Basic Concepts of Trend Trading : Chart Pattern Analysis

Basic Concepts of Trend Trading : Chart Pattern Analysis

Trend Trading in Forex- Chart Pattern Analysis

What is a Trend?

Trends, in the context of the Forex market, refer to the price movement that occurs in a particular direction, over a period of time. Hence a FX trader, who is into trend trading, will analyze and predict the current price movements or the trends, based on the past or historical movements of price. Here it is of essence to understand that any kind of technical analysis in the trading world, in general, is based on the belief that “History does repeat itself”.

Another noteworthy aspect of technical analysis is the way the charts look, when it comes to the markets, including the Forex market. The charts here depict the trend lines, which are either peaking or falling, at intervals.  It is therefore a graph that signifies the price movements for the chosen currency pairs, as they peak and trough. Here a trader must notice that trends do not always climb upwards or spiral down. They tend to spread out sideways too. Hence price movements or trends in FX can be for long term or for a short term.

Trend trading : Always based on Technical Analysis

As mentioned above, in terms of trading, FX traders who are into trend trading, are into technical analysis of the market. Dubai based FX expert, Kishore M says, “A technical analysis fundamentally believes that the price movement patterns of the past influences the price movement of the present. Therefore the belief that follows is: that the history of price movements aid in predicting not only the present trading conditions but also makes for a good trend prediction”.

The world of FX trading is a speculative one. Trading notions and beliefs are adhered to strictly. “Trends” are often called “friends”. This follows from the fact that trends allow a trader to decide his entry and exit from the market. However, this holds true only as long as a trend stay.

In the FX trading market, predictions are made with the help of two tools: A chart or an indicator.  A chart is a tool that works on the founding belief of Technical analysis, which is about history repeating itself. Though a chart does help in making prediction, seasoned traders allow themselves the usage of indicators too. An indicator is a tool which gives a trader the “signals” to enter or exit the trade. On the other hand, a chart is indicative of the price movement in the market.

Chart pattern analysis:

Though a chart usually follows a trend or pattern, it cannot be 100% on target. Yet chart patterns are still followed and believed in. Here are the two broad categories that every trader in FX trading follows: Reversals and Continuation.

Reversals:

As the name suggests, this kind of chart depicts the reversal of a price trend from the past , once the current pattern is over. It is defined as the change (either positive or negative) in the direction of the current price trend. Reversals are mostly noticed in intra day trading or short term trades, though they maybe a feature of the long trades too.

Four of the most popular and must know reversal chart for any new FX trader are :

  • Head and Shoulder ;
  • Double Top and Bottom;
  • Triple Top and Bottom;

Reversals explained:

1) Head & Shoulder:

This chart has three peaks. The middle peak is the highest high. This is the head. The lowest high on either side (left and right) are the shoulders. The trend line is drawn across to connect the two shoulders. The entry point is taken as the level at which the neckline pattern is broken. The stop loss orders are likewise placed below the last highest low.

2) Double top and bottom:

These reversals charts are used for technical analysis in markets across the world of trading like in stocks, commodities, FX etc.  In these charts, a double top would mean that the current prices will no longer hold and hence a lower price will ensue soon. A double bottom, on the other hand, will mean that the prices are not going to fall any further and hence the prices will pick up soon.

In double tops, the price movement is seen peaking and then dropping down and peaking again to the prior point, before it eventually drops again. The level that the peaking point or the highest high touches, is resistant to further price rise. Hence the prices cannot peak any higher. This resistance is the precise reason why the prices will start to fall. At this point in time, it is safe to bet on short trade, as probability of steep price fall seems inevitable. A stop loss order is usually placed above the second peak.

In the double bottom, on the reverse, the prices fall and pull back, then fall again and pull back. The levels of the lowest low of the falling prices remain the same, proving to be resistant. This can only push the prices higher and therefore a good opportunity for a long trade.

