TECHNICAL ANALYSIS- Patterns and probabilities 1
CHARTS PATTERNS
Charts are graphical representation of price movement over a specific period of
frame employed depends on the user’s need.
Basic Types of Charts
Line Charts
A line chart shows a line connecting the closing prices which is the last price
recorded at the end of a specific period of time or session.
Bar Charts
A bar chart also shows closing prices, while simultaneously showing opening
prices, as well as the highs and lows. The bottom of the vertical bar indicates
the highest price paid. The vertical par indicates the currency pair’s trading
range as a whole. The horizontal has on the left side of the bar i the opening
price, and the right-side horizontal has is the closing price.
Bar charts are also called “OHLC” charts, because they indicate the Open, the
High, the Low and the Close for that particular currency.
Candlestick Charts
Candlestick charts show the same information as a bar chart, but in a nicer
graphic format.
Candlestick bars still indicate the high-low range with a vertical line. However,
in the candlestick charting, the larger block in the middle indicates the range
between the opening and the closing prices. Traditionally, if the block in the
middle is filled or colored in, then the currency closed lower than it opened.
In the following example, the “filled color” is white. For our “filled” blocks,
the top of the block is the opening price, and the bottom of the block is the
closing price. If the closing price is higher than the opening price, the block in
the middle will be “black” or hollow or unfilled.
Forex Charts - Candlestick Explanation
The purpose of a candlestick charting is strictly to serve as a visual aid, since
the exact same information appears on an OHLC bar chart. Candlesticks are
formed using the open, high, low and close.
If the close is above the open, then a hollow candlestick (usually displayed as
black) is drawn.
If the close is below the open, then a filled candlestick (usually displayed as
white) is drawn.
The hollow or filled section of the candlestick is called the “real body” or
body.
The thin lines poking above and below the body display the high/low range and
are called shadows.
The top of the upper shadow is the “high”.
The bottom of the lower shadow is the “low”.
SUPPORT AND RESISTANCE ANALYSIS
Support and Resistance concept is very popular among forex technical traders.
Not only the concept is widely used but also might look slightly confusing at
first glance, just like everything else in forex trading! It is however very
important for you to understand support and resistance concept in order to
fully understand forex charts.
Welcome to the forex war between supply and demand! Currency buyers (the
bulls) bring the prices up while currency sellers (the bears) bring the prices
down. The buyers control the prices at a certain level (support level) and do
everything not to let the prices go below that level. The sellers also control the
prices, but at a different level (resistance level) and do everything not to let
the prices go above that level.
So far so good. Now you know that there are two indicators that dominate
forex market and determine the price – supply and demand.
When there are more bears than bulls the currency price will be going down.
Why so? That's because more and more sellers (our so called bears) will be
lowering their asking price. The bears' objective is to discourage buyers (or so
called bulls) from buying.
When there are more bulls than bears the currency price will be going up. Why
so? That's because more and more buyers (our so called bulls) want to take
their bid prices up. Their agenda is to force the stubborn sellers to sell.
Alright. But how does support and resistance fit into this picture?
The price level where there are a big number of BUY orders in the market is
called SUPPORT.
The price level where there are a big number of SELL orders in the market is
called RESISTANCE.
How to tell when support or resistance level is broken? This is not a simple
question and there is no concrete answer to it. It is better to view support and
resistance levels as areas rather then a definite numbers. Line chart is actually
much more useful when it comes to finding those areas. Build your support and
resistance lines around areas where the price movements are making several
"hills".
Also, time plays an important role. Try to locate the areas where the price
spends the least amount of time. That's the area where bears and bulls are
picking up the offerings.
TREND AND TRENDLINE ANALYSIS
Trend is simply the overall direction prices are moving, either up, down or flat.
Classification of trends:
Short term: less than 3 weeks
Medium term: 3 weeks to 6 months
Long term (Major trend): more than 6 months
Trendlines Analysis
This is the method of anlysing trend in forex. There are two kinds of trendlines,
the ascending and descending trendline.
The Ascending Trendline: this is a straight line passing through “the rising”
troughs of an up-move
A reversal of the trend is indicated by a violation of the up-trend line.
The descending trendline: this is a straight line passing through “the falling”
troughs of a down-move
A reversal of the trend is indicated by a violation of the down-trend line.
Channels
When prices trade between two parallel trendlines they form a channel. When
prices hit the bottom trendline, this may be used as a buying are and when
prices hit the top trendline as a selling area.
Double Top Pattern
The Double Top Reversal is a bearish reversal pattern typically found on bar
charts, line charts and candlestick charts. As its name implies, the pattern is
made up of two consecutive peaks that are roughly equal, with a moderate
trough in-between.
Although there can be variations, the classic Double Top Reversal marks at
least an intermediate change, if not long-term change, in trend from bullish to
bearish. Many potential Double Top Reversals can form along the way up, but
until key support is broken, a reversal cannot be confirmed. To help clarify, we
will look at the key points in the formation and then walk through an example.
Prior Trend: With any reversal pattern, there must be an existing trend to
reverse. In the case of the Double Top Reversal, a significant uptrend of several
months should be in place.
First Peak: The first peak should mark the highest point of the current trend.
As such, the first peak is fairly normal and the uptrend is not in jeopardy (or in
question) at this time.
Trough: After the first peak, a decline takes place that typically ranges from 10
to 20%. Volume on the decline from the first peak is usually inconsequential.
The lows are sometimes rounded or drawn out a bit, which can be a sign of
tepid demand.
Second Peak: The advance off the lows usually occurs with low volume and
meets resistance from the previous high. Resistance from the previous high
should be expected. Even after meeting resistance, only the possibility of a
Double Top Reversal exists. The pattern still needs to be confirmed. The time
period between peaks can vary from a few weeks to many months, with the
norm being 1-3 months. While exact peaks are preferable, there is some
leeway. Usually a peak within 3% of the previous high is adequate.
Decline from Peak: The subsequent decline from the second peak should
witness an expansion in volume and/or an accelerated descent, perhaps
marked with a gap or two. Such a decline shows that the forces of demand are
weaker than supply and a support test is imminent.
Support Break: Even after trading down to support, the Double Top Reversal
and trend reversal are still not complete. Breaking support from the lowest
point between the peaks completes the Double Top Reversal. This too should
occur with an increase in volume and/or an accelerated descent.
Support Turned Resistance: Broken support becomes potential resistance and
there is sometimes a test of this newfound resistance level with a reaction
rally. Such a test can offer a second chance to exit a position or initiate a
short.
Price Target: The distance from support break to peak can be subtracted from
the support break for a price target. This would infer that the bigger the
formation is, the larger the potential decline.
Double Bottom Pattern
The Double Bottom Reversal is a bullish reversal pattern typically found on bar
charts, line charts and candlestick charts. As its name implies, the pattern is
made up of two consecutive troughs that are roughly equal, with a moderate
peak in-between.
The double bottom is a complete opposite of the double top, therefore the
opposite of the key points in the formation of the double top should be
considered to ascertain a true double bottom pattern.
Head and Shoulders Pattern
A head and shoulders pattern is also a trend reversal formation.
It is formed by a peak (shoulder), followed by a higher peak (head), and then
another lower peak (shoulder). A "neckline" is drawn by connecting the lowest
points of the two troughs. The slope of this line can either be up or down.
Typically, when the slope is down, it produces a more reliable signal.
The head is the second peak and is the highest point in the pattern. The two
shoulders also form peaks but do not exceed the height of the head.
With this formation, we put an entry order below the neckline.
We can also calculate a target by measuring the high point of the head to the
neckline. This distance is approximately how far the price will move after it
breaks the neckline.
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