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Demand and Supply zones


What is Supply and Demand trading?

Goods are bought and sold at what their perceived value is at the time. The same applies for financial
instruments, with the expectation that their price will change in the future and will be bought or sold at
differing prices, potentially bringing a profit for traders.

Prices adjust according to willing buyers and sellers, in-turn creating supply and demand zones, the
sellers represent the amount that is available for sale (supply) while buyers represent the amount
available to be bought (demand). It is when there is an imbalance between buyers and sellers that we see
a change in price, for example, when there are more willing sellers, price will begin to fall until it finds
more buyers and when there are more willing buyers, price will rise until it finds more sellers. Knowing
where these areas are on a price chart will give you an edge, and allow you to follow the interests of
big/smart money, the real market movers.

Identifying Supply/Demand zones

First we look at the chart for an area where price strongly shot up from (demand) or dropped away from
(supply).

The next step is to mark the base of these moves.

We always mark the outermost limit of a move, marking the inner is a personal preference for each of us
depending how loose or tight one wants to keep their zones.
RBD DBR and RBR DBD

As price moves it creates (swing) highs and lows, the extremes of these moves can be marked as
bases, just like the ones marked above. When bases are created after a rally or a drop they form a
Rally-Base-Drop (RBD) or a Drop-Base-Rally (DBR).

Lets mark some on a chart.


Price can also create small bases along a rally or a drop, these smaller moves are known as Drop-Base-
Drops (DBD) and Rally-Base-Rallies (RBR).

Lets find some on a chart.


Balance vs. Imbalance

During the formation of a base, we consider price to be in balance. This is because there is not a
significant difference in the amount of buy or sell orders in this area thus price doesnt rally or drop as
long as this balance exists. For price to start moving in a direction there needs to be more of one type of
order (buys or sells) than the other causing price to rally or to drop, it is at this point a base is confirmed
and a decision that price was either too cheap or too expensive has been made. When price moves
away from a base there are naturally unfilled orders which remain, so when price returns to the base in
the future we can expect the remaining orders to be triggered causing a reaction in price. It is this what
supply/demand traders try and take advantage of.

When Supply/Demand breaks

After a level is tested many times or during a strong move, Supply and Demand levels eventually break.
This can be due to the once remaining orders being triggered and gradually removed, or an
overwhelming amount of orders in the opposite direction breaking the level. Orders can even be removed
manually by a trader who formed the level.

Every broken supply/demand level holds some significance. Where once were more sell orders (supply)
now more buy orders remain/exist, with the opposite applying for demand levels. This means upon return
to a broken level, we could see a reaction in price, these levels are often referred to as swap levels.

It is at these levels where we can look for conformation to take a trade. This is how the look on a chart:
Part 2: Supply and Demand as reactions to the FTR

Wouldnt it be nice if we were able to trade supply/demand levels knowing when one will hold or when
one will break? Well believe it or not we can, because as hard as it may sound supply/demand levels are
NOT created equally! There are some that are much more important than others, and some even further
beyond important. Most articles on supply/demand will mostly have you read about reactions to levels,
because that is what is important right? Sure, they are important if all you want to do is look at the far right
of your charts and gamble, but what are the supply/demand levelsthemselves reactions to?

Hopefully we have pricked your attention, because this is going to be the first time something as
important as this will be covered in a supply/demand article and it is very exciting to be writing about. I
can already hear you all screaming; hold on! Supply/demand levels can be reactions to other
supply/demand levels! Or Support/Resistance levels! Or MAs and fibs! PleaseIf you are still using MAs
and fibs, let me direct you to our technical analysis article.

The truth is; supply/demand are often reactions to the Flag Limit (a RBD or DBR after a break of a high or
low). You can read about the FL here. It is these levels that are the important ones, the ones that will
contain price in a range, and give you the heads up when price is going to change direction. Sure there
are other areas and reasons supply/demand forms, just like the ones you yelled at me earlier, but these
are lesser important levels, ones that are much more subjected to breaks and fake moves! Knowing the
important ones will keep you on the right side of the market at all times.

Here is some help on defining these levels, but remember, to truly understand them you need to find and
mark them out for yourselves!
There are plenty of other supply/demand levels which I did not mark, but they would all hold lesser
importance than the ones formed after the breaks of highs or low. However, important levels can also
break so it is important to monitor these levels for signs of reversals. When they break however, they hold
a lot of importance.
You can see from the image above I marked a DBR after a break of the highs to the left of it. This is a
level that forms after a break of a high, its a FTR, and we can expect it to bounce price, but it doesnt, it
breaks. The FTR that proceeds is the RBD that is the important one, this is where we want to keenly look
for PA.

How to trade Supply and Demand Areas

Conventional supply and demand trading teaches the game of probabilities; by trading enough zones,
with a decent enough RR, one should make money. These levels are in general blindly traded with a stop
just above, and a target at the next level, this is very often done with limit orders, longing there is a decent
enough RR (2:1 is usually good enough).

If a proper plan is in place, this method will make you money, but it is still essentially gambling, and here
at RTM we dont gamble. We want to be absolutely sure a level is going to hold, and once we know, we
want the very best RR on every trade we take (yes 15:1 can be more common than you think!). By
looking for PA in the correct spots, there is no reason you shouldnt be able to get into great trades, with
great rewards and very little risk. You can find everything you need to know about PAin
the markepedia section. So get to work, log your progress in the homework section and join our great
community.
Support and Ressitance
What is Support and Resistance?

As price moves it creates highs and lows, these often provide support or resistance when price
returns. This happens because more orders of one kind are in that area (buy or sells). When no more
orders remain in these places, price will go through and we say that the support/resistance level breaks.

This is essential for price to move, otherwise it would be trapped inside a range forever. So support and
resistance is important as is its breaks.

But first lets see what it looks like.

It is a common misconception that the more times price bounces off Support or Resistance then the
stronger that level is. Every time price bounces off them a decision is made on price value (if price is
cheap or expensive). But as we said price bounces off these places because one type of orders (buys or
sells) are more than the other. Each time price visits, it consumes orders. At some point price will go
through as there will be no more opposing orders there any more and this is what makes a Support or
Resistance level to break.
In a similar way we could draw some more SR lines on that same image.
It is very common for price to break Support and Resistance levels, old highs and lows break as the
orders get depleted from them and price moves through. Broken S/R areas will often react on return as
now more orders of the opposite kind remain unfilled in these places.

How to find S/R levels?

A common practice is to zoom out like in the chart below so you have a wider picture of the area you look
at. Then look for places that price bounced off and mark it with a horizontal line. See how price often
respects these lines, then breaks them and when price returns they often get respected again. Support
becomes resistance and the opposite.
Of course you will see many times price breaking through and then reversing, often this is called a false
break (false breakout, or fakeout are some other names commonly used). The simple reason this
happens is because price looks for liquidity and this often happens in these places as traders trade these
breakouts from S/R and get trapped, having their stops hit as price fakes and moves in the other
direction.

Further Study

http://www.readthemarket.com/index.php/education/markepedia
https://www.tradingview.com/chart/EURUSD/DZblrqHg-How-to-draw-Supply-and-Demand-zone-
EDUCATIONAL/

https://www.tradingview.com/chart/EURUSD/0CHocSUo-HEAD-AND-SHOULDERS-PATTERN-SECRETS/

Price Action Theory

http://www.tradingsetupsreview.com/how-to-identify-demand-and-supply-using-price-action/
YOU ARE HERE: HOME / TRADING ARTICLES / HOW TO IDENTIFY DEMAND AND SUPPLY
USING PRICE ACTION

HOW TO IDENTIFY DEMAND AND


SUPPLY USING PRICE ACTION
Want to find demand and supply in the market? Just look at the market depth screen and you will
see orders to buy and sell at different prices. Those numbers show demand and supply.

Thats all. Youve found demand and supply. What can you do with it? Nothing.

Now, think again. Do you really want to find demand and supply?
In a liquid market, there is constant supply and demand. People are always willing to buy and
sell at different prices. Demand and supply are everywhere. There is no need to find them.

What you really want to find are the price zones where supply overwhelms demand and where
demand overwhelms supply.

The former is known as resistance. When the market bumps into resistance, price will drop. Then,
you can make money by shorting the market.
The latter is market support. With the support of demand, price will rise. Then, you can profit from
a long position.

In a nutshell, we want to find market turning points, and not merely demand and supply. Follow
the three steps below to find and trade these profitable turning points.

1. FOCUS ON A PRICE LEVEL (ZONE)


Its difficult to analyze the market without a focal point. If you look for turning points at every
price level, you will only find confusion.

How do you know which price level to focus on? Which price levels are potential market turning
points?

There are many ways to find potential turning points. You can use swing pivots, calculated pivot
points, Fibonacci levels, and volume signals. Learn about these methods and make use of those
that make sense to you.

EXAMPLE
In this example, I focus on a valid swing pivot. (The concept of a valid swing pivot is explained
in myprice action course. Essentially, it is a form of major market pivot.)
The ES 5-minute chart above shows a valid swing low. Pay attention to this price zone to find
out if demand prevails.

2. OBSERVE WHAT HAPPENED (HAPPENS)


AT THE POTENTIAL SUPPORT/RESISTANCE
SIGNS OF STRONG DEMAND
When the market tests a potential support, look out for:

Bullish price pattern


Inability to clear below the support
Increased volume
Congestion

SIGNS OF STRONG SUPPLY


When the market tests a potential resistance, look out for:

Bearish price pattern


Inability to clear above the resistance
Increased volume
Congestion

Look for these price action signals in the past, as well as in real-time price action. The more
signs you see, the more likely youve found a true support/resistance zone.

EXAMPLE
Lets take a closer look at the same ES 5-minute chart to check the price action.

1. Volume increased as the market dipped into the price zone. It was a clue of a demand surge.
2. Bullish price patterns formed as the market tested the support zone. (Marubozu and Outside Bar)
3. It was clear that the market had difficulty closing within or below the support zone.

These signs confirmed that demand would likely overwhelm supply in the indicated price zone.

3. LIMIT YOUR RISK


Once youve found a potential support or resistance level, remember the word potential. It is a
tendency and not a guarantee.
Hence, you should limit your risk when you trade supply and demand zones. There are two
trading approaches to do so.

METHOD ONE DEMAND CONFIRMATION


Let price show you the way. Look for price patterns. Then, use stop orders to enter as the market
confirms your opinion.

You will enter late, but you will save yourself from many bad trades. The main drawback of this
strategy is that you will enter at a worse price. Hence, use this strategy only when you expect
significant profit potential. Otherwise, the reward-to-risk ratio is too low.

METHOD TWO TRADE AGGRESSIVELY


Get in early (without confirmation) with a tight stop-loss and a conservative target. In this case,
use a limit order placed within the support/resistance zone.

This strategy is ideal when you are:

Confident of the demand and supply conditions;


But are uncertain of how far the market would go.

EXAMPLE
In our ES 5-minute example, the support zone looked reliable. Hence, we were confident that
demand would stop the market decline.

However, given that the market has been falling, long positions were against the recent trend. It
was unwise to set ambitious profit targets.

Under such considerations, the aggressive trading approach is suitable.


A consistent stop-loss and target of 2 points will work for both trades. It produced two swift and
high probability scalps. (The stop-loss and target depends on the market volatility.)

USE PRICE ACTION TO UNDERSTAND HOW


DEMAND AND SUPPLY INTERACTS
Remember that you are anticipating the strength of demand and supply. We are interested in their
interaction.

Will demand conquer supply at this price level?


Will supply overwhelm demand at this price level?
What does this (series of) price bar(s) tell me about demand and supply?

These are the questions you want to think about as you go through the three steps above.

As our example showed, the market context is crucial. It helps you to tailor your trading
approach to the market.

Hence, dont focus on a simplistic definition of support and resistance. Spend your effort in
studying price action clues to decipher demand and supply forces.
INSTANTLY IMPROVE YOUR
TRADING STRATEGY WITH
SUPPORT AND RESISTANCE
By Galen Woods in Trading Articles on January 2, 2014

What is the best way to improve your trading strategy? Use support and resistance concepts in
your trading strategy.

Learn how to use support and resistance levels in your trading strategy to improve your trading
results.

WHAT ARE SUPPORT AND RESISTANCE


LEVELS?
Before you learn about support and resistance, you must first understand basic demand and
supply.

Demand and supply are the underlying forces of price movements. Market turns up when
demand overwhelms supply and turns down when supply overcomes demand.

(Technical analysis studies recurring price patterns that result from demand and supply changes.
Fundamental analysis drills into the determinants of demand and supply.)

Prices move up when demand is stronger than supply. Buyers are more eager to buy than sellers
are willing to sell. So buyers will offer a higher price to entice sellers. Price rises.
Prices drop when supply is stronger than demand. Sellers are more eager to sell than buyers are
willing to buy. In this case, sellers will lower their asking price until buyers are willing to buy.
Prices fall.

At support levels, we expect demand to overwhelm supply. When demand is stronger than
supply, price will rise. Or at least, price will stop falling at the support level.

At resistance levels, as supply overcomes demand, we expect the price to stop rising and fall.

Take note that support and resistance are not clear-cut price levels. They occur over a range of
prices. However, for convenience and clarity, many technical analysts draw lines to mark out
support and resistance.

Drawing lines to represent support and resistance is acceptable as long as you understand that the
lines actually represent zones where the demand and supply imbalance switches.

HOW TO FIND SUPPORT AND RESISTANCE


LEVELS?
SWING HIGHS AND SWING LOWS

Swing highs and swing lows are earlier market turning points. Hence, they are natural choices
for projecting support and resistance levels.

Every swing point is a potential support or resistance level. However, for effective trading, focus
on major swing highs and lows.

Learn: Find Powerful Anchor Zones for High Probability Trades


CONGESTION AREAS

Market participants have spent a prolonged time in congestion areas. It is likely that they have
formed psychological attachment or have established actual trading interest within that price
range. Hence, earlier market congestion areas are reliable support and resistance levels.

Congestion areas reinforces the idea that support and resistance are zones, and not a specific
price level.

If you need help finding congestion areas, price by volume charts might help.

PSYCHOLOGICAL NUMBERS
Humans attach significance to certain numbers.

Round numbers are the best examples. Round numbers always make financial
headlines. TheNatural Number Trading Strategy derives its trading edge from round numbers.

The 52-week high and low price of a security is another example of a psychologically important
number.
CALCULATED SUPPORT/RESISTANCE

You can also derive support and resistance from calculated values like the moving average. They
work best in trending markets.

Combining candlestick patterns with a moving average is a reliable trading method that uses
moving average as support/resistance.
Fibonacci retracement is another popular method for projecting support and resistance by
calculation. With a decent charting package, we can mark out retracement levels easily without
manual calculation.

Identify major market swings and focus on retracement of the move by a Fibonacci ratio.

Fibonacci ratios include 23.6%, 38.2%, 50%, 61.8% and 100%. A 100% retracement is the same
as using a swing high/low as resistance/support.

The intraday trend trading strategy we reviewed uses Fibonacci retracements to find the best
trades.
FLIPPING OF SUPPORT/RESISTANCE

Flipping is an important concept for support and resistance. It refers to the phenomenon of
support turning into resistance or resistance turning into support.

When price breaks through a support level, it shows a shift of power from buyers to sellers. The
support level then becomes a resistance level that sellers are confident of defending. The reverse
is true for price breaking through resistance.

This concept is applicable regardless of the method you use to find support and resistance levels.

SUPPORT/RESISTANCE FROM HIGHER TIME-FRAME


To focus on major support and resistance levels, you can find them on higher time-frames before
applying them to your trading time-frame for analysis.

For instance, you can note down the support and resistance levels from the weekly chart. Then,
plot them on the daily chart to find trading opportunities.

This method keeps you focused on important support and resistance levels instead of flooding
your chart with dozens of potential support and resistance levels.
HOW TO USE SUPPORT AND RESISTANCE
LEVELS IN YOUR TRADING STRATEGY?
TRADING DIRECTION
In up trends, support levels are likely to hold. In down trends, resistance levels tend to hold.

Hence, if you see that support levels are holding up, you might consider taking only long trades.
The reverse is true if you see resistance levels holding up.

Paying attention to price levels is a simple way to find a clear market bias.

This example shows major swing lows that are holding up as support, which is a sign of a bullish
market.

FILTER BAD TRADES


Your trading strategy might have its own way of determining market bias. In that case, do not
confuse your analysis with support and resistance. Rely on your trading strategy for a primary
bias.
However, you can use support and resistance analysis to augment your trading strategy.

For instance, if your trading strategy dictates a buy, but price is right below a major resistance
level, you might want to wait for a clear break-out of the resistance before entering on pullbacks.

By waiting for more price action to unfold near support and resistance levels, you can avoid low-
quality trades.

TRADE ENTRIES
Look for bullish signals at support levels and bearish signals at resistance levels. This is the key
to finding the best trades in any trading strategy.

This chart shows a trade from the MACD with inside bar trading strategy. The bullish inside bar
was a result of support at an area of earlier price congestion. It had the makings of a high-quality
trade.

TRADE EXITS
Support and resistance, even the minor ones, are effective as price targets and stops.
For day traders, the high and low of the previous trading session are important support and
resistance levels. This example (retrace day trading setup) shows that the low of the previous
session was the perfect price target for this trade.