Double Top

Forex Trading Double Top

Double Bottom:

3) Triple Top and Bottom:

Almost the same as the above, the triple Top and bottom have three indicative pulls and pushes or three indicative pushes and pulls.

In the triple Top pattern, after the initial two pushes, the third push might just be there, but the resistance level holds. After the second highest high, a short term trade is advisable, wherein a trader should sell and exit but if a trader ready to risk it a bit more and hold on for the third push to go through, it could prove profitable. But of course, the risk here is more since after the second peak the prices may breakthrough.

In the triple bottom pattern, the logic holds the same as that for the Tops. As the prices trough and fall through, long trades are advisable, since the prices are predictably going to peak. The third low is a risk. However, if that goes through the profits will also be high.

Tripple Top

Tripple Bottom:

Forex trading triple bottom

Continuation charts:

These charts are the ones which depict the continuity of the current trend after a pattern ends. In other words, these charts will tell a trader that a current trend will not go out of season. Here are four of the most popular and must know continuation charts for any new FX trader:

  • Wedges ;
  • Flags; &
  • Triangle

1) Wedges:

These show multiple reversals of price waves. They are more long term technical analysis charts. When the prices fluctuate, they rise up and fall in continuation, within the trend lines, a pattern is usually formed. The price fight here is amongst the buyers and sellers as each set of traders try to outset the other. The parallel lines here converse.

The wedges form in two distinct fashions. The wedges, close to each other in a uptrend bullish trend, mean that the sellers are trying to push the prices high,  while the buyers are forcing it to stay low. In a bullish trend, the buyers win.
The reverse happens when the wedges start shaping up in a bearish downtrend wedge. Here the buyers try to keep the prices low while the sellers try to push the prices high.

2) Flags:

Probably one of the most favored charts, these charts build up after a previous trend. Here too the patterns build up as wedges. The only difference is that, here the price fluctuations are within parallel lines.  During the bullish periods, the uptrend shows up. The breakout above the trend line indicates the recurring probability of the trend.

During the bearish periods, the downtrend shows up. The breakout point is below the trend line as the lowest point of the pole.

3) Triangle:

Triangles in a chart pattern are actually trend lines that taper towards each over a period of time. These trend lines depict supply and demand. In these charts, the lines would usually converge into each other as supply and demand diminishes forming a triangle. This is one of the charts that show that sideways trending of the FX market.

These charts show three distinct types of triangles: Ascending, Descending and symmetrical. Triangles are horizontal chart patterns. Hence like in any triangle, base up, the beginning of these patterns are wide at the mouth, which gradually tapers to a cone as they progress, finally merging to form the point of a triangle. Notice that the trend lines here actually represents the simultaneous cold shoulder from the buyers and the sellers towards a trade.

Ascending triangles form over a period of time, four weeks at least. This trend however hardly holds more than 90 days. The lower trend line of this triangle touches the lowest low points that build up and is indicative of a uptrend. The lower trend line also serves as the support of the trades. Ascending triangles are considered bullish charts.

The Descending triangle, on the other hand, depicts a downtrend and therefore bearish. In this triangle however the lower trend line is a flat line unlike the rising bottom line of the ascending chart. Here volume of trade is a major push towards the way the chart forms.

Symmetrical triangles are the “no news” charts. Here the buyers and the sellers are neither pushing nor pulling prices as the both seem to be at the same level of indecision. At this point in time, when everything seems like a lull, the movement picks up once the traders make up their minds. Most of the times however, the tempo is picked up for the prevailing trend.

  

Conclusion:

Trading uses a lot of tools to understand market behavior. Though charts have been in use since before the automated indicators were discovered, the traders today do not solely depend on either one exclusively. Chart readings as well as indicators, together gives the traders an edge in making the right investments while planning their entry, exits and hold tenures.

2018-11-01T11:03:51+00:00

Power Up Forex Training

RECENT TWEETS