goes for traders with a day job, there is a possibility that trading the longer term just will not work. I have a friend who started trading the FX market using the 1min chart. His trading wasn’t going the way he expected so he moved to the 15 min, then to the 30 min and finally to the 1H charts, where he felt most comfortable trading (and of course profits also increased).

So to summarize, you should use the time frames that better fit your personality and time requirements, and the best way to know which one fits you better is by trading as many time frames as possible, then choose the one you felt most comfortable with.

Technical Analysis, technical indicators, Relative Strength Index (RSI)

RSI is an extremely popular oscillator developed by Welles Wilder in 1978. It measures the strength in which the market trends up or down (the ratio of up and down candlesticks for a chosen period of time). The values of the RSI oscillate between 0 and 100. A value close to 100 indicates the market has been trending up sharply, while values close to zero indicate the market has been trending down.

As the RSI approaches to extreme levels, the indicator becomes less sensitive to price fluctuations, making the indicator to go back to neutral levels.

RSI Usage

Usage No 1 - Overbought/oversold conditions. Values above 80 are considered overbought and values below 20 are considered oversold. As the market reaches higher levels, there is a possibility that every bull interested in the instrument has already taken a position (this took the RSI above the 80 level). At this point weak longs start taking profits and closing out positions. This gives the market a chance to retrace, letting the RSI get back to neutral levels, breaking back down the 80 level as the price sells off. The same is true for a downside move, as the RSI reaches the oversold territory (below zero), bears start to take profits, giving the RSI the strength needed to get back to neutral levels, making the price rally.

[Chart 16]

Remember overbought and oversold signals are triggered then the indicators returns to neutral territory from an overbought or oversold condition. These types of signals tend to work better when the market is ranging.

Usage No 2 – Divergence. Like other indicators, the RSI is also used for divergence trades but probably the RTI is the best indicator to measure and trade off divergences. When prices reach new levels and the indicator fails to make comparable highs/lows, divergence is present.

[Chart 17]

In this chart we clearly see how the market reaches lower lows while the indicator is unable to replicate those lower lows (it makes higher highs). This indicates that the market isn’t as strong as it was at the beginning. As other trading signals, when the divergence is present it could signal a trend reversal, retracement or a consolidation period.

Usage No 3 - Trend indicator. When the values of the RSI are above 50 it indicates that the average gains are greater than the average loses (uptrend). Readings below 50 indicate that the average loses are greater than the average gains (downtrend).

[Chart 18]

The basic rule would be: when the RSI is above 50 the market is to be considered in an uptrend, when the RSI is below 50 the market is considered to be in a downtrend.

It is important to mention that when using the RSI in this way, it is advisable to choose longer periods [i.e. RSI(40) or RSI(80)] .

Technical Analysis, Important Chart Patterns Considerations

Please take into consideration the following:

1. Most technical chart patterns require confirmation in order to complete the pattern.

2. Chart patterns are present in all timeframes, from the monthly chart to the minute chart. But remember, the greater the time frame the more significant the pattern is. For instance, a rectangle can be formed in the 5-minute chart and at the same time a rectangle can also be formed in the 1-hour chart, in this case, the latter rectangle is more significant. But it doesn't mean that a pattern in a 5 minute chart is not significant, it means that if there are two patterns on different timeframes, the pattern with the longer time frame is more significant. All patterns represent the same supply and demand interaction in different time frames.

3. It is advised to use other techniques in combination with chart patterns, such as candlestick patterns, technical indicators, etc. this way we will increase the significance of every signal.

Technical Analysis, Falling & Rising Wedge

You may wonder why is it that we have the falling and rising wedge in a separate section. The reason is simple, these patterns can be either reversal or continuation patterns. Depending on where the pattern was formed and its slope it could signal a continuation of the trend or a trend reversal. 

Let’s see each one of them.

Continuation Rising Wedge

As all wedges, this one begins wide and contracts as the market reaches new highs:

[Image 3]

Continuation rising wedges are a bearish continuation pattern. It starts out wide, but narrows as prices keep going up. The highs and the lows of the pattern form a falling wedge. Two or more touched points are required to form the converging trendlines. This pattern is completed when the price breaks through the support trendline.

What makes this wedge a continuation pattern?

The slope of the wedge is against the previous trend.

Continuation Rising Wedge in Action

[Chart 6]

This rising wedge is a continuation pattern because the slope (upward) of the wedge is against the trend (downtrend). When the pattern got completed (support trendline got broken), led to further downside movements.

Continuation Falling Wedge

[Image 9]

Continuation falling wedges are a bullish continuation pattern. It starts out wide, but narrows as prices keep going down. The highs and the lows of the pattern form a falling wedge. Two or more touched points are required to form the converging trendlines. This pattern is completed when the price breaks through the resistance trendline.

What makes this wedge a continuation pattern?

The slope of the wedge is against the previous trend.

Continuation Falling Wedge in Action

[Chart 6]

This falling wedge is a continuation pattern because the slope (downward) of the wedge is against the direction of the trend (uptrend). When the market broke the support trendline and the pattern got completed, it led to further gains.

Reversal Rising Wedge

This pattern begins wide and contracts as the market keeps rising:

[Image 7]

Reversal rising wedges are a bearish reversal pattern found at the end of the uptrend. Starts out wide, and narrows as the market reaches new highs forming a rising wedge when two or more points are connected. The pattern is completed when the price breaks the support trendline.

What makes this wedge a reversal pattern?

The slope of the wedge is in direction of the trend. In this case the market was trending up and the slope of the wedge is upward.

Reversal Rising Wedge in Action

[Chart 6]

This rising wedge is a reversal pattern because the slope (upward) of the wedge is in the same direction of the trend (uptrend). The pattern is completed when the market breaks the support-trendline. Notice the reversal rising wedge here forecasts a retracement, not a trend reversal. The market movement after a wedge or any reversal pattern could produce: a trend reversal, the beginning of a retracement or a consolidation period.

Reversal Falling Wedge

[Image 7]

Reversal falling wedges are a bullish reversal pattern. It starts out wide, but narrows as prices keep going down. The highs and the lows of the pattern form a falling wedge. Two or more touched points are required to form the converging trendlines. This pattern is completed when the price breaks through the resistance trendline.

What makes this wedge a reversal pattern?

The slope of the wedge is in direction of the trend. In this case the market was trending up and the slope of the wedge is upward.

Reversal Falling Wedge in Action

[Chart 6]

This falling wedge is a reversal pattern because the slope (downward) of the wedge is in the same direction of the trend (downtrend). The pattern is not complete until the market breaks the resistance trendline.

Commonly used target for all wedges

Measure the height of the pattern (in its widest side) in terms of pips, and then subtract/sum the same amount of pips from the eventual break out level.

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, Chart Patterns

The same psychology used with candlesticks applies to chart patterns.

Investors and traders make transactions for a wide variety of reasons; most trading decisions are emotionally driven: closing a position because of fear of losing more, adding more positions in hope of greater gains and many more. All these result in an imbalance of supply and demand and they are all uncovered by price movements.

These movements tend to repeat themselves, as traders open, close or add positions for the same reasons.

We must remember that the important questions to answer are where is the price? And what it is more likely to do? The reasons behind why is the pattern formed are not important.

There are two types of chart patterns: reversal and continuation chart patterns.

Continuation Chart Patterns – Set up the market for a follow through in direction of the prevailing trend. Among the most important continuation patterns are:

• Wedges – Rising and falling wedges
• Triangles – symmetrical, ascending and descending triangles.
• Rectangles – periods of consolidation*

* When rectangles have a slope they are called rising and falling channels.

Reversal Chart Patterns – These types of patterns set up the market for a trend reversal once the pattern is confirmed. Reversal patterns are:

• Double Top and Bottom
• Triple Top and Bottom
• Head and Shoulders Top and Bottom

Rising and Falling Wedges – Falling wedges can be bullish and reversal patterns. Read this section to discover why.

Next, we will review some of the most important patterns.

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.