SUPPORT & RESISTANCE ESSENTIAL &


EFFECTIVE
Support and resistance are essential features of the price landscape. Do not navigate prices
without them.

Before considering any trade, mark out the support and resistance levels. These potential zones
of demand and supply will help you understand the market.

Use this understanding in your trading strategy to your instant advantage.


INSTANTLY IMPROVE YOUR
TRADING STRATEGY WITH
SUPPORT AND RESISTANCE
By Galen Woods in Trading Articles on January 2, 2014

What is the best way to improve your trading strategy? Use support and resistance concepts in
your trading strategy.

Learn how to use support and resistance levels in your trading strategy to improve your trading
results.

WHAT ARE SUPPORT AND RESISTANCE


LEVELS?
Before you learn about support and resistance, you must first understand basic demand and
supply.

Demand and supply are the underlying forces of price movements. Market turns up when
demand overwhelms supply and turns down when supply overcomes demand.

(Technical analysis studies recurring price patterns that result from demand and supply changes.
Fundamental analysis drills into the determinants of demand and supply.)

Prices move up when demand is stronger than supply. Buyers are more eager to buy than sellers
are willing to sell. So buyers will offer a higher price to entice sellers. Price rises.

Prices drop when supply is stronger than demand. Sellers are more eager to sell than buyers are
willing to buy. In this case, sellers will lower their asking price until buyers are willing to buy.
Prices fall.

At support levels, we expect demand to overwhelm supply. When demand is stronger than
supply, price will rise. Or at least, price will stop falling at the support level.

At resistance levels, as supply overcomes demand, we expect the price to stop rising and fall.
Take note that support and resistance are not clear-cut price levels. They occur over a range of
prices. However, for convenience and clarity, many technical analysts draw lines to mark out
support and resistance.

Drawing lines to represent support and resistance is acceptable as long as you understand that the
lines actually represent zones where the demand and supply imbalance switches.

HOW TO FIND SUPPORT AND RESISTANCE


LEVELS?
SWING HIGHS AND SWING LOWS

Swing highs and swing lows are earlier market turning points. Hence, they are natural choices
for projecting support and resistance levels.

Every swing point is a potential support or resistance level. However, for effective trading, focus
on major swing highs and lows.

Learn: Find Powerful Anchor Zones for High Probability Trades


CONGESTION AREAS

Market participants have spent a prolonged time in congestion areas. It is likely that they have
formed psychological attachment or have established actual trading interest within that price
range. Hence, earlier market congestion areas are reliable support and resistance levels.

Congestion areas reinforces the idea that support and resistance are zones, and not a specific
price level.

If you need help finding congestion areas, price by volume charts might help.

PSYCHOLOGICAL NUMBERS
Humans attach significance to certain numbers.

Round numbers are the best examples. Round numbers always make financial
headlines. TheNatural Number Trading Strategy derives its trading edge from round numbers.

The 52-week high and low price of a security is another example of a psychologically important
number.
CALCULATED SUPPORT/RESISTANCE

You can also derive support and resistance from calculated values like the moving average. They
work best in trending markets.

Combining candlestick patterns with a moving average is a reliable trading method that uses
moving average as support/resistance.
Fibonacci retracement is another popular method for projecting support and resistance by
calculation. With a decent charting package, we can mark out retracement levels easily without
manual calculation.

Identify major market swings and focus on retracement of the move by a Fibonacci ratio.

Fibonacci ratios include 23.6%, 38.2%, 50%, 61.8% and 100%. A 100% retracement is the same
as using a swing high/low as resistance/support.

The intraday trend trading strategy we reviewed uses Fibonacci retracements to find the best
trades.
FLIPPING OF SUPPORT/RESISTANCE

Flipping is an important concept for support and resistance. It refers to the phenomenon of
support turning into resistance or resistance turning into support.

When price breaks through a support level, it shows a shift of power from buyers to sellers. The
support level then becomes a resistance level that sellers are confident of defending. The reverse
is true for price breaking through resistance.

This concept is applicable regardless of the method you use to find support and resistance levels.

SUPPORT/RESISTANCE FROM HIGHER TIME-FRAME


To focus on major support and resistance levels, you can find them on higher time-frames before
applying them to your trading time-frame for analysis.

For instance, you can note down the support and resistance levels from the weekly chart. Then,
plot them on the daily chart to find trading opportunities.

This method keeps you focused on important support and resistance levels instead of flooding
your chart with dozens of potential support and resistance levels.
HOW TO USE SUPPORT AND RESISTANCE
LEVELS IN YOUR TRADING STRATEGY?
TRADING DIRECTION
In up trends, support levels are likely to hold. In down trends, resistance levels tend to hold.

Hence, if you see that support levels are holding up, you might consider taking only long trades.
The reverse is true if you see resistance levels holding up.

Paying attention to price levels is a simple way to find a clear market bias.

This example shows major swing lows that are holding up as support, which is a sign of a bullish
market.

FILTER BAD TRADES


Your trading strategy might have its own way of determining market bias. In that case, do not
confuse your analysis with support and resistance. Rely on your trading strategy for a primary
bias.
However, you can use support and resistance analysis to augment your trading strategy.

For instance, if your trading strategy dictates a buy, but price is right below a major resistance
level, you might want to wait for a clear break-out of the resistance before entering on pullbacks.

By waiting for more price action to unfold near support and resistance levels, you can avoid low-
quality trades.

TRADE ENTRIES
Look for bullish signals at support levels and bearish signals at resistance levels. This is the key
to finding the best trades in any trading strategy.

This chart shows a trade from the MACD with inside bar trading strategy. The bullish inside bar
was a result of support at an area of earlier price congestion. It had the makings of a high-quality
trade.

TRADE EXITS
Support and resistance, even the minor ones, are effective as price targets and stops.
For day traders, the high and low of the previous trading session are important support and
resistance levels. This example (retrace day trading setup) shows that the low of the previous
session was the perfect price target for this trade.

SUPPORT & RESISTANCE ESSENTIAL &


EFFECTIVE
Support and resistance are essential features of the price landscape. Do not navigate prices
without them.

Before considering any trade, mark out the support and resistance levels. These potential zones
of demand and supply will help you understand the market.

Use this understanding in your trading strategy to your instant advantage.


RELIABLE SUPPORT AND
RESISTANCE ZONES WITH HIGH
VOLUME SIGNALS
By Galen Woods in Trading Articles on December 2, 2014

Price never moves in a straight line. Price action bounces up and down between support and
resistance levels. In fact, when skilled price action traders analyse a chart, they are just looking
for support and resistance zones.

We look at major support and resistance for market bias. We also make use of minor support and
resistance for timing purposes.

Support and resistance is a key price action trading concept. Hence, it is not surprising to find a
myriad of techniques for projecting support and resistance.

Traders seem to buy in areas of support and sell in areas of resistance. But they do not react to
support and resistance because of magic. They do because they are interested in those price
levels.

The best way to gauge market interest is by observing volume. When a price zone gets the
interest of the market, the market trades. Volume surges.

Hence, by paying attention to volume clues, we can find reliable support and resistance areas.
The easiest way to find volume-based support and resistance is to focus on climatic volume
signals. While they do not occur often, you cannot miss them when they do.

What are climatic volume signals? How high is high?

Here, I will use the volume benchmark that I applied to find Anchor Bars and Exhaustion Gaps.

The benchmark is the upper Bollinger Band with a look-back setting of 233 and a displacement
of 3 standard deviations. If a price bar shows volume higher than this benchmark, we will zoom
in and analyse it as a potential support or resistance area.
First, find a high volume price bar, Then, mark its high and low prices. The area between is the
potential support or resistance area.

Lets take a look at the two examples below.

HIGH VOLUME SUPPORT/RESISTANCE


SPY ETF

The top panel shows the daily price bars of SPY. The lower panel shows the volume of each day.
The orange line is the Bollinger Band benchmark as described above. Look out for instances
when the volume rises above the orange line.

1. These two consecutive high volume bars caught our attention.


2. Using the highest and lowest traded price of these two days, we drew a price zone.
3. As the market rose, the price zone became a potential support zone.
4. At the end of the first deep pullback down, the price zone offered perfect support to halt the market
descent.

This is a textbook example. Buying when the market dipped into the support zone was a great
trade with almost no adverse movement.
The next example will show that price action around a support zone is not always as neat.

HIGH VOLUME SUPPORT/RESISTANCE


LEN

This chart shows the daily price bars of Lennar Corporation (LEN on NYSE).

1. We spotted this clear surge in volume.


2. Using the high and low of the high volume bar, we marked out a potential support/resistance zone.
3. After rising above the price zone, the market tested the support zone for five times before leaving it
alone. The fourth test was the strongest and shook most weak bulls out of their positions.

The tests of the support zone were of varying strengths. Such market movement made it difficult
to make use of the support zone for trade entries. Thus, blindly buying a bounce off the support
zone was not ideal. It was essential to use more specific trading setups to define our risk and
reward.

TRADING WITH HIGH VOLUME SUPPORT


AND RESISTANCE ZONES
When trading with any form of support/resistance, always look out for support/resistance zones
that have failed.

Generally, if the market falls sharply through a support area, it becomes invalid as a support.
(You can still observe it for flip trades as the support switches into a potential resistance zone.)
The same logic applies for a market rising through a resistance area with clear momentum.

A tip for day traders: fine tune your support and resistance levels with range bars instead of time-
based charts. Range bars with high volume are effective intraday support and resistance levels.

High volume price zones are potential support and resistance areas. Potential is the key word
here. They do not always work. Hence, you must not trade them blindly.

While looking out for high volume price zones is great for mapping the market structure, it is not
a complete trading method. You should always use other trading methods to time your entry.

Suffering from whipsaws and uncontrolled risk? Learn to time your trades with a simple and
effective price pattern.

ANCHOR ZONES TRADING


STRATEGY
By Galen Woods in Trading Setups on February 3, 2014

L. A. Little wrote two excellent books on trend trading. In his books, he explained a key timing
concept called anchor zones, which is a very useful tool for price action traders.

In our review, we will find anchor zones and design a trading strategy around them. However,
bear in mind that anchor zones are just a part of L. A. Littles trading framework. To apply
anchor zones in L. A. Littles trend framework. you must refer to his books.

Trend Trading Set-Ups: Entering and Exiting Trends for Maximum Profit (Wiley Trading)
Trend Qualification and Trading: Techniques To Identify the Best Trends to Trade (Wiley
Trading)

ANCHOR ZONES
To mark out anchor zones, we must first find anchor bars. Anchor bars have one or more of the
following signs of extreme price activity:

Wide range
Gaps
High volume

Once you find the anchors bars, you can draw the anchor zones by marking the limits of the bars.
The chart below shows how to do it.

The steps are simple.

1. Find bars with extreme volume, range, or gaps.


2. These are the anchors bars.
3. Draw zones along the limits of the anchor bars and expect price to stay within the zone.

For the examples below, we marked out the anchor zones using the same method.
TRADING RULES ANCHOR ZONES
LONG TRADING SETUP
1. A bullish reversal bar that tests the support anchor zone
2. Buy on break of high of reversal bar

SHORT TRADING SETUP


1. A bearish reversal bar that tests the resistance anchor zone
2. Sell on break of low of reversal bar

ANCHOR ZONES TRADING EXAMPLES


WINNING TRADE BULLISH TRADE

The examples in L. A. Littles books are mostly from the stock market and in the daily time-
frame. However, in this trade, we used the anchor zones method on a 20-minute chart of the 6J
futures on CME.

1. The extreme range and volume highlighted the anchors bars which guided us to mark out the
support and resistance zones.
2. The bullish reversal bar that poked slightly below the anchor support zone is our trading signal.
We placed a buy stop order on its high. Prices rose and stopped just short of the resistance zone,
giving us a enough room for profit.
3. This anchor zone was very successful in containing the price movement. The red and green circles
highlight other potential anchor zone trades.

LOSING TRADE BULLISH TRADE

This is a daily chart of EBAY. It shows anchor zones that provided some support and resistance
but did not lead to a profitable trade.

1. Taking our cue from the volume and range plots, we marked out the anchor zones.
2. Prices fell quickly to the support zone. It held up with a bullish outside bar and inside bar.
However, neither bullish patterns had follow-through.
3. Finally, a bullish reversal bar formed on the support zone, and we bought as price broke above it.
However, the trade failed swiftly as price fell through the anchor zone to test an earlier swing low.

REVIEW ANCHOR ZONES TRADING


STRATEGY
Price action often exhaust themselves with climatic moves. Anchors bars include gaps, wide
range, and high volume. These are also signs of climatic moves. Hence, anchor bars are
exhaustive moves.
Marking out support and resistance zones with anchor bars is a superb trading method. It
integrates price and volume to find key price ranges that work well to contain prices.

This concept of anchoring prices with exhaustive moves also work in day trading. The high
and/or low of the each trading session is often formed within the first trading hour. The first hour
of the trading day usually has wide range and high volume. Hence, it serves as an anchor for the
rest of the trading session. Morning reversal trades and opening range break-out trades work on
the same premise.

Our trading rules focus on reversal bars as entry signals for simplicity. In fact, you can look out
for any candlestick pattern to time the trade.

More experienced traders can even enter with limit orders slightly beyond the anchor zones.
Using limit orders will result in minimal adverse price movement in successful trades. The stop-
loss is tight and the reward to risk ratio is excellent. However, you must have ironclad discipline
to exit without hesitation.

Read: Trading Ranges with Gimmee Bars

If you find this anchor zone concept effective, you should see how it works with L. A. Littles
trading framework in his highly reviewed books.

YOU ARE HERE: HOME / TRADING ARTICLES / RELIABLE SUPPORT AND RESISTANCE
ZONES WITH HIGH VOLUME SIGNALS
RELIABLE SUPPORT AND
RESISTANCE ZONES WITH HIGH
VOLUME SIGNALS
By Galen Woods in Trading Articles on December 2, 2014

Price never moves in a straight line. Price action bounces up and down between support and
resistance levels. In fact, when skilled price action traders analyse a chart, they are just looking
for support and resistance zones.

We look at major support and resistance for market bias. We also make use of minor support and
resistance for timing purposes.

Support and resistance is a key price action trading concept. Hence, it is not surprising to find a
myriad of techniques for projecting support and resistance.

Traders seem to buy in areas of support and sell in areas of resistance. But they do not react to
support and resistance because of magic. They do because they are interested in those price
levels.

The best way to gauge market interest is by observing volume. When a price zone gets the
interest of the market, the market trades. Volume surges.

Hence, by paying attention to volume clues, we can find reliable support and resistance areas.
The easiest way to find volume-based support and resistance is to focus on climatic volume
signals. While they do not occur often, you cannot miss them when they do.

What are climatic volume signals? How high is high?

Here, I will use the volume benchmark that I applied to find Anchor Bars and Exhaustion Gaps.

The benchmark is the upper Bollinger Band with a look-back setting of 233 and a displacement
of 3 standard deviations. If a price bar shows volume higher than this benchmark, we will zoom
in and analyse it as a potential support or resistance area.

First, find a high volume price bar, Then, mark its high and low prices. The area between is the
potential support or resistance area.
Lets take a look at the two examples below.

HIGH VOLUME SUPPORT/RESISTANCE


SPY ETF

The top panel shows the daily price bars of SPY. The lower panel shows the volume of each day.
The orange line is the Bollinger Band benchmark as described above. Look out for instances
when the volume rises above the orange line.

1. These two consecutive high volume bars caught our attention.


2. Using the highest and lowest traded price of these two days, we drew a price zone.
3. As the market rose, the price zone became a potential support zone.
4. At the end of the first deep pullback down, the price zone offered perfect support to halt the
market descent.

This is a textbook example. Buying when the market dipped into the support zone was a great
trade with almost no adverse movement.

The next example will show that price action around a support zone is not always as neat.
HIGH VOLUME SUPPORT/RESISTANCE
LEN

This chart shows the daily price bars of Lennar Corporation (LEN on NYSE).

1. We spotted this clear surge in volume.


2. Using the high and low of the high volume bar, we marked out a potential support/resistance
zone.
3. After rising above the price zone, the market tested the support zone for five times before leaving
it alone. The fourth test was the strongest and shook most weak bulls out of their positions.

The tests of the support zone were of varying strengths. Such market movement made it difficult
to make use of the support zone for trade entries. Thus, blindly buying a bounce off the support
zone was not ideal. It was essential to use more specific trading setups to define our risk and
reward.

TRADING WITH HIGH VOLUME SUPPORT


AND RESISTANCE ZONES
When trading with any form of support/resistance, always look out for support/resistance zones
that have failed.

Generally, if the market falls sharply through a support area, it becomes invalid as a support.
(You can still observe it for flip trades as the support switches into a potential resistance zone.)
The same logic applies for a market rising through a resistance area with clear momentum.

A tip for day traders: fine tune your support and resistance levels with range bars instead of time-
based charts. Range bars with high volume are effective intraday support and resistance levels.

High volume price zones are potential support and resistance areas. Potential is the key word
here. They do not always work. Hence, you must not trade them blindly.

While looking out for high volume price zones is great for mapping the market structure, it is not
a complete trading method. You should always use other trading methods to time your entry.

Suffering from whipsaws and uncontrolled risk? Learn to time your trades with a simple and
effective price pattern.

HOW TO IDENTIFY DEMAND AND


SUPPLY USING PRICE ACTION
By Galen Woods in Trading Articles on June 5, 2015

Want to find demand and supply in the market? Just look at the market depth screen and you will
see orders to buy and sell at different prices. Those numbers show demand and supply.

Thats all. Youve found demand and supply. What can you do with it? Nothing.

Now, think again. Do you really want to find demand and supply?
In a liquid market, there is constant supply and demand. People are always willing to buy and
sell at different prices. Demand and supply are everywhere. There is no need to find them.

What you really want to find are the price zones where supply overwhelms demand and where
demand overwhelms supply.

The former is known as resistance. When the market bumps into resistance, price will drop. Then,
you can make money by shorting the market.
The latter is market support. With the support of demand, price will rise. Then, you can profit
from a long position.

In a nutshell, we want to find market turning points, and not merely demand and supply. Follow
the three steps below to find and trade these profitable turning points.

1. FOCUS ON A PRICE LEVEL (ZONE)


Its difficult to analyze the market without a focal point. If you look for turning points at every
price level, you will only find confusion.

How do you know which price level to focus on? Which price levels are potential market turning
points?

There are many ways to find potential turning points. You can use swing pivots, calculated pivot
points, Fibonacci levels, and volume signals. Learn about these methods and make use of those
that make sense to you.

EXAMPLE
In this example, I focus on a valid swing pivot. (The concept of a valid swing pivot is explained
in myprice action course. Essentially, it is a form of major market pivot.)
The ES 5-minute chart above shows a valid swing low. Pay attention to this price zone to find
out if demand prevails.

2. OBSERVE WHAT HAPPENED (HAPPENS)


AT THE POTENTIAL SUPPORT/RESISTANCE
SIGNS OF STRONG DEMAND
When the market tests a potential support, look out for:

Bullish price pattern


Inability to clear below the support
Increased volume
Congestion

SIGNS OF STRONG SUPPLY


When the market tests a potential resistance, look out for:

Bearish price pattern


Inability to clear above the resistance
Increased volume
Congestion

Look for these price action signals in the past, as well as in real-time price action. The more
signs you see, the more likely youve found a true support/resistance zone.

EXAMPLE
Lets take a closer look at the same ES 5-minute chart to check the price action.

1. Volume increased as the market dipped into the price zone. It was a clue of a demand surge.
2. Bullish price patterns formed as the market tested the support zone. (Marubozu and Outside
Bar)
3. It was clear that the market had difficulty closing within or below the support zone.

These signs confirmed that demand would likely overwhelm supply in the indicated price zone.

3. LIMIT YOUR RISK


Once youve found a potential support or resistance level, remember the word potential. It is a
tendency and not a guarantee.
Hence, you should limit your risk when you trade supply and demand zones. There are two
trading approaches to do so.

METHOD ONE DEMAND CONFIRMATION


Let price show you the way. Look for price patterns. Then, use stop orders to enter as the market
confirms your opinion.

You will enter late, but you will save yourself from many bad trades. The main drawback of this
strategy is that you will enter at a worse price. Hence, use this strategy only when you expect
significant profit potential. Otherwise, the reward-to-risk ratio is too low.

METHOD TWO TRADE AGGRESSIVELY


Get in early (without confirmation) with a tight stop-loss and a conservative target. In this case,
use a limit order placed within the support/resistance zone.

This strategy is ideal when you are:

Confident of the demand and supply conditions;


But are uncertain of how far the market would go.

EXAMPLE
In our ES 5-minute example, the support zone looked reliable. Hence, we were confident that
demand would stop the market decline.

However, given that the market has been falling, long positions were against the recent trend. It
was unwise to set ambitious profit targets.

Under such considerations, the aggressive trading approach is suitable.


A consistent stop-loss and target of 2 points will work for both trades. It produced two swift and
high probability scalps. (The stop-loss and target depends on the market volatility.)

USE PRICE ACTION TO UNDERSTAND HOW


DEMAND AND SUPPLY INTERACTS
Remember that you are anticipating the strength of demand and supply. We are interested in their
interaction.

Will demand conquer supply at this price level?


Will supply overwhelm demand at this price level?
What does this (series of) price bar(s) tell me about demand and supply?

These are the questions you want to think about as you go through the three steps above.

As our example showed, the market context is crucial. It helps you to tailor your trading
approach to the market.

Hence, dont focus on a simplistic definition of support and resistance. Spend your effort in
studying price action clues to decipher demand and supply forces.
Read more about Price Action Trading, Support And Resistance, Volume

COMMENTS

1. HS says

October 23, 2015 at 10:45 PM

After reading this article, I still have no clues about supply and demand. How should one
determining it? Is it by engulfing candlestick?

Reply

o Galen Woods says

October 26, 2015 at 12:03 PM

As a start, you can use swing pivots, calculated pivot points, Fibonacci levels, and volume signals to
find potential supply and demand price zones. Then, to confirm that supply or demand is indeed
present in those zones, you can look out for price patterns (engulfing falls under this), rejections,
volume surges, and price congestion.
Gauging Support And
Resistance With Price By
Volume
By Justin Kuepper

Many say that charting is nothing more than predicting the direction of a price
between significant support and resistance levels. We know that a support level
is a price level which a stock has had difficulty falling below. This is where a lot of
buyers tend to enter the stock. Similarly, we know that resistance is a price level
above which a stock has difficulty climbing. This is where a lot of buyers take
profits and shorts enter. Typically, a stock's price will range between these levels
until it breaks out or breaks down. Hundreds of different methods can be used to
locate these areas of support and resistance, but one of the most underrated
methods is simply using price by volume (PBV) charts. In this article, we explain
what PBV charts are and explore techniques that you can use to make effective
trades using these charts. (For additional reading on volume, see Volume
Oscillator Confirms Price Movements, Volume Rate of Change and Gauging The
Market's Psychological State.)
Trendlines, chart patterns, pivot points, Fibonacci lines and Gann lines are
among the most popular methods used to identify areas of support and
resistance. But the less commonly used PBV charts, which illustrate volume
using a vertical volume histogram, can be invaluable when determining not only
the location of key support and resistance levels, but also the strength of these
levels. (For further reading, see Support And Resistance Zones - Part 1 and Part
2.)

What Are PBV Charts?


A price by volume chart is simply the standard volume histogram reapplied to
price instead of time (price is seen on the Y axis and time on the X axis). So,
instead of being able to determine when a stock is going in and out of favor
(indicated by increasing volume levels over time), PBV enables you to determine
the level of buying or selling interest at a given price level. PBV charts can be
created in many different charting applications, as well as by using free online
charting services from websites like BigCharts.com and StockCharts.com.

Using PBV Charts


PBV charts are relatively easy to use and understand. There are three major
elements involved:

Volume strength indicates the amount of shares that traded at the given
price level. This is indicated by the horizontal length of the PBV histogram.
Volume type refers to the number of shares sold compared to the number
of shares bought. This is indicated by the two different colors seen on each
bar.
Successful reactions or tests means the number of times a stock
successfully tests and "bounces off" a given level.

Together, these three factors will allow you to determine the strength of a
particular price level. Once you have a good idea of price strength, you can
combine this information with trendlines and other studies to determine support
and resistance levels, find support bases and even play gaps.

Finding Support Bases


Support bases are simply instances in which a stock ranges before continuing a
trend, or reversing. To determine when a stock is basing, simply follow these
steps:

1. Draw two parallel, horizontal lines that connect parallel highs and lows in a trading range after a trending move.
2. Then, use the PBV histogram to see if these parallel lines are located near key price levels.
3. Finally, note the buying or selling pressure (colors) as well as the total volume to determine in which direction a b

Figure 1 shows Hudson City Bancorp (HCBK) along with the price by volume
histogram. Looking at this chart, we can see that the longer blue bars indicate
buying pressure or support, while a longer red bar indicates selling pressure or
resistance. Meanwhile, the larger overall bar indicates that that particular price
level is of interest to traders. In this case, we note that $12.50 appears to be a
level at which we can watch for a breakout to the upside.

Source: StockCharts.com

Figure 1

Locating Support and Resistance Levels


Support and resistance levels are simply areas beyond which the price has
difficulty moving due to large buying or selling interests. To determine areas of
support or resistance, simply do the following:

1. Identify areas where the PBV histogram shows significant buying or selling interest.
2. Determine whether these large interests are buying or selling interests.
3. Draw horizontal trendlines parallel to these PBV bars, giving preference to those that also connect highs and low
Let's take a look at Google (GOOG) for an example:

Source: StockCharts.com

Figure 2

Trending between these support and resistance levels should be immediately


apparent. These areas are known as "soft areas", where only short volume bars
exist between two long bars. One common strategy is to buy and sell based on
the trends between these "soft areas". In the chart for Google (Figure 2), for
example, we'd look to short GOOG when it breaks Support 1 and cover when it
hits Support 2.

Playing Gaps
Gaps occur when an asset's price rapidly moves from one point to another,
creating a visible gap or break between prices in the chart. You can use PBV
charts to help predict when a gapping stock will find support simply by looking for
an area where there was a lot of prior interest. Also, gaps themselves can
produce areas of future support and/or resistance, which can be reinforced by
the PBV histogram. Let's take a look at a few examples:
Source: StockCharts.com

Figure 3

In the case of DHB Industries (Figure 3), a PBV trader would look to buy a
breakout from Resistance 2 and sell when Resistance 1 is reached. Notice that
the gap down creates an area of very little resistance to upward movement - this
tells us that it is likely that the second target will be reached.

Source: StockCharts.com

Figure 4
In the case of Elan Corp. (Figure 4), we can see that a trader who bought on a
break above $7.60 (the long PBV bar) would have already realized a gain of
nearly 100%. Notice that once the key resistance was broken, there was very
little resistance to the upside.

Clearly, PBV can be extremely useful when combined with gaps if you are
attempting to buy rebounds or retracements after gaps occur. (To learn more,
see Playing The Gap and Retracement Or Reversal: Know The Difference.)

Conclusion
PBV charts can be an invaluable tool in your stock analysis arsenal. When you
combine it with other methods such as trendline analysis and Fibonacci, it is easy
to see how much additional insight can be gained from this charting method.
Here are some key points to remember:

The first color represents volume on days when the price moved higher.
The second color represents volume on days when the price moved lower.
When one color of the bar is significantly longer than the other, strong support or resistance is present.
Horizontal trendlines connect the top of the PBV bar for resistance and the bottom of the PBV bar for support.
PBV bars are used for support and resistance levels, trading bases and gap areas.

Note: This article was written with the help of Cal Stanke, co-founder
of ChartSetups.com, where he uses PBV analysis extensively in his own
research.

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Playing The Gap
By Justin Kuepper

Gaps are areas on a chart where the price of a stock (or another financial
instrument) moves sharply up or down, with little or no trading in between. As a
result, the asset's chart shows a "gap" in the normal price pattern. The
enterprising trader can interpret and exploit these gaps for profit. This article will
help you understand how and why gaps occur, and how you can use them to
make profitable trades.

Gap Basics
Gaps occur because of underlying fundamental or technical factors. For
example, if a company's earnings are much higher than expected, the company's
stock may gap up the next day. This means that the stock price opened higher
than it closed the day before, thereby leaving a gap. In the forex market, it is not
uncommon for a report to generate so much buzz that it widens the bid and ask
spread to a point where a significant gap can be seen. Similarly, a stock breaking
a new high in the current session may open higher in the next session,
thus gapping up for technical reasons.

Gaps can be classified into four groups:

Breakaway gaps are those that occur at the end of a price pattern and
signal the beginning of a new trend.
Exhaustion gaps occur near the end of a price pattern and signal a final
attempt to hit new highs or lows.
Common gaps are those that cannot be placed in a price pattern - they
simply represent an area where the price has "gapped."
Continuation gaps occur in the middle of a price pattern and signal a rush
of buyers or sellers who share a common belief in the underlying stock's
future direction.

To Fill or Not to Fill


When someone says that a gap has been "filled," that means that the price has
moved back to the original pre-gap level. These fills are quite common and occur
because of the following:

Irrational Exuberance: The initial spike may have been overly optimistic
or pessimistic, therefore inviting a correction.
Technical Resistance: When a price moves up or down sharply, it doesn't
leave behind any support or resistance.
Price Pattern: Price patterns are used to classify gaps, and can tell you if
a gap will be filled or not. Exhaustion gaps are typically the most likely to
be filled because they signal the end of a price trend, while continuation
and breakaway gaps are significantly less likely to be filled, since they are
used to confirm the direction of the current trend.

When gaps are filled within the same trading day on which they occur, this is
referred to as fading. For example, let's say a company announces
great earnings per share for this quarter, and it gaps up at open (meaning it
opened significantly higher than its previous close). Now let's say that, as the day
progresses, people realize that the cash flow statement shows some
weaknesses, so they start selling. Eventually, the price hits yesterday's close,
and the gap is filled. Many day traders use this strategy during earnings
season or at other times when irrational exuberance is at a high.

SEE: The Madness Of Crowds

How to Play the Gaps


There are many ways to take advantage of these gaps, with a few more popular
strategies. Some traders will buy when fundamental or technical factors favor a
gap on the next trading day. For example, they'll buy a stock after-hours when a
positive earnings report is released, hoping for a gap up on the following trading
day. Traders might also buy or sell into highly liquid or illiquid positions at the
beginning of a price movement, hoping for a good fill and a continued trend. For
example, they may buy a currency when it is gapping up very quickly on
low liquidity and there is no significant resistance overhead.

Some traders will fade gaps in the opposite direction once a high or low point has
been determined (often through other forms of technical analysis). For example,
if a stock gaps up on some speculative report, experienced traders may fade the
gap by shorting the stock. Lastly, traders might buy when the price level reaches
the prior support after the gap has been filled. An example of this strategy is
outlined below.

Here are the key things you will want to remember when trading gaps:

Once a stock has started to fill the gap, it will rarely stop, because there is
often no immediate support or resistance.
Exhaustion gaps and continuation gaps predict the price moving in two
different directions - be sure that you correctly classify the gap you are
going to play.
Retail investors are the ones who usually exhibit irrational exuberance;
however, institutional investors may play along to help their portfolios - so
be careful when using this indicator, and make sure to wait for the price to
start to break before taking a position.
Be sure to watch the volume. High volume should be present in breakaway
gaps, while low volume should occur in exhaustion gaps.

Example
To tie these ideas together, let's look at a basic gap trading system developed for
the forex market. This system uses gaps in order to predict retracements to a
prior price. Here are the rules:

1. The trade must always be in the overall direction of the price (check hourly
charts).
2. The currency must gap significantly above or below a key resistance level on
the 30-minute charts.
3. The price must retrace to the original resistance level. This will indicate that
the gap has been filled, and the price has returned to prior resistance turned
support.
4. There must be a candle signifying a continuation of the price in the direction of
the gap. This will help ensure that the support will remain intact.

Note that because the forex market is a 24-hour market (it is open 24 hours a
day from 5pm EST on Sunday until 4pm EST Friday), gaps in the forex market
appear on a chart as large candles. These large candles often occur because of
the release of a report that causes sharp price movements with little to no
liquidity. In the forex market, the only visible gaps that occur on a chart happen
when the market opens after the weekend.

Let's look at an example of this system in action:

Figure 1 - The large candlestick identified by the left arrow on


this GBP/USD chart is an example of a gap found in the forex market. This does
not look like a regular gap, but the lack of liquidity between the prices makes it
so. Notice how these levels act as strong levels ofsupport and resistance.

We can see in Figure 1 that the price gapped up above some consolidation
resistance, retraced and filled the gap, and finally, resumed its way up before
heading back down. We can see that there is little support below the gap, until
the prior support (where we buy). A trader could also short the currency on the
way down to this point, if he or she were able to identify a top.
The Bottom Line
Those who study the underlying factors behind a gap and correctly identify its
type, can often trade with a high probability of success. However, there is always
a risk that a trade can go bad. You can avoid this, firstly, by watching the real-
time electronic communication network (ECN) and volume. This will give you an
idea of where different open trades stand. If you see high-volume resistance
preventing a gap from being filled, then double check the premise of your trade
and consider not trading it if you are not completely certain that it is correct.

Second, be sure that the rally is over. Irrational exuberance is not necessarily
immediately corrected by the market. Sometimes stocks can rise for years at
extremely high valuations and trade high on rumors, without a correction. Be sure
to wait for declining and negative volume before taking a position.Lastly, always
be sure to use a stop-loss when trading. It is best to place the stop-loss point
below key support levels, or at a set percentage, such as -8%.

Remember, gaps are risky (due to low liquidity and high volatility), but if properly
traded, they offer opportunities for quick profits.

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Retracement Or Reversal:
Know The Difference
By Justin Kuepper

Most of us have wondered, at some point, whether a decline in the price of a


stock we're holding is long term or a mere market hiccup. Some of us have sold
our stock in such a situation, only to see it rise to new highs just days later. This
is a frustrating and all too common scenario, but it can be avoided if you know
how to identify and trade retracements properly.

What Are Retracements?


Retracements are temporary price reversals that take place within a larger trend.
The key here is that these price reversals are temporary, and do not indicate a
change in the larger trend.
Figure 1: An example of retracements in the price action of a particular
stock.

Notice that despite the retracements, the long-term trend shown in this chart is
still intact - that is, the price of the stock is still going up.

The Importance of Recognizing Retracements


It is important to know how to distinguish a retracement from a reversal. There
are several key differences between the two that you should take into account
when classifying a price movement:

Factor Retracement Reversal

Volume Profit taking by retail traders Institutional selling (large


(small block trades) block trades)

Money Flow Buying interest during Very little buying interest


decline

Chart Patterns Few, if any, reversal patterns Several reversal patterns -


- usually limited to candles usually chart patterns
(double top, etc.)
Short Interest* No change in short interest Increasing short interest

Time Frame Short-term reversal, lasting Long-term reversal, lasting


no longer than one to two longer than a couple of
weeks weeks

Fundamentals No change in fundamentals Change or speculation of


change in fundamentals

Recent Activity Usually occurs right after Can happen at any time,
large gains even during otherwise
regular trading

Candlesticks "Indecision" candles - these Reversal candles - these


typically have long tops and include engulfings, soldiers
bottoms (spinning tops, etc.) and other similar patterns

Figure 2 - *Note that short interest is delayed when reported, so it can be


difficult to tell for certain depending on your time frame.
So, why is recognizing retracements so important? Whenever a price reverses,
most traders and investors are faced with a tough decision. They have three
options:

1. Hold throughout the sell-off, which could result in large losses if the
retracement turns out to be a larger trend reversal.

2. Sell and re-buy if the price recovers, which will definitely result in money
wasted on commissions and spreads. This may also result in a missed
opportunity if the price recovers sharply.

3. Sell permanently, which could result in a missed opportunity if the price


recovers.

By properly identifying the movement as either a retracement or a reversal, you


can reduce cost, limit loss and preserve gains.

Determining Scope
Once you know how to identify retracements, you can learn how to determine
their scope. The following are the most popular tools used to do this:

Fibonacci retracements
Pivot point support and resistance levels
Trendline support and resistance levels

Fibonacci Retracements
Fibonacci retracements are excellent tools for calculating the scope of a
retracement. They are most widely used in the foreign exchange market, but are
also used in the stock market. To use them, simply use the Fibonacci
retracement tool (available in most charting software) to draw a line from the top
to the bottom of the latest impulse wave.

Figure 3: An example of the Fibonacci retracement tool.

In most cases, retracements will stay around 38.5% (daily) or 50% (intraday). If
the price moves below these levels, then a reversal may be forming.

SEE: Top 4 Fibonacci Retracement Mistakes To Avoid

Pivot Points
Pivot point levels are also commonly used when determining the scope of a
retracement. Most traders look at the lower supports (R1, R2 and R3) - if these
are broken, then a reversal may be forming.

Trendline Supports
Finally, if major trendlines supporting the larger trend are broken on high volume,
then a reversal is most likely in effect. Chart patterns and candlesticks are often
used in conjunction with these trendlines to confirm reversals.

Dealing with False Signals


Even a retracement that meets all the criteria outlined in our table in Figure 2
may turn into a reversal with very little warning. The best way to protect yourself
against such a reversal is to use stop-loss points. Here is how you can do this:

1. You can estimate retracement levels using technical analysis and place your
stop-loss point just below these levels.

2. Alternatively, you can place the stop-loss just below the long-term support
trendline or moving average.

Ideally, what you want to do is lower your risk of exiting during a retracement,
while still being able to exit a reversal in a timely manner.

The Bottom Line


As a trader, you need to be able to differentiate between retracements and
reversals. Without this knowledge, you risk many things such as exiting too soon
and missing opportunities, holding onto losing positions and losing money and
wasting money on commissions/spreads. By combining technical analysis with
some basic identification measures, you can protect yourself from these risks
and put your trading capital to better use.

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Top 4 Fibonacci
Retracement Mistakes To
Avoid
By Richard Lee

Every foreign exchange trader will use Fibonacci retracements at some point in
their trading career. Some will use it just some of the time, while others will apply
it regularly. But no matter how often you use this tool, what's most important is
that you use it correctly each and every time. (For background reading on
Fibonacci, see Fibonacci And The Golden Ratio.)

TUTORIAL: Top 10 Forex Trading Rules

Improperly applying technical analysis methods will lead to disastrous results,


such as bad entry points and mounting losses on currency positions. Here we'll
examine how not to apply Fibonacci retracements to the foreign exchange
markets. Get to know these common mistakes and chances are you'll be able to
avoid making them - and suffering the consequences - in your trading.

1. Don't mix Fibonacci reference points.


When fitting Fibonacci retracements to price action, it's always good to keep your
reference points consistent. So, if you are referencing the lowest price of a trend
through the close of a session or the body of the candle, the best high price
should be available within the body of a candle at the top of a trend: candle body
to candle body; wick to wick. (Learn more about candles in Candlestick Charting:
What Is It?)

Misanalysis and mistakes are created once the reference points are mixed -
going from a candle wick to the body of a candle. Let's take a look at an example
in the euro/Canadian dollar currency pair. Figure 1 shows consistency. Fibonacci
retracements are applied on a wick-to-wick basis, from a high of 1.3777 to the
low of 1.3344. This creates a clear-cut resistance level at 1.3511, which is tested
and then broken.

Figure 1: A Fibonacci retracement applied to price action in the euro/Canadian


dollar currency pair.

Source: FX Intellicharts

Figure 2, on the other hand, shows inconsistency. Fibonacci retracements are


applied from the high close of 1.3742 (35 pips below the wick high). This causes
the resistance level to cut through several candles (between February 3 and
February 7), which is not a great reference level.
Figure 2: A Fibonacci retracement applied incorrectly.

Source: FX Intellicharts

By keeping it consistent, support and resistance levels will become more


apparent to the naked eye, speeding up analysis and leading to quicker trades.
(To read more about reading this indicator, see Retracement Or Reversal: Know
The Difference.)

2. Don't ignore long-term trends.


New traders often try to measure significant moves and pullbacks in the short
term - without keeping the bigger picture in mind. This narrow perspective makes
short-term trades more than a bit misguided. By keeping tabs on the long-term
trend, the trader is able to apply Fibonacci retracements in the correct direction
of momentum and set themselves up for great opportunities.

In Figure 3, below, we establish that the long-term trend in the British pound/New
Zealand dollar currency pair is upward. We apply Fibonacci to see that our first
level of support is at 2.1015, or the 38.2% Fibonacci level from 2.0648 to 2.1235.
This is a perfect spot to go long in the currency pair.
Figure 3: A Fibonacci retracement applied to the British pound/New Zealand dollar
currency pair establishes a long-term trend.

Source: FX Intellicharts

But, if we take a look at the short term, the picture looks much different.

Figure 4: A Fibonacci retracement applied on a short-term time frame can give the
trader a false impression.

Source: FX Intellicharts

After a run-up in the currency pair, we can see a potential short opportunity in the
five-minute time frame (Figure 4). This is the trap.

By not keeping to the longer term view, the short seller applies Fibonacci from
the 2.1215 spike high to the 2.1024 spike low (February 11), leading to a short
position at 2.1097, or the 38% Fibonacci level.
This short trade does net the trader a handsome 50-pip profit, but it comes at the
expense of the 400-pip advance that follows. The better plan would have been to
enter a long position in the GBP/NZD pair at the short-term support of 2.1050.

Keeping in mind the bigger picture will not only help you pick your trade
opportunities, but will also prevent the trade from fighting the trend. (For more on
identifying long-term trends, see Forex Trading: Using The Big Picture.)

3. Don't rely on Fibonacci alone.


Fibonacci can provide reliable trade setups, but not without confirmation.

Applying additional technical tools like MACD or stochastic oscillators will support
the trade opportunity and increase the likelihood of a good trade. Without these
methods to act as confirmation, a trader will be left with little more than hope of a
positive outcome. (For more information on oscillators, see our tutorial
on Exploring Oscillators and Indicators.)

Taking a look at Figure 5, we see a retracement off of a medium-term move


higher in the euro/Japanese yen currency pair. Beginning on January 10, 2011,
the EUR/JPY exchange rate rose to a high of 113.94 over the course of almost
two weeks. Applying our Fibonacci retracement sequence, we arrive at a 38.2%
retracement level of 111.42 (from the 113.94 top). Following the retracement
lower, we notice that the stochastic oscillator is also confirming the momentum
lower.

Figure 5: The stochastic oscillator confirms a trend in the EUR/JPY pair.


Source: FX Intellicharts

Now the opportunity comes alive as the price action tests our Fibonacci
retracement level at 111.40 on January 30. Seeing this as an opportunity to go
long, we confirm the price point with stochastic - which shows an oversold signal.
A trader taking this position would have profited by almost 1.4%, or 160 pips, as
the price bounced off the 111.40 and traded as high as 113 over the next couple
of days.

4. Don't use Fibonacci over short intervals.


Day trading the foreign exchange market is exciting but there is a lot of volatility.

For this reason, applying Fibonacci retracements over a short time frame is
ineffective. The shorter the time frame, the less reliable the retracements levels.
Volatility can, and will, skew support and resistance levels, making it very difficult
for the trader to really pick and choose what levels can be traded. Not to mention
the fact that in the short term, spikes and whipsaws are very common. These
dynamics can make it especially difficult to place stops or take profit points as
retracements can create narrow and tight confluences. Just check out the
Canadian dollar/Japanese yen example below.

Figure 6: Fibonacci is applied to an intraday move in the CAD/JPY pair over a three-
minute time frame.

Source: FX Intellicharts

In Figure 6, we attempt to apply Fibonacci to an intraday move in the CAD/JPY


exchange rate chart (over a three-minute time frame). Here, volatility is high. This
causes longer wicks in the price action, creating the potential for misanalysis of
certain support levels. It also doesn't help that our Fibonacci levels are separated
by a mere six pips on average - increasing the likelihood of being stopped out.

Remember, as with any other statistical study, the more data that is used, the
stronger the analysis. Sticking to longer time frames when applying Fibonacci
sequences can improve the reliability of each price level.

The Bottom Line


As with any specialty, it takes time and practice to become better at using
Fibonacci retracements in forex trading. Don't allow yourself to become
frustrated; the long-term rewards definitely outweigh the costs. Follow the simple
rules of applying Fibonacci retracements and learn from these common mistakes
to help you analyze profitable opportunities in the currency markets. (For related
reading, also take a look at How To Become A Successful Forex Trader or
discuss other Fibonacci strategies.)

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Make Sharp Trades Using


Andrew's Pitchfork
By Richard Lee
Invented by and named after renowned educator Dr Alan H. Andrews,
the technical indicator known as Andrew's pitchfork can be used by traders to
establish profitable opportunities and swing possibilities in the currency markets.
On a longer-term basis, it can be used to identify and gauge overall cycles that
affect the underlying spot activity. Here we explain what this indicator is and how
you can apply it to your trades using two different approaches: trading within the
lines and trading outside the lines.

Defining the Pitchfork


Available on numerous programs and charting packages, Andrew's pitchfork
(sometimes referred to as "median line studies") is widely recognized by both
novice and experienced traders. Comparable to the run-of-the-
mill support and resistance lines, the application offers two formidable
support/resistance lines with a middle line that can serve as both
support/resistance or as a pseudo-regression line. Andrews believed that
market price action would gravitate towards the median line 80% of the time, with
wild fluctuations or changes in sentiment accounting for the remaining 20%. As a
result, the overall longer-term trend will (in theory) remain intact, regardless of
the smaller fluctuations. If sentiment changes and supply and demand forces
shift, prices will stray, creating a new trend. It is these situations that can create
significant profit opportunities in the currency markets. A trader can increase the
accuracy of these trades by using Andrew's pitchfork in combination with other
technical indicators, which we'll discuss below.

Applying the Pitchfork


In order to apply Andrew's pitchfork, the trader must first identify a high or low
that has previously occurred on the chart. The first point, or pivot, will be drawn at
this peak or trough and labeled as point A (as shown in Figure 1).

Once the pivot has been chosen, the trader must identify both a peak and a
trough to the right of the first pivot. This will most likely be a correction in the
opposite direction of the previous move higher or lower. Turning to Figure 1, the
minor correction off of the trough (point A) will serve nicely as we establish both
points B and C.

Once these points have been isolated, the application can be placed.
The handle of the formation begins with the pivot point (point A) and serves as
the median line. The two prongs, formed by the following peak and trough pair
(points B and C), serve as the support and resistance of the trend.

Figure 1 - Application of Andrew\'s pitchfork to a chart showing the


price action of the EUR/USD. The pivot point (A) has been drawn at
a previously occurring trough, and points B and C have been
established to the right of the pivot. The line drawn from point A is
the median line, while the two "prongs" serve as support and
resistance.

When the pitchfork is applied, the trader can either trade within the channel or
isolate breakouts to the upside or downside of the channel. Looking at Figure 2,
you can see that the price action works well serving as support and resistance
where traders can enter off of bottoms (point E) and sell from tops (point D) as
the price will gravitate towards the median. As always, the accuracy of the trade
improves when confirmation is sought. A basic price oscillator will be just enough
to add to the overall trade.

Figure 2 - Application of the pitchfork on an


uptrending GBP/USD. Notice the multiple opportunities offered
to the trader inside and outside the boundaries.

Additionally, the trader can initiate positions on breaks of the support and
resistance. Two great examples are presented at points F and G. Here,
the market sentiment shifted, creating price action that strayed from the median
line and broke through the channel trendlines. As the price action attempts to fall
back into the median area, the trader can capture the windfall that tends to
happen. However, as with any trade, sound money
management and confirmation must play important roles.
Trading Within the Lines
Let's take a look at how a trader might profit from trading within the lines. Figure
3 is a good example, as it shows us that the price action in the
EUR/CAD currency pair has bounced off of the median line and has risen to the
top resistance of the pitchfork (point A1). Zooming in a little closer in Figure 4, we
see a textbook evening star formation. Here, the once-rising
buying momentum has started to disappear, forming the doji, or cross-like,
formation right below the upper prong. When we apply a stochastic oscillator, we
see a cross below thesignal line, which confirms downside momentum.

Taking these indications into consideration, the trader would do well to place the
entry at point X (Figure 4), slightly below the close of the third candle. Using
sound money management and including an appropriate stop loss, the entry
would be executed on the downward momentum as the price action once again
gravitates towards the median line. Even better, here, the trader would be
entered into a profitable position of close to 1000 pips over the life of the trade.
Figure 3 - Another great setup in the EUR/CAD cross currency: we see
a prime example of an "inside the line" profit opportunity as price
action approaches the 1.5000 figure.
Figure 4 - A closer look at the opportunity reveals textbook technical
formations that aid the entry. Here, the trader can confirm the trade
with the downward crossover in the stochastic and the evening star
formation.

Trading Outside the Lines


Although trading outside the lines occurs considerably less frequently than within,
they can lead to extended runs. However, they can be slightly trickier to attempt.
The assumption here is that the price action will gravitate back towards the
median, like wayward price action within the lines. But it is possible that the
market has decided to shift its direction; therefore, the break outside may very
well be a new trend forming. To avoid a catastrophic loss, simple parameters are
added and placed in order to capture the retracements into the channel and, at
the same time, filter out adverse movements that ultimately result in traders
closing their positions too early.
Looking at Figure 5, we see that the price action at point A offers such an
opportunity. The chart shows that the EUR/USD price action has broken through
support in the first week of April. Once the break has been identified, we isolate
and zoom in to obtain a better perspective.

Figure 5 - Notice how the price action gravitates once again towards the
median. This is a great opportunity, but money management and
strategy remain important in capturing the run-up.

In Figure 6, the trader is offered multiple opportunities to trade a break back into
the overall trend as the underlying spot consolidates in ranging conditions.
However, the real opportunity lies in the break that occurs later on in October.
More specifically, the trader can see that the price action ranges or consolidates
prior to the break, establishing the $1.1958 support level (blue line). Using
a moving average convergence divergence (MACD) price oscillator, the
individual sees that a bullish convergence signal is forming, as there is a large
peak and a subsequently smaller secondary peak in the histogram. The entry is
key here. The trader will see a potential breakout opportunity as the price rises to
test the upper resistance at $1.2446.

Figure 6 - The convergence in the MACD, combined with the decline in the
underlying spot price, suggests a near-term upward break.

How would you place the entry in this example? First, you need to make sure
that the upper resistance is tested before you even consider a trade. If the
resistance is not tested, it may mean that a downward trend is in the works, and
by knowing this, you will have saved yourself from the trouble of entering into a
non-profitable trade. You can see in Figure 6 that the price action breaks back
into the prongs in early October, hitting a high of $1.2446. If the price action can
break above this resistance, it will confirm a further rise in the price action, as
fresh buying momentum will have entered the market. As a result, you should
place your entry 30 pips above the target (red line), with your subsequent stop
applied upon entry. Once your order is executed, the stop should be applied 5
pips below the previous session low. Given buying momentum, the assumption is
that the low will not be tested because the price action will continue to rise and
not spike downward.

Breaking It Down Step-by-Step


Although the two methods discussed here (trading within the lines and trading
outside the lines) may seem somewhat complex, they are quite easily applied
when you break them down step-by-step. Traders will find that the pitchfork
method yields far better results when applied to major currency pairs such as the
EUR/USD and GBP/USD because of their nature to trend rather than
range. Cross currencies, although they do exhibit trending patterns, tend to be
choppier and yield less satisfying results. (For further reading, see Make The
Currency Cross Your Boss and Identifying Trending & Range-Bound Currencies.)

Figure 7 - Identifying two great opportunities in the NZD/USD currency


pair.
Now, let's break the process down. The NZD/USD currency pair, seen in Figures
7, 8 and 9, presents a perfect example of both "within the lines" and "outside the
lines" opportunities that traders can capitalize on. First we'll take the in-line
approach, choosing example A in Figure 7:

1. Identify price action that has broken through the median line and that
is approaching the upper resistance prong.
2. Testing the upper resistance prong, recognize a textbook evening
star or another bearish candlestick pattern. Looking at Figure 8, we see
a textbook evening star formation at point X. This will serve as the first
signal.
3. Confirm the decline through a price oscillator. In Figure 8, a downward
cross occurs in the stochastic oscillator, confirming the
following downtrend in the currency. Also notice how the cross occurs
before the formation is complete, giving traders a heads up.
4. Place the entry slightly below the close of the third and final candle of
the formation. As little as 5 pips below the low will usually suffice in these
situations.
5. Apply a stop to the position that is approximately 50 pips above the
entry. If the price action rises after the evening star, traders will want to
exit as soon as possible to minimize losses but still maintain a healthy risk
measure. In this example, the entry would ideally be placed at 0.6595, with
a stop at 0.6645 and a target of 0.6454 - an almost 3:1 risk/reward ratio.
Figure 8 - An evening star formation at point X suggests an
impending sell-off that is confirmed by the downward crossover in the
stochastic oscillator.
For breaks outside the trendlines, we take a look at the next example, point B in
Figure 7. Here, the price action has broken above the upper trendline but looks
set to retrace back to the median or middle line. Using the same NZD/USD
currency pair, let's take another approach:

1. Identify the price action moving toward the median or middle


line. What traders want to confirm is that the price is indeed falling and will
break back through the upper trendline. In Figure 9, the currency spot falls
through the trendline, confirming selling pressure.
2. Identify the significant support/resistance line. Here, traders will want a
confirmed break of a significant support level in order to isolate sufficient
momentum and increase the probability of the trade.
3. Place the entry order 30 pips below the support level. In our example
(see Figure 9), since the support level is at the 0.7200 figure, the entry
would be placed at 0.7180. The following stop would be applied slightly
above the 0.7300 figure - the previous session's high - and give us an
almost 2:1 risk/reward ratio when we take profits at the 0.7000 price.
4. Receive confirmation through a price oscillator. The downward cross
that occurs when the stochastic oscillator is used gives traders ample
confirmation of the break of support in the price.

Figure 9 - Taking a closer look, a great opportunity exists as the price


action moves towards the median line.

Conclusion
Although it is primarily applied in the futures and equities forums and seldom
used in the currency markets, Andrew's pitchfork can provide the currency trader
with profitable opportunities in the longer or intermediate term, capitalizing on
preferably longer market swings. When the pitchfork is applied accurately and is
used in combination with strict money management and textbook technical
analysis, the trader is able to isolate great setups while weeding out the
sometimes choppier price action in the forex markets that may increase his or
her losses. If all of the criteria above are applied, the trade will be able to ride its
way to profitability compared to its shorter-term peers.

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Using Bullish Candlestick


Patterns To Buy Stocks
By Marianna Galstyan | June 23, 2015 11:35 AM EDT
Candlestick charts are a type of financial chart for tracking the movement of
securities. They have their origins in the centuries-old Japanese rice trade and
have made their way into modern day price charting. Some investors find them
more visually appealing than the standard bar charts and the price actions easier
to interpret.

Candlesticks are so named because the rectangular shape and lines on either
end resemble a candle with wicks. Each candlestick usually represents one days
worth of price data about a stock. Over time, the candlesticks group into
recognizable patterns that investors can use to make buying and selling
decisions. In this article we will focus on identifying bullish candlestick patterns
that signal a buying opportunity. (Read more in Candlestick Charting: What Is It?)

How to Read a Single Candlestick

Each candlestick represents one days worth of price data about a stock through
four pieces of information: the opening price, the closing price, the high price,
and the low price. The color of the central rectangle (called the real body) tells
investors whether the opening price or the closing price was higher. A black or
filled candlestick means the closing price for the period was less than the
opening price; hence, it is bearish and indicates selling pressure. Meanwhile, a
white or hollow candlestick means that the closing price was greater than the
opening price. This is bullish and shows buying pressure. The lines at both ends
of a candlestick are called shadows, and they show the entire range of price
action for the day, from low to high. The upper shadow shows the stocks highest
price for the day and the lower shadow shows the lowest price for the day.

Bullish Candlestick Patterns

Over time, groups of daily candlesticks fall into recognizable patterns with
descriptive names like three white soldiers, dark cloud cover, hammer, morning
star, and abandoned baby, to name just a few. Patterns form over a period of
one to four weeks and are a source of valuable insight into a stocks future price
action. Before we delve into individual bullish candlestick patterns, note the
following two principles:

1. Bullish reversal patterns should form within a downtrend. Otherwise, its


not a bullish pattern, but a continuation pattern.
2. Most bullish reversal patterns require bullish confirmation. In other
words, they must be followed by an upside price move which can come as
a long hollow candlestick or a gap up, and be accompanied by high trading
volume. This confirmation should be observed within three days of the
pattern.

The bullish reversal patterns can further be confirmed through other means of
traditional technical analysislike trend lines, momentum oscillators, or volume
indicatorsto reaffirm buying pressure. (For insight into ancillary technical
indicators see Basics of Technical Analysis) There are great many candlestick
patterns that indicate an opportunity to buy. We will focus on five bullish
candlestick patterns that give the strongest reversal signal.

1. The Hammer or The Inverted Hammer

The Hammer is a bullish reversal pattern, which signals that a stock is nearing
bottom in a downtrend. The body of the candle is short with a longer lower
shadow which is a sign of sellers driving prices lower during the trading session,
only to be followed by strong buying pressure to end the session on a higher
close. Before we jump in on the bullish reversal action, however, we must
confirm the upward trend by watching it closely for the next few days. The
reversal must also be validated through the rise in the trading volume.

The Inverted Hammer also forms in a downtrend and represents a likely trend
reversal or support. Its identical to the Hammer except for the longer upper
shadow, which indicates buying pressure after the opening price, followed by
considerable selling pressure, which however wasnt enough to bring the price
down below its opening value. Again, bullish confirmation is required and it can
come in the form of a long hollow candlestick or a gap up, accompanied by a
heavy trading volume.
2. The Bullish Engulfing

The Bullish Engulfing pattern is a two-candle reversal pattern. The second candle
completely engulfs the real body of the first one, without regard to the length of
the tail shadows. The Bullish Engulfing pattern appears in a downtrend and is a
combination of one dark candle followed by a larger hollow candle. On the
second day of the pattern, price opens lower than the previous low, yet buying
pressure pushes the price up to a higher level than the previous high, culminating
in an obvious win for the buyers. It is advisable to enter a long position when the
price moves higher than the high of the second engulfing candlein other words
when the downtrend reversal is confirmed.
3. The Piercing Line

Similar to the engulfing pattern, the Piercing Line is a two-candle bullish reversal
pattern, also occurring in downtrends. The first long black candle is followed by a
white candle that opens lower than the previous close. Soon thereafter, the
buying pressure pushes the price up halfway or more (preferably two-thirds of the
way) into the real body of the black candle.
4. The Morning Star

As the name indicates, the Morning Star is a sign of hope and a new beginning in
a gloomy downtrend. The pattern consists of three candles: one short-bodied
candle (called a doji or a spinning top) between a preceding long black candle
and a succeeding long white one. The color of the real body of the short candle
can be either white or black, and there is no overlap between its body and that of
the black candle before. It shows that the selling pressure that was there the day
before is now subsiding. The third white candle overlaps with the body of the
black candle and shows a renewed buyer pressure and a start of a bullish
reversal, especially if confirmed by the higher volume.
5. The Three White Soldiers

This pattern is usually observed after a period of downtrend or in price


consolidation. It consists of three long white candles that close progressively
higher on each subsequent trading day. Each candle opens higher than then
previous open and closes near the high of the day, showing a steady advance of
buying pressure. Investors should exercise caution when white candles appear to
be too long as that may attract short sellers and push the price of the stock
further down. (See more in How do I build a profitable strategy when spotting a
Three White Soldiers Pattern?)
The chart below for Enbridge, Inc. (ENB) shows three of the bullish reversal
patterns discussed above: the Inverted Hammer, the Piercing Line, and the
Hammer.
The chart for Pacific DataVision, Inc. (PDVW) shows the Three White Soldiers
pattern. Note how the reversal in downtrend is confirmed by the sharp increase in
the trading volume.

The Bottom Line

Investors should use candlestick charts like any other technical analysis tool (i.e.,
to study the psychology of market participants in the context of stock trading).
They provide an extra layer of analysis on top of the fundamental analysis that
forms the basis for trading decisions. We looked at five of the more popular
candlestick chart patterns that signal buying opportunities. They can help identify
a change in trader sentiment where buyer pressure overcomes seller pressure.
Such a downtrend reversal can be accompanied by a potential for long gains.
That said, the patterns themselves do not guarantee that the trend will reverse.
Investors should always confirm reversal by the subsequent price action before
initiating a trade. (Read more in Candlestick Charting: Perfecting The Art)

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Candlestick Charting:
Perfecting The Art
By Investopedia Staff

It is the confirmation or denial of a trend that determines whether an investor will


sit tight today and hold his or her position or decide to enter or exit an issue that
could be long or short the market. Candlestick charting allows investors to focus
on continuation patterns and use them to confirm or deny trends that
the chartist can learn to recognize. Here, we look at candlestick charting as an
art, and put aspiring investors on the path to honing their craft.

Patterns on the Bullish and Bearish Sides

In the world of Japanese candlesticks, there are a number of bullish and bearish
continuation patterns. With a short list on the bullish side of the market, a chartist
would look for the following patterns:

1. Mat Hold
2. Rising Three Methods
3. Separating Three Lines
4. Side-by-Side White Lines
5. Upside Gap Three Methods
6. Upside Tasuki Gap

This article focuses on rising three methods, mat hold and separating three lines.

With a short list on the bearish side of the market, one would look for the
following patterns:

1. Falling Three Methods


2. In-Neck
3. On-Neck
4. Separating Lines
5. Side-by-Side White Lines
6. Black Crows

In this article, we focus on falling three methods, separating lines and in-neck.

Illustrating the Patterns

For each continuation pattern shown below, we describe the pattern and break it
down, allowing you to recognize the formation more easily in the future. Starting
with the bulls, let's have a look at rising three methods.

Rising Three Methods


This pattern starts out with what is called a "long white day". Then, on the
second, third and fourth trading sessions small real bodies appear - these small
real bodies form from a fall-off in price, but they still stay within the price range of
the long white day (day one in the pattern). The fifth and last day of the pattern
shows another long white day.

This pattern is, in the world of Japanese candlestick charting, a very bullish chart.
It shows an upward trend on day one with investors taking a few trading sessions
to relax to prepare for the next rise in price that occurs on the fifth day. Even
though the pattern shows us that the prices are falling for three straight days, a
new low is not seen and the bulls prepare for the next leg up.

Bullish Mat Hold

This pattern begins with a long white day and then, on the second day of trading,
the issue gaps up and is a black day. What we see next in this pattern is
somewhat similar to the previous pattern.

The second, third, and fourth days see the issue falling off slightly but not trading
outside the range of the long white day on day one. Finally, the last day in the
pattern is another long white day that closes above the close of the first long
white day.

Separating Lines (Bullish)

In the pattern of bullish separating lines, you can see that the first day is a black
day and the next day is a white day. The key to the second day is that the issue
has the same opening price as day one.
In a bullish market, this pattern is simply viewed as a continuation of the trend
because the second day starts off from where day one left off and continues
the trading session to close higher still.

Now, on the bearish side of the equation, let's have a look at what the bears are
looking for, starting with separating lines.

Separating Lines (Bearish)

You can see immediately that the bearish separating lines pattern is the exact
opposite of the bullish separating lines pattern, so it does not need any further
explanation.

Falling Three Methods (Bearish)

The pattern known as bearish falling three methods confuse many chartists at
first. It is not until the third or fourth day of the pattern that it becomes clear.

Look closely and you can see that a new high is not formed from the high set on
the first day. This is a very bearish signal and short sellers react strongly to this
pattern.

In-Neck (Bearish)
The first day of the in-neck continuation pattern is a long black day and the
second is a white day that shows an opening of trading below the low of the prior
trading session. Then on the close, the price is equal to or just above the closing
price of the prior session.

This pattern has the bears looking for the falling trend to continue but it may be
some time before it is confirmed.

Conclusion

Learning to read and recognize candlestick patterns is important for anyone who
aspires to trade based on chart patterns. Perfecting this skill will take time and
practice - mastering it will elevate it to the level of an art. Remember it's your
money, so think, learn and invest it wisely.

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Advanced Candlestick
Patterns
By Justin Kuepper

Candlestick patterns can give you invaluable insight into price action at a glance.
While the basic candlestick patterns can tell you what the market is thinking, they
often generate false signals because they are so common. Here we introduce
you to more advanced candlestick patterns, with a higher degree of reliability, as
well as explore how they can be combined with gaps to produce
profitable trading strategies.

Island Reversal Patterns


Island reversals are strong short-term trend reversal indicators. They are
identified by a gap between a reversal candlestick and two candles on either side
of it. Here are two examples that occurred on the chart of Doral Financial (DRL).
Figure 1

Figure 2

Here are some important things you need to consider when using this pattern:

Entry: Confirming the reversal pattern - When looking for an island


reversal, you are looking for indecision and a battle between bulls and
bears. This type of scenario is best characterized by a long-
ended doji candle that has high volume occurring after a long prior trend; it
is important to look for these three elements to confirm any potential
reversal pattern.
Exit: Defining the target and stop - In most cases, you will see a sharp
reversal (as seen in Figs. 1 and 2) when using this pattern. This reversal
pattern does not necessarily indicate a medium- or long-term reversal, so it
would be prudent to exit your position after theswing move has been
made. If the next candle ever fills the gap, then the reversal pattern is
invalidated, and you should exit prudently.

Island reversals can also occur in "clusters" - that is, in a multi-candle reversal
pattern, such as an engulfing, as opposed to a single candle reversal. Clusters
are easier to spot, but they often result in weaker reversals that are not as sharp
and take longer to occur.

Hook Reversal Patterns


Hook reversals are short- to medium-term reversal patterns. They are identified
by a higher low and a lower high compared to the previous day. Figures 3 and 4
are two examples that occurred on the chart of Microsoft Corp. (MSFT).

Figure 3
Figure 4

There are several important things to remember when using this pattern:

Entry: Confirming the reversal pattern - If the pattern occurs after


an uptrend, then the open must be near the prior high, and the low must be
near the prior low. If the pattern occurs after a downtrend, then the
opposite is true. As with the island reversal pattern, we are also looking for
high volume on this second candle. Finally, the stronger the prior trend, the
more reliable the reversal pattern.
Exit: Defining the target and stop - In most cases, you will see a sharp
reversal (as seen in Figs. 3 and 4) when using this pattern. If the next
candle shows a strong continuation of the prior trend, then the reversal
pattern is invalidated, and you should exit quickly, but prudently.

San-Ku (Three Gaps) Patterns


San-ku patterns are anticipatory trend reversal indicators. In other words, they do
not indicate an exact point of reversal; rather, they indicate that a reversal is
likely to occur in the near future. They are identified by three gaps within a strong
trend. Here is an example that occurred on the chart of Microsoft Corp. (MSFT).
Figure 5

Here are some important things to remember when using this pattern:

Entry: Confirming the reversal pattern - This pattern operates on the


premise that prices are likely to retreat after sharp moves
because traders are likely to start booking profits. Therefore, this pattern is
best used with other exhaustion indicators. So, look for extremes being
reached in indicators such as the RSI (relative strength
index), MACD (moving average convergence divergence) crossovers, and
other such indicators. It is also useful to look for volume patterns that
suggest exhaustion.
Exit: Defining the target and stop - In most cases, when using this
pattern, you will see a price reversal shortly after the third gap takes place
(as seen in Fig. 5). However, if there are any breakouts on high volume
after the last gap, then the pattern is invalidated, and you should exit
quickly, but prudently.
Kicker Patterns
Kicker patterns are some of the strongest, most reliable candlestick patterns.
They are characterized by a very sharp reversal in price during the span of two
candlesticks. Here's an example that occurred on the Microsoft (MSFT) chart.

Figure 6

Here are some important things you need to remember when using this pattern:

Entry: Confirming the reversal pattern - This kind of price action tells
you that one group of traders has overpowered the other (often as a result
of a fundamental change in the company), and a new trend is being
established. Ideally, you should look for a gap between the first and
second candles, along with high volume.

Exit: Defining a target and stop - When using this pattern, you will see
an immediate reversal, which should result in an overall trend change. If
the trend instead moves sideways or against the reversal direction, then
you should exit quickly, but prudently.

Using Gaps with Candlesticks


When gaps are combined with candlestick patterns and volume, they can
produce extremely reliable signals. (For further reading, see Playing The Gap.)
Here is a simple process that you can use to combine these powerful tools:

1. Screen for breakouts using your software or website of choice.


2. Make sure that the breakouts are high volume and significant (in terms of length).
3. Watch for reversal candlestick patterns (such as the ones mentioned above) after the gap has occurred. This will
4. Take a position when such a reversal occurs.

Attempting to play reversals can be risky in any situation because you are trading
against the prevailing trend. Do make sure that you keep tight stops and only
enter positions when trades meet the exact criteria. (To learn more,
see Retracement Or Reversal: Know The Difference.)

Conclusion
Now you should have a basic understanding of how to find reversals using
advanced candlestick patterns, gaps and volume. The patterns and strategies
discussed in this article represent only a few of the many candlestick patterns
that can help you better understand price action, but they are among the most
reliable. For further reading, see The Art Of Candlestick Charting - Part 1, Part
2, Part 3 and Part 4.

Read more: Advanced Candlestick Patterns |


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Candlestick Charting: What
Is It?
By Investopedia Staff

The candlestick techniques we use today originated in the style of technical


charting used by the Japanese for over 100 years before the West developed
the bar and point-and-figure analysis systems. In the 1700s, a Japanese man
named Homma, a trader in the futures market, discovered that, although there
was a link between price and the supply and demand of rice, the markets were
strongly influenced by the emotions of traders. He understood that when
emotions played into the equation, a vast difference between the value and the
price of rice occurred. This difference between the value and the price is as
applicable to stocks today as it was to rice in Japan centuries ago. The principles
established by Homma are the basis for the candlestick chart analysis, which is
used to measure market emotions surrounding a stock.

This charting technique has become very popular among traders. One reason is
that the charts reflect only short-term outlooks, sometimes lasting less than eight
to 10 trading sessions. Candlestick charting is a very complex and sometimes
difficult system to understand. Here we get things started by looking at what a
candlestick pattern is and what it can tell you about a stock.

Candlestick Components
When first looking at a candlestick chart, the student of the more common bar
charts may be confused; however, just like a bar chart, the daily candlestick line
contains the market's open, high, low and close of a specific day. Now this is
where the system takes on a whole new look: the candlestick has a wide part,
which is called the "real body". This real body represents the range between the
open and close of that day's trading. When the real body is filled in or black, it
means the close was lower than the open. If the real body is empty, it means the
opposite: the close was higher than the open.

Figure 1: A candlestick

Just above and below the real body are the "shadows". Chartists have always
thought of these as the wicks of the candle, and it is the shadows that show the
high and low prices of that day's trading. If the upper shadow on the filled-in body
is short, it indicates that the open that day was closer to the high of the day. A
short upper shadow on a white or unfilled body dictates that the close was near
the high. The relationship between the day's open, high, low and close
determines the look of the daily candlestick. Real bodies can be either long or
short and either black or white. Shadows can also be either long or short.

Comparing Candlestick to Bar Charts


A big difference between the bar charts common in North America and the
Japanese candlestick line is the relationship between opening and closing prices.
We place more emphasis on the progression of today's closing price from
yesterday's close. In Japan, chartists are more interested in the relationship
between the closing price and the opening price of the same trading day.

In the two charts below we are showing the exact same daily charts of IBM to
illustrate the difference between the bar chart and the candlestick chart. In both
charts you can see the overall trend of the stock price; however, you can see
how much easier looking at the change in body color of the candlestick chart is
for interpreting the day-to-day sentiment.
Basic Candlestick Patterns
In the chart below of EBAY, you see the "long black body" or "long black line".
The long black line represents a bearish period in the marketplace. During
the trading session, the price of the stock was up and down in a wide range and
it opened near the high and closed near the low of the day.

By representing a bullish period, the "long white body," or "long white line" (in the
EBAY chart below, the white is actually gray because of the white background) is
the exact opposite of the long black line. Prices were all over the map during the
day, but the stock opened near the low of the day and closed near the high.

Spinning tops are very small bodies and can be either black or white. This
pattern shows a very tight trading range between the open and the close, and it
is considered somewhat neutral.

Doji lines illustrate periods in which the opening and closing prices for the period
are very close or exactly the same. You will also notice that, when you start to
look deep into candlestick patterns, the length of the shadows can vary.
spinning tops

The Bottom Line


The candlestick charting pattern is one that any experienced trader must know.
As Japanese rice traders discovered centuries ago, investors' emotions
surrounding the trading of an asset have a major impact on that asset's
movement. Candlesticks help traders to gauge the emotions surrounding a stock,
and thus make better predictions about where that stock might be headed.

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Candlesticks Light The Way


To Logical Trading
By Investopedia Staff

In Candlestick Charting: What Is It? we looked at the history and the basics of the
art of Japanese candlestick charting. Here we look deeper into how to analyze
candlestick patterns.

Principles Behind the Art


Before learning how to analyze candlestick charts, we need to understand that
candle patterns, for all intents and purposes, are merely traders' reactions to the
market at a given time. The fact that human beings often react en masse to
situations allows candlestick chart analysis to work.

Many of the investors who rushed to the marketplace in the fall and winter of
1999-2000 had, before that time, never bought a single share in a public
company. The volumes at the top were record breaking and the smart money
was starting to leave the stock market. Hundreds of thousands of new investors,
armed with computers and new online trading accounts, were sitting at their
desks buying and selling the dotcom flavor of the moment. Like lemmings, these
new players took greed to a level never seen before, and, before long, they saw
the market crash around their feet.

Figure 1: JDSU shows long bulling candles in August 1999 to March 2000

Source: TradeStation

Let's have a look at what was a favorite of many investors during that time. This
presentation of JDS Uniphase (JDSU) on the chart above is a lesson in how to
recognize long bullish candles, which formed as the company's stock price
moved from the $25 area in late August 1999 to an outstanding $140 plus in
March 2000. Just look at the number of long green candles that occurred during
a seven-month ride.

Analyzing Patterns

Traders must remember that a pattern may consist of only one candlestick but
could also contain a number or series of candlesticks over a number of trading
days.

A reversal candle pattern is a number or series of candlesticks that normally


show a trend reversal in a stock or commodity being analyzed; however,
determining trends can be very difficult. Perhaps this is best explained by
Gregory L. Morris in the chapter he wrote for John J. Murphy's classic "Technical
Analysis of the Financial Markets" (1999):

"One serious consideration that must be used to identify patterns as being either
bullish or bearish is the trend of the market preceding the pattern. You cannot
have a bullish reversal pattern in an uptrend. You can have a series of
candlesticks that resemble the bullish pattern, but if the trend is up it is not a
bullish Japanese candle pattern. Likewise, you cannot have a bearish reversal
candle pattern in a downtrend."

The reader who takes Japanese candlestick charting to the next level will read
that there could be as many as 40 or more patterns that will indicate reversals.
One-day reversals form candlesticks such as hammers and hanging men. A
hammer is an umbrella that appears after a price decline and, according to
candlestick pros, comes from the action of "hammering" out a bottom. If a stock
or commodity opens down and the price drops throughout the session only to
come back near the opening price at close, the pros call this a hammer.

A hanging man is very important to recognize and understand. It is an umbrella


that develops after a rally. The shadow should be twice as long as the body.
Hanging men that appear after a long rally should be noted and acted upon. If a
trading range for the hanging day is above the entire trading range of the
previous day, a "gap" day may be indicated.
Let's look at two charts, one with a hammer and the other with a hanging man.
The first charts Lucent Technologies and shows a classic hanging man. After
three days a rising price, the hanging man appears; on the following day, the
stock price drops by more than 20%. The second chart shows a hammer from a
period in 2001 when Nortel Networks was trading in the $55-$70 range. The
hammer appears after two days of declining prices and effectively stops the slide,
marking the beginning of a nine-day run with the stock price moving up $11.

Figure 2: A basic hanging man pattern in a chart of Lucent Technologies

Source: TradeStation
Figure 3: A hammer pattern in a chart of Nortel in 2001

Source: TradeStation

For those of you who would like to explore this area of technical analysis more
deeply, check out books written by Steve Nison. He has written a number of
textbooks that even a novice can use to better understand candlestick charting.

Conclusion

The fact that human beings often react en masse to situations is what allows
candlestick chart analysis to work. By understanding what these patterns are
telling you, you can learn to make optimal trade decisions, rather than just
following the crowd.

Remember it's your money - invest it wisely.

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Advanced Candlestick
Patterns
By Justin Kuepper

Candlestick patterns can give you invaluable insight into price action at a glance.
While the basic candlestick patterns can tell you what the market is thinking, they
often generate false signals because they are so common. Here we introduce
you to more advanced candlestick patterns, with a higher degree of reliability, as
well as explore how they can be combined with gaps to produce
profitable trading strategies.

Island Reversal Patterns


Island reversals are strong short-term trend reversal indicators. They are
identified by a gap between a reversal candlestick and two candles on either side
of it. Here are two examples that occurred on the chart of Doral Financial (DRL).
Figure 1

Figure 2

Here are some important things you need to consider when using this pattern:

Entry: Confirming the reversal pattern - When looking for an island


reversal, you are looking for indecision and a battle between bulls and
bears. This type of scenario is best characterized by a long-
ended doji candle that has high volume occurring after a long prior trend; it
is important to look for these three elements to confirm any potential
reversal pattern.
Exit: Defining the target and stop - In most cases, you will see a sharp
reversal (as seen in Figs. 1 and 2) when using this pattern. This reversal
pattern does not necessarily indicate a medium- or long-term reversal, so it
would be prudent to exit your position after theswing move has been
made. If the next candle ever fills the gap, then the reversal pattern is
invalidated, and you should exit prudently.

Island reversals can also occur in "clusters" - that is, in a multi-candle reversal
pattern, such as an engulfing, as opposed to a single candle reversal. Clusters
are easier to spot, but they often result in weaker reversals that are not as sharp
and take longer to occur.

Hook Reversal Patterns


Hook reversals are short- to medium-term reversal patterns. They are identified
by a higher low and a lower high compared to the previous day. Figures 3 and 4
are two examples that occurred on the chart of Microsoft Corp. (MSFT).

Figure 3
Figure 4

There are several important things to remember when using this pattern:

Entry: Confirming the reversal pattern - If the pattern occurs after


an uptrend, then the open must be near the prior high, and the low must be
near the prior low. If the pattern occurs after a downtrend, then the
opposite is true. As with the island reversal pattern, we are also looking for
high volume on this second candle. Finally, the stronger the prior trend, the
more reliable the reversal pattern.
Exit: Defining the target and stop - In most cases, you will see a sharp
reversal (as seen in Figs. 3 and 4) when using this pattern. If the next
candle shows a strong continuation of the prior trend, then the reversal
pattern is invalidated, and you should exit quickly, but prudently.

San-Ku (Three Gaps) Patterns


San-ku patterns are anticipatory trend reversal indicators. In other words, they do
not indicate an exact point of reversal; rather, they indicate that a reversal is
likely to occur in the near future. They are identified by three gaps within a strong
trend. Here is an example that occurred on the chart of Microsoft Corp. (MSFT).
Figure 5

Here are some important things to remember when using this pattern:

Entry: Confirming the reversal pattern - This pattern operates on the


premise that prices are likely to retreat after sharp moves
because traders are likely to start booking profits. Therefore, this pattern is
best used with other exhaustion indicators. So, look for extremes being
reached in indicators such as the RSI (relative strength
index), MACD (moving average convergence divergence) crossovers, and
other such indicators. It is also useful to look for volume patterns that
suggest exhaustion.
Exit: Defining the target and stop - In most cases, when using this
pattern, you will see a price reversal shortly after the third gap takes place
(as seen in Fig. 5). However, if there are any breakouts on high volume
after the last gap, then the pattern is invalidated, and you should exit
quickly, but prudently.
Kicker Patterns
Kicker patterns are some of the strongest, most reliable candlestick patterns.
They are characterized by a very sharp reversal in price during the span of two
candlesticks. Here's an example that occurred on the Microsoft (MSFT) chart.

Figure 6

Here are some important things you need to remember when using this pattern:

Entry: Confirming the reversal pattern - This kind of price action tells
you that one group of traders has overpowered the other (often as a result
of a fundamental change in the company), and a new trend is being
established. Ideally, you should look for a gap between the first and
second candles, along with high volume.

Exit: Defining a target and stop - When using this pattern, you will see
an immediate reversal, which should result in an overall trend change. If
the trend instead moves sideways or against the reversal direction, then
you should exit quickly, but prudently.

Using Gaps with Candlesticks


When gaps are combined with candlestick patterns and volume, they can
produce extremely reliable signals. (For further reading, see Playing The Gap.)
Here is a simple process that you can use to combine these powerful tools:

1. Screen for breakouts using your software or website of choice.


2. Make sure that the breakouts are high volume and significant (in terms of length).
3. Watch for reversal candlestick patterns (such as the ones mentioned above) after the gap has occurred. This will
4. Take a position when such a reversal occurs.

Attempting to play reversals can be risky in any situation because you are trading
against the prevailing trend. Do make sure that you keep tight stops and only
enter positions when trades meet the exact criteria. (To learn more,
see Retracement Or Reversal: Know The Difference.)

Conclusion
Now you should have a basic understanding of how to find reversals using
advanced candlestick patterns, gaps and volume. The patterns and strategies
discussed in this article represent only a few of the many candlestick patterns
that can help you better understand price action, but they are among the most
reliable. For further reading, see The Art Of Candlestick Charting - Part 1, Part
2, Part 3 and Part 4.

Read more: Advanced Candlestick Patterns |


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The 5 Most Powerful
Candlestick Patterns
(NUAN, GMCR)
By Alan Farley | September 23, 2015 12:49 AM EDT

Candlestick charts are a technical tool that pack data for multiple timeframes into
single price bars. This makes them more useful than traditional open-high, low-
close bars (OHLC) or simple lines that connect the dots of closing prices.
Candlesticks build patterns that predict price direction once completed. Proper
color coding adds depth to this colorful technical tool, which dates back to
18th century Japanese rice traders.

Steve Nison brought candlestick patterns to the Western world in his popular
1991 book, "Japanese Candlestick Charting Techniques." Many traders can now
identify dozens of these formations, which have colorful names like bearish dark
cloud cover, evening star andthree black crows. In addition, single bar patterns
including the doji and hammer have been incorporated into dozens of long- and
short-side trading strategies.

Candlestick Pattern Reliability


Not all candlestick patterns work equally well. Their huge popularity has lowered
reliability because theyve been deconstructed by hedge funds and
their algorithms. These well-funded players rely on lightning speed execution to
trade against retail and traditional fund managers who execute technical
analysis strategies found in popular texts. In other words, they use software to
trap participants looking for the high odds bullish or bearish outcomes. However,
reliable patterns continue to appear, allowing short- and long-term profit
opportunities.

Here are five candlestick patterns that perform exceptionally well as precursors
of price direction and momentum. Each works within the context of surrounding
price bars in predicting higher or lower prices. They are also time sensitive in two
ways. First, they only work within the limitations of the chart being reviewed,
whether intraday, daily, weekly or monthly. Second, their potency decreases
rapidly 3-to-5 bars after the pattern has completed.

Top 5 Candlestick Patterns


This analysis relies on the work of Thomas Bulkowski, who built performance
rankings for candlestick patterns in his 2008 book, "Encyclopedia of Candlestick
Charts." He offers statistics for two kinds of expected pattern
outcomes: reversal and continuation. Candlestick reversal patterns predict a
change in price direction while continuation patterns predict an extension in
the current price direction.

In the following examples, the hollow white candlestick denotes a closing print
higher than the opening print while the black candlestick denotes a closing print
lower than the opening print.

Three Line Strike


The bullish three line strike reversal pattern carves out three black candles within
a downtrend. Each bar posts a lower low and closes near the intrabar low. The
fourth bar opens even lower but reverses in a wide-range outside bar that closes
above the high of the first candle in the series. The opening print also marks the
low of the fourth bar. According to Bulkowski, this reversal predicts higher prices
with an 84% accuracy rate.

Two Black Gapping


The bearish two black gapping continuation pattern appears after a notable top in
an uptrend, with a gap down that yields two black bars posting lower lows. This
pattern predicts the decline will continue to even lower lows, perhaps triggering a
broader scale downtrend. According to Bulkowski, this pattern predicts lower
prices with a 68% accuracy rate.

Three Black Crows


The bearish three black crows reversal pattern starts at or near the high of an
uptrend, with three black bars posting lower lows that close near intrabar lows.
This pattern predicts the decline will continue to even lower lows, perhaps
triggering a broader scale downtrend. The most bearish version starts at a new
high (A) because it traps buyers entering momentum plays. According to
Bulkowski, this pattern predicts lower prices with a 78% accuracy rate.

Evening Star
The bearish evening star reversal pattern starts with a tall white bar that carries
an uptrend to a new high. The market gaps higher on the next bar but fresh
buyers fail to appear, yielding a narrow range candlestick. A gap down on the
third bar completes the pattern, which predicts the decline will continue to even
lower lows, perhaps triggering a broader scale downtrend. According to
Bulkowski, this pattern predicts lower prices with a 72% accuracy rate.

Abandoned Baby
The bullish abandoned baby reversal pattern appears at the low of a downtrend,
after a series of black candles print lower lows. The market gaps lower on the
next bar but fresh sellers fail to appear, yielding a narrow range doji candlestick
with opening and closing prints at the same price. A bullish gap on the third bar
completes the pattern, which predicts the recovery will continue to even higher
highs, perhaps triggering a broader scale uptrend. According to Bulkowski, this
pattern predicts higher prices with a 70% accuracy rate.

The Bottom Line


Candlestick patterns capture the attention of market players but many reversal
and continuation signals emitted by these patterns dont work reliably on the
modern electronic environment. Fortunately, statistics by Thomas Bulkowski
show unusual accuracy for a narrow selection of these patterns, offering
traders actionable buy and sell signals.
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Two Candlestick Patterns


Predicting A Bottom
By Ayton MacEachern | July 24, 2008 2:00 AM EDT

Candlesticks were developed by rice traders in Japan many centuries ago to help
display price activity over a trading period. Candlesticks represent the opening,
high, low and closing values for one period of trading; the period can be
absolutely anything, including one minute, one hour, one day or even one year.
The candles in the stock charts below are one-day candles.

The main body of the candlestick, as seen in the image below, represents the
range between the opening price and closing price. In the case where the open is
higher than the close, the candle is known as an open candlestick; it is often
displayed in white or green (displayed blue in our charts below). If the closing
price is below the opening price, the candlestick is known as a closed
candlestick; it is often displayed in black or red (displayed red in our charts
below.) The lines above and below the candlestick represent the high and low
prices of the trading period, and are often known as wicks, or shadows.

There are many patterns that candlestick pattern traders can use to predict the
movement of a stock. Because candlesticks are so visually appealing, traders
can recognize patterns at glance that may signify a continuation or reversal. Let's
take a look at two reversal patterns that could be signaling a bottom in the stocks
they track.

Bullish Harami

As you can see in the example above, the bullish harami is a candlestick chart
pattern in which a large closed candlestick is followed by a smaller open
candlestick, the body of which is located within the vertical range of the larger
body. This pattern predicts the reversal of a downward trend; the smaller the
open candlestick, the more likely the reversal. Here are two stocks that have just
shown us this chart pattern.
Midway Gold Corp. (NYSE:MDW) - This stock is a thinly traded stock that is
currently at the bottom of its 52-week range. The Relative Strength Index is
currently indicating that the stock may be oversold and poised for a reversal as it
crosses back across the 30 line. This bullish harami candlestick pattern may
confirm that a reversal is about to occur. Bullish traders should enter in long here,
with a stop loss at $1.57, the low of the previous candle

Oil-Dri Corp. of America (NYSE:ODC) - Oil-Dri's stock is another that has just
created a bullish harami candlestick pattern. Like with MDW, the RSI has verified
that this stock is oversold. Although the RSI did not cross below the 30 level in
this case, it is bouncing off this level and appears to be looking for support.
Bullish traders going long here will want to place stop losses at the low of the
previous candle - $16.31.
Bullish Engulfing Pattern

In the chart pattern above, we see the bullish engulfing pattern of a small closed
candlestick is followed by a large open candlestick that completely "engulfs" the
previous closed candlestick. The shadows, or tails, of the closed candlestick are
short, which enables the body of the large candlestick to cover the entire
candlestick from the previous period. This pattern suggests that the bulls have
taken control of the price, and a reversal is anticipated. Here are a couple stocks
that have just shown us a bullish engulfing pattern.

Lattice Semiconductor CP (Nasdaq:LSCC) - This stock is trading near its 52-


week lows, and seems to be finding support at a pivot low. The price action of
LSCC has created a bullish engulfing pattern, which, along with the recent RSI
cross above the 30 level, is a good sign of reversal. Traders wishing to go long
here should place a stop loss at the low of the engulfing candle - $2.66.

Netflix Inc. (Nasdaq:NFLX) - Netflix is an example of a bullish engulfing pattern


that does not have verification of a reversal by the RSI. As you can see in the
chart below, there is a strong engulfment that has occurred, but RSI is indicating
indifference on whether the stock is oversold. Looking back about six trading
days, you can see that another engulfing pattern was created, which ended up
being a false signal. This stock is a perfect example of why candlestick patterns
should only be used along with other technical indicators to predict future price
action.
Candlesticks are merely a visual representation of supply and demand. As
demand increases, the chance of the close being near the high is much better.
The opposite is true as supply begins to outpace demand; the close will be closer
to the low of the day as the price falls to try and boost demand. Because supply
and demand are the main tenets of our financial markets, being able to visualize
the relationship at a moment's notice is a great advantage to the trader. These
patterns can be a useful tool for predicting future price movement when
combined with other technical indicators such as the Relative Strength Index.

To learn more on candlesticks and their patterns, be sure to read The Art Of
Candlestick Charting Part 1, Part 2, Part 3 and Part 4.

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Bullish Engulfing Candle In
An Uptrend
By Cory Mitchell | January 17, 2012 2:00 AM EST

A bullish engulfing candlestick pattern can be a very good indicator for finding
turning points in a stock. The pattern occurs when an up-candle (close above
open) completely envelopes the prior down-candle (close below open). This
pattern occurs in the following four stock charts. While many people will look for
this candlestick pattern to try to find reversals in downtrends, the pattern can be
very useful when it occurs in the same direction as the current trend. The
following four stocks are all in uptrends and have seen recent pullbacks. The
appearance of a bullish engulfing pattern in such an environment shows the bulls
are still alive, and the stocks could be due for another wave higher.

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Philip Morris (NYSE:PM) was a great long in 2011 and remains in an uptrend.
So far in 2012, though, the stock has been retreating. On January 13 a bullish
engulfing pattern occurred; the price jumped from an open of $76.22 to close out
the day at $77.32. This bullish day dwarfed the prior day's intra-range where the
stock finished down marginally. The move shows the bulls are still alive and
another wave in the uptrend could occur. Targets for the next wave are $82.50
and $85. Stops can be placed a little bit below $76, which provides an attractive
risk/reward ratio. (From picking the right type of stock to setting stop-losses, learn
how to trade wisely. For more, see Day Trading Strategies For Beginners.)
Dollar General (NYSE:DG) is another stock that had a great 2011, but started
out 2012 by pulling back (not much though). With the stock still in an uptrend, the
buyers stepped back in on Friday, creating a bullish engulfing pattern. Since last
November the stock has been moving in a more choppy fashion, which means
there is resistance and support close at hand. If the engulfing pattern does in fact
indicate the stock is going higher, it will need to break through the recent high at
$42.10. If it does, the target is $45 to $46. Ideally, volume should increase as the
stock moves higher. Support is presently just above $38 and can be used as a
stop level. A tighter stop, which has a higher chance of being triggered but
reduces the risk, can be placed just below $39.50. (For related reading,
see Interpreting Support And Resistance Zones.)
Nisource (NYSE:NI) was having a hard time breaking above $23 in the last half
of 2011, but in December managed to climb to $24. As the New Year kicked off,
the stock fell and has been falling since ... that is until the bulls stepped in in
force on Friday, pushing the stock up 2.8%. The progressively higher lows since
August 2011 indicate there is underlying strength, and the strong showing on
Friday means the stock could hit a new 52-week high fairly soon. If a wave higher
occurs, the target is $25 to $25.50. Stops can be placed near $22, with primary
support just above $21. (Understanding this key concept can drastically improve
your short-term investing strategy. For more, see Support & Resistance Basics.)
Sunoco Logistics Partners (NYSE:SXL) has been on a tear since last October,
and the uptrend may not be finished yet. Since the start of this year, the stock
has been pulling back, but the recent bullish engulfing pattern means the
correction could be over. There is a support band between $36 and $34, so this
is a likely spot for the bulls to step back in. If the stock breaks the 52-week high
at $39.98 the first target is $42 followed by $44. Stops can be placed just above
$33 (primary support) or near $35, which is below the engulfing pattern. (For
more on stops, see Maximize Profits With Volatility Stops.)
The Bottom Line
A bullish engulfing pattern can be a powerful signal, especially when combined
with the current trend. All these stocks are in uptrends but have seen
recent pullbacks, and the candlestick pattern indicates the correction could be
over. The pattern shows that bulls are present and willing to buy, and the uptrend
lends reliability to the signal. As with any pattern, this is not always reliable, so
stop losses should be used. (For more on candlesticks, see Candlestick
Charting: What Is It?)

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Most Commonly Used Forex


Chart Patterns
By Cory Mitchell

With so many ways to trade currencies, picking common methods can save time,
money and effort. By fine tuning common and simple methods a trader can
develop a complete trading plan using patterns that regularly occur, and can be
easy spotted with a bit of practice. Chart, candlestick and Ichimoku patterns all
provide visual clues on when to trade. While these methods could be complex,
there are simple methods that take advantage of the most commonly traded
elements of these respective patterns. (For more on charts, readCharting Your
Way To Better Returns.)

TUTORIAL: Analyzing Chart Patterns

While there are a number of chart patterns of varying complexity, there are two
common chart patterns which occur regularly and provide a relatively simple
method for trading. These two patterns are the head and shoulders and
the triangle.

Head and Shoulders (H&S)


The H&S pattern can be a topping formation after an uptrend, or a bottoming
formation after a downtrend. A topping pattern is a price high, followed
by retracement, a higher price high, retracement and then a lower low. The
bottoming pattern is a low, a retracement followed by a lower low (head) and a
retracement then a higher low (second shoulder) (see Figure 1). The pattern is
complete when the trendline ("neckline"), which connects the two highs
(bottoming pattern) or two lows (topping pattern) of the formation, is broken.

This pattern is tradable because it provides an entry level, a stop level and
a profit target. In Figure 1 there is a daily chart of the EUR/USD and an H&S
bottoming pattern that occurred. The entry is provided at 1.24 when the
"neckline" of the pattern is broken. The stop can be placed below the right
shoulder at 1.2150 (conservative) or it can be placed below the head at 1.1960;
the latter exposes the trader to more risk, but it has less chance of being stopped
before the profit target is hit. The profit target is determined by taking the height
of the formation and then adding it to the breakout point. In this case the profit
target is 1.2700-1.1900 (approx) = 0.08 + 1.2400 (this is the breakout point) =
1.31. The profit target is marked by the square at the far right, where the market
went after breaking out. (For more on the Head and Shoulder pattern, see Price
Patterns Part 2: Head-And-Shoulders Pattern.)

Triangles
Triangles are very common, especially on short-term time frames and can
be symmetric, ascending or descending. While the patterns appear slightly
different for trading purposes there is minimal difference.Triangles occur when
prices converge with the highs and lows narrowing into a tighter and tighter price
area.

Figure 2 shows a symmetric triangle. It is tradable because the pattern provides


an entry, stop and profit target. The entry is when the perimeter of the triangle is
penetrated in this case to the upside making the entry 1.4032. The stop is the
low of the pattern at 1.4025. The profit target is determined by adding the height
of the pattern to the entry price (1.4032). The height of the pattern is 25 pips,
thus making the profit target 1.4057, which was quickly hit and exceeded. (For
more on triangles, read Triangles: A Short Study In Continuation Patterns.)
Engulfing Pattern
Candlestick charts provide more information than line, OHLC or area charts. For
this reason, candlestick patterns are a useful tool for gauging price movements
on all time frames. While there are many candlestick patterns, there is one which
is particularly useful in forex trading.

An engulfing pattern is an excellent trading opportunity because it can be easily


spotted and the price action indicates a strong and immediate change in
direction. In a downtrend an up candle real body will completely engulf the prior
down candle real body (bullish engulfing). In an uptrend a down candle real body
will completely engulf the prior up candle real body (bearish engulfing).

The pattern is highly tradable because the price action indicates a


strong reversal since the prior candle has already been completely reversed. The
trader can participate in the start of a potential trend while implementing a stop.
In Figure 3 we can see a bullish engulfing pattern that results in the emergence
of an upward trend. The entry is the open of the first bar after the pattern is
formed, in this case 1.4400. The stop is placed below the low of the pattern at
1.4157. There is no distinct profit target for this pattern. (For more on candlestick
charting, read The Basic Language Of Candlestick Charting.)
Ichimoku Cloud Bounce
Ichimoku is a technical indicator that overlays the price data on the chart. While
patterns are not as easy to pick out in the actual Ichimoku drawing, when we
combine the Ichimoku cloud with price action we see a pattern of common
occurrences. The Ichimoku cloud is former support and resistance levels
combined to create a dynamic support and resistance area. Simply put, if price
action is above the cloud it is bullish and the cloud acts as support. If price action
is below the cloud, it is bearish and cloud acts as resistance.

The "cloud" bounce is a common continuation pattern, yet since the cloud's
support/resistance is much more dynamic that traditional horizontal
support/resistance lines it provides entries and stops not commonly seen. By
using the Ichimoku cloud in trending environments, a trader is often able to
capture much of the trend. In an upward or downward trend, such as can be
seen in Figure 4, there are several possibilities for multiple entries (pyramid
trading) or trailing stop levels. (To learn more about Ichimoku charts, check
out An Introduction To Ichimoku Charts In Forex Trading.)

In a decline that began in September, 2010, there were eight potential entries
where the rate moved up into the cloud but could not break through the opposite
side. Entries could be taken when the price moves back below (out of) the cloud
confirming the downtrend is stillin play and the retracement has completed. The
cloud can also be used a trailing stop, with the outer bound always acting as the
stop. In this case, as the rate falls, so does the cloud the outer band (upper in
downtrend, lower in uptrend) of the cloud is where the trailing stop can be placed.
This pattern is best used in trend based pairs, which generally include the USD.

Bottom Line
There are multiple trading methods all using patterns in price to find entries and
stop levels. Chart patterns, which include the head and shoulders as well as
triangles, provide entries, stops and profit targets in a pattern that can be easily
seen. The engulfing candlestick pattern provides insight into trend reversal and
potential participation in that trend with a defined entry and stop level. The
Ichimoku cloud bounce provides for participation in long trends by using multiple
entries and a progressive stop. As a trader progresses they may wish combine
patterns and methods to create a unique and customizable personal trading
system. (To help you become a trader, check out How To Become A Successful
Forex Trader.)

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Retracement Or Reversal:
Know The Difference
By Justin Kuepper
Most of us have wondered, at some point, whether a decline in the price of a
stock we're holding is long term or a mere market hiccup. Some of us have sold
our stock in such a situation, only to see it rise to new highs just days later. This
is a frustrating and all too common scenario, but it can be avoided if you know
how to identify and trade retracements properly.

What Are Retracements?


Retracements are temporary price reversals that take place within a larger trend.
The key here is that these price reversals are temporary, and do not indicate a
change in the larger trend.

Figure 1: An example of retracements in the price action of a particular


stock.

Notice that despite the retracements, the long-term trend shown in this chart is
still intact - that is, the price of the stock is still going up.
The Importance of Recognizing Retracements
It is important to know how to distinguish a retracement from a reversal. There
are several key differences between the two that you should take into account
when classifying a price movement:

Factor Retracement Reversal

Volume Profit taking by retail traders Institutional selling (large


(small block trades) block trades)

Money Flow Buying interest during Very little buying interest


decline

Chart Patterns Few, if any, reversal patterns Several reversal patterns -


- usually limited to candles usually chart patterns
(double top, etc.)

Short Interest* No change in short interest Increasing short interest

Time Frame Short-term reversal, lasting Long-term reversal, lasting


no longer than one to two longer than a couple of
weeks weeks

Fundamentals No change in fundamentals Change or speculation of


change in fundamentals

Recent Activity Usually occurs right after Can happen at any time,
large gains even during otherwise
regular trading

Candlesticks "Indecision" candles - these Reversal candles - these


typically have long tops and include engulfings, soldiers
bottoms (spinning tops, etc.) and other similar patterns

Figure 2 - *Note that short interest is delayed when reported, so it can be


difficult to tell for certain depending on your time frame.
So, why is recognizing retracements so important? Whenever a price reverses,
most traders and investors are faced with a tough decision. They have three
options:

1. Hold throughout the sell-off, which could result in large losses if the
retracement turns out to be a larger trend reversal.
2. Sell and re-buy if the price recovers, which will definitely result in money
wasted on commissions and spreads. This may also result in a missed
opportunity if the price recovers sharply.

3. Sell permanently, which could result in a missed opportunity if the price


recovers.

By properly identifying the movement as either a retracement or a reversal, you


can reduce cost, limit loss and preserve gains.

Determining Scope
Once you know how to identify retracements, you can learn how to determine
their scope. The following are the most popular tools used to do this:

Fibonacci retracements
Pivot point support and resistance levels
Trendline support and resistance levels

Fibonacci Retracements
Fibonacci retracements are excellent tools for calculating the scope of a
retracement. They are most widely used in the foreign exchange market, but are
also used in the stock market. To use them, simply use the Fibonacci
retracement tool (available in most charting software) to draw a line from the top
to the bottom of the latest impulse wave.
Figure 3: An example of the Fibonacci retracement tool.

In most cases, retracements will stay around 38.5% (daily) or 50% (intraday). If
the price moves below these levels, then a reversal may be forming.

SEE: Top 4 Fibonacci Retracement Mistakes To Avoid

Pivot Points
Pivot point levels are also commonly used when determining the scope of a
retracement. Most traders look at the lower supports (R1, R2 and R3) - if these
are broken, then a reversal may be forming.

Trendline Supports
Finally, if major trendlines supporting the larger trend are broken on high volume,
then a reversal is most likely in effect. Chart patterns and candlesticks are often
used in conjunction with these trendlines to confirm reversals.

Dealing with False Signals


Even a retracement that meets all the criteria outlined in our table in Figure 2
may turn into a reversal with very little warning. The best way to protect yourself
against such a reversal is to use stop-loss points. Here is how you can do this:

1. You can estimate retracement levels using technical analysis and place your
stop-loss point just below these levels.

2. Alternatively, you can place the stop-loss just below the long-term support
trendline or moving average.

Ideally, what you want to do is lower your risk of exiting during a retracement,
while still being able to exit a reversal in a timely manner.

The Bottom Line


As a trader, you need to be able to differentiate between retracements and
reversals. Without this knowledge, you risk many things such as exiting too soon
and missing opportunities, holding onto losing positions and losing money and
wasting money on commissions/spreads. By combining technical analysis with
some basic identification measures, you can protect yourself from these risks
and put your trading capital to better use.

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8 price action secrets every trader


should know about
Rolf How To, Technical Analysis, Tips 34 Comments 54,162 Views

Contents in this article [hide]


#1 Support and resistance zones are better than levels
#2 Highs and lows are all you need to focus on
#3 Location improve your trading instantly
#4 Everything is relative get context
#5 The 4 clues of candlesticks and price action
#6 Broker time doesnt matter
#7 The amateur squeeze and stop hunting
#8 Correct market selection
Price action is among the most popular trading concepts and a trader who knows how
to use price action the right way can often improve his performance and his way of
looking at charts significantly. However, there are still a lot of misunderstandings and
half-truths circulating that confuse traders and set them up for failure. In this article we
explore the 8 most important price action secrets and share the best price action tips.

#1 Support and resistance zones are better


than levels
Support and resistance is probably the most popular price action concept, but only very
few traders can actually make money with it. The reason is often very simple, although
its not as obvious at first glance.

Most traders just use single, horizontal lines when it comes to trading support and
resistance which look great in hindsight but fail during live trading. The reason is that
singles lines are no effective way of looking at price movements creating support and
resistance zones is much more effective when it comes to understanding price.
The screenshot below shows it nicely: the trader who just uses a single line either
misses trading opportunities when price does not reach his lines or he gets thrown out
during volatility spikes; the trader who uses zones instead can filter out the noise that
exists in the zones.
#2 Highs and lows are all you need to focus on
This point describes a very basic concept, but its so important to understand and,
sadly, not used widely enough. The analysis of highs and lows offers so much
information about trend strength, market direction and can even foreshadow the end of
trends and trade reversals in advance.

The analysis of highs and lows can be combined with all conventional trading methods
and its a very powerful price action secret that should not be one. Here are a few things
that will help you understand highs and lows beyond the general trading knowledge:

Do you see long trend waves with small pullbacks only? (this signals a strong trend)
Is price barely making higher highs/lower lows? (this could indicate fading momentum)
Do you see increasing volatility larger candle wicks while price makes new highs/lows?
(youve probably heard the quote that volatility is greatest at turning points)
An uptrend where price fails to make a higher high should get your attention
I challenge you: take a look at any textbook chart pattern out there and youll see that
the only thing that really matters is how highs and lows form within that pattern.

#3 Location improve your trading instantly


Even if you see the best and most promising price action signal, you can still greatly
increase your odds by only taking trades at important and meaningful price levels. Most
amateur traders make the mistake of taking price action signals regardless of where
they occur and then wonder why their winrate is so low.
In my own trading, I first draw support and resistance zones and mark supply and
demand areas and then wait for price to get there; and I only take a trade when a price
action signal forms at my pre-marked price areas. This does not only provide a stress-
free trading approach (use price alerts around your levels to even free up more time),
but it will significantly improve the quality of your trading.

#4 Everything is relative get context


A big mistake many traders make is that they treat price action like a blueprint or
template trading methodology and just hunt for candlesticks that fit their textbook
criteria. In trading, everything is relative and you need to put price information in relation
to what has happened before.

The graphic below shows what this means. During the uptrend, you see multiple pinbars
but the first two are relatively small, compared to the price action before that. Thus, they
dont offer meaningful signals and the pinbars fail. The real pinbar at the very top
showed a very strong rejection where the pinbar was even larger than previous candles.

Always compare the most recent price action to what has happened before.

#5 The 4 clues of candlesticks and price action


This ties in with the previous point and it further demonstrates the importance of putting
together the pieces when you trade price action and avoid blueprint-thinking. The 4
following points will help you avoid many of the common trading mistakes people make
who just look for blueprint patterns.

1) The length of wicks


If you see a lot of long wicks, it means that volatility and uncertainty is increasing.
Especially during market tops or tight congestions, wicks tend to get larger.

2) Bullish vs. bearish wicks


Do you see more/longer wicks to the upside or to the downside? Wicks that stick out to
the downside typically signal rejection and failed bearish attempts.
3) Position of the body
Is the body of a candle positioned closer to the top or the bottom of the candle? Bodies
that close near the top often signal bullish pressure especially if the candle comes
with a long bearish wick.

4) The body
The ratio between the body and the wicks can tell you a lot. Candles with a large body
and small wicks usually indicate a lot of strength whereas candles with a small body and
large wicks signal indecision.

#6 Broker time doesnt matter


We get the question how broker time and candle closing time influences price action a
lot. Truth be told, it does not make any difference to your overall trading although time
frames such as the 4H or daily will look different on different brokers.

The graphic below illustrates what we mean. The charts show the same market and the
same period and both are 4H time frames. They used different closing times for their
candles and, thus, the charts look slightly different. Some of the important clues that the
left market shows are not visible on the right chart and vice versa. So there is no broker
time that is better than the other just the signals you get slightly vary. The most
important point is that you make consistent decisions and dont confuse yourself by
changing between different broker feeds.
Dont stress out about your broker time; over the long-term, everything averages out as
long as you stay consistent.
#7 The amateur squeeze and stop hunting
Conventional price action patterns are very obvious and many traders believe that their
broker hunts their stops because they always seem to get stopped out even though
the setup was so clear.

It is very easy for the professional trader to estimate where the amateur traders enter
trades and place stops when a price action pattern forms. The stop hunting youll see
is not done by your broker, but by profitable traders who simply squeeze amateurs to
generate more liquidity. You should either wait for the amateur squeeze to be over or
add some extra space to your stop to avoid getting kicked out of potentially profitable
price action trades.
When a pattern looks too good to be true, it usually is.

#8 Correct market selection


Building a watchlist prior to your trading is important and market selection is a very
misunderstood concept in trading. Let me give you an example from my trading: every
Sunday I sit down and go through all of the 15+ forex pairs that I consider trading.
However, usually only 6-8 make it on my actual trading watchlist for the week ahead.
And the main reason why the others get cut is because of low probability price action
which usually means tight congestions, squeeze consolidations and narrow ranges with
a lot of volatility.
An effective market selection is important and you should only look for markets that
offer clear price action and stay away from markets that are too erratic and noisy. Dont
make this mistake of being too fixated on the pairs you trade rotate them and only
focus on markets with good price action.

Most of those tips are probably not considered price action secrets by most advanced
traders, but amateurs can usually improve the quality of their trading and how they view
the markets by just picking a few of them. If you have any other tips or know about
some mistakes traders do in price action trading, leave a comment below.

How To Use Volume To


Improve Your Trading
Loading the player...
Volume is a measure of how much of a given financial asset has been traded in a given period of
time. It is a very powerful tool, but it's often overlooked because it is such a simple indicator.
Volume information can be found just about anywhere, but few traders or investors know how to
use it to increase their profits and minimize risk.

TUTORIAL: Analyzing Chart Patterns

For every buyer there needs to be someone who sold them the shares they bought, just as there
must be a buyer in order for a seller to get rid of his or her shares. This battle between buyers and
sellers for the best price on all different timeframes creates movement while longer term
technical and fundamental factors play out. Using volume to analyze stocks (or any financial
asset) can bolster profits and also reduce risk.

Basic Guidelines for Using Volume


When analyzing volume, there are guidelines we can use to determine the strength or weakness
of a move. As traders, we are more inclined to join strong moves and take no part in moves that
show weakness - or we may even watch for an entry in the opposite direction of a weak move.
These guidelines do not hold true in all situations, but they are a good general aid in trading
decisions.

Volume and Market Interest


A rising market should see rising volume. Buyers require increasing numbers and increasing
enthusiasm in order to keep pushing prices higher. Increasing price and decreasing volume show
lack of interest and this is a warning of a potential reversal. This can be hard to wrap your mind
around, but the simple fact is that a price drop (or rise) on little volume is not a strong signal. A
price drop (or rise) on large volume is a stronger signal that something in the stock has
fundamentally changed.

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e and rising volume.

Exhaustion Moves and Volume


In a rising or falling market we can see exhaustion moves. These are generally sharp moves in
price combined with a sharp increase in volume, which signal the potential end of a trend.
Participants who waited and are afraid of missing more of the move pile in at market tops,
exhausting the number of buyers. At a market bottom, falling prices eventually force out large
numbers of traders, resulting in volatility and increased volume. We will see a decrease in
volume after the spike in these situations, but how volume continues to play out over the next
days, weeks and months can be analyzed by using the other volume guidelines. (For related
reading, take a look at 3 Key Signs Of A Market Top.)
spike indicating a change of direction.

Bullish Signs
Volume can be very useful in identifying bullish signs. For example, imagine volume increases
on a price decline and then price moves higher, followed by a move back lower. If price on the
move back lower stays higher than the previous low, and volume is diminished on second
decline, then this is usually interpreted as a bullish sign.
elling interest on the second decline.

Volume and Price Reversals


After a long price move higher or lower, if price begins to range with little price movement and
heavy volume, often it indicates a reversal. (See Retracement Or Reversal: Know The
Difference for additional information)

Volume and Breakouts Vs. False Breakouts


On the initial breakout from a range or other chart pattern, a rise in volume indicates strength in
the move. Little change in volume or declining volume on a breakout indicates lack of interest
and a higher probability for a false breakout.

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ng volume on breakout.

Volume History
Volume should be looked at as relative to recent history. Comparing today to volume 50 years
ago provides irrelevant data. The more recent the data sets, the more relevant they are likely to
be.
Volume Indicators
Volume indicators are mathematical formulas that are visually represented in most commonly
used charting platforms. Each indicator uses a slightly different formula and, therefore,
a trader should find the indicator that works best for their particular market approach. Indicators
are not required, but they can aid in the trading decision process. There are many volume
indicators; the following will provide a sampling of how several can be used.

On Balance Volume (OBV)


OBV is a simple but effective indicator. Starting from an arbitrary number, volume is added
when the market finishes higher, or volume is subtracted when the market finishes lower. This
provides a running total and shows which stocks are being accumulated. It can also show
divergences, such as when a price rises but volume is increasing at a slower rate or even
beginning to fall. Figure 5 shows that OBV is increasing and confirming the price rise in Apple
Inc's (AAPL) share price. (For more on the OBV, see On-Balance Volume: The Way To Smart
Money.)

BV confirms the price move.

Chaikin Money Flow


Rising prices should be accompanied by rising volume, so this formula focuses on expanding
volume when prices finish in their upper or lower portion of their daily range and then provides
value for the corresponding strength. When closes are in the upper portion of the range and
volume is expanding, the values will be high; when closes are in the lower portion of the range,
values will be negative.
Chaikin money flow can be used as a short term indicator because it oscillates, but it is more
commonly used for seeing divergence. Figure 6 shows how volume was not confirming the
continual lower lows (price) in AAPL stock. Chaikin money flow showed a divergence that
resulted in a move back higher in the stock. (For related information, see Discovering Keltner
Channels and the Chaikin Oscillator.)

vergence that indicates a potential reversal.

Klinger Volume Oscillator


Fluctuation above and below the zero line can be used to aid other trading signals. The Klinger
volume oscillator sums the accumulation (buying) and distribution (selling) volumes for a given
time period. In Figure 7 we see a quite negative number - this is in the midst of an
overall uptrend - followed by a rise above the trigger or zero line. The volume indicator stayed
positive throughout the price trend. A drop below the trigger level in January 2011 signalled the
short term reversal. Price stabilized, however, and that is why indicators should generally not be
used in isolation. Most indicators give more accurate readings when they are used in association
with other signals. (See Trend-Spotting With The Accumulation/Distribution Line for more.)
nger confirms the uptrend.

The Bottom Line


Volume is an extremely useful tool and, as you can see, there are many ways to use it. There are
basic guidelines that can be used to assess market strength or weakness, as well as to check if
volume is confirming a price move or signalling a reversal. Indicators can be used to help in the
decision process. In short, volume is a not a precise entry and exit tool, however, with the help of
indicators, entry and exit signals can be created by looking at price action, volume and a volume
indicator.

For additional reading, take a look at Interpreting Volume for the Futures Market.

Read more: How To Use Volume To Improve Your Trading |


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How to use fibonacci and fibonacci
extensions
Contents in this article [hide]
Step 1 Find an A to B move
Step 2 Find the retracement point C
Using Fibonacci
Conclusion: Fibonaccis are multifunctional
Who has not seen the beach girl who is throwing back her wet hair, corn flowers or
shells that all have the perfect Fibonacci spiral assigned to it? People then try to tell you
that Fibonaccis are a natural occurrence and that their presence signals something
special. The truth is, for every Fibonacci spiral that you randomly find somewhere, there
will be tens of thousands of things where a Fibonacci sequence cannot be seen.

And especially, when it comes to trading, Fibonaccis are not a superior way of
predicting and analyzing price behavior, but it is more like a self-fulfilling prophecy when
you see it work. When you can use it in combination with other concepts, you will be
able to benefit from it and no doubt, Fibonaccis can be a great addition to your trading
arsenal as you will see shortly.

How to use Fibonacci? There is no right or wrong


Often, traders who have no prior experience with Fibonaccis are worried that they are
doing it wrong and dont use the Fibonacci tool correctly. I can assure you, there is no
right or wrong and you will also see that many traders use Fibonaccis in a slightly
different way. When it comes to using Fibonaccis, there are only a handful of things you
have to be aware of. But after playing around with Fibonaccis for a short while, you will
become comfortable very quickly.

Step 1 Find an A to B move


To use the Fibonacci retracements, you have to identify an A to B move where you can
use the Fibonacci retracement tool. What do we mean with A to B?
A = the origin of a new price move. These are usually swing highs and lows, or
tops and bottoms.
B = Where the move pauses and reverses.

The following 4 screenshots show typical A to B


moves
Now lets apply the Fibonacci retracement tool to the A to B moves. Just pick the
Fibonacci tool from your platform, select point A, drag it to B and release it.

Connecting A to B moves with the Fibonacci


retracement tool
Step 2 Find the retracement point C
After you have identified an A to B move and plotted your Fibonacci tool on your charts,
you should be able to find point C.

C = the point where the retracement ends and price reverses into the original
direction.

As you can see, the first 3 screenshots show the typical ABC move of a Fibonacci
retracement. Point C is very obvious on all three charts and price bounced off the
Fibonacci levels accurately.
Finding the C-Fibonacci retracement level

click to enlarge

click to enlarge

click to enlarge
The fourth screenshot shows a scenario where price did not go back to the B-Fibonacci
level, but breaks the prior A-Fibonacci. Its important to understand that not all price
moves will stop at a Fibonacci level. But, as you can see on the fourth screenshot, the
Fibonacci tool can be used to identify support and resistance areas as well as we will
explore in more detail shortly; the last screenshot shows nicely how price reacts to
several different Fibonacci levels during the retracement.

Tip #1: Trial and error


Especially for beginners, the following exercise will help you build a strong foundation
when it comes to drawing Fibonacci levels: Just grab the Fibonacci retracement tool
and try to put it on different spots, while observing how price reacts to it. Usually, the
more snaps (price bouncing off a level) you see, the more important the Fibonacci
retracement is.

Tip #2: Dont force a Fibonacci


Not every time youll be able to use a Fibonacci retracement to make sense of a price
move. If you cant make the Fibonacci levels snap, dont try to force it. The best and
most helpful Fibonacci retracements are those where you dont have to look long.
Using Fibonacci
#1 Retracements as re-entries
The most common use for Fibonacci levels is the regular retracement strategy. After
identifying the A to B move, you pay attention to the retracement level C.

The screenshots below show a sudden bullish move in a larger uptrend. Often, traders
miss such sudden outbursts and then try to find re-entries during pullbacks. The
Fibonacci tool is ideal to identify swing-points during pullbacks as the sequence
indicates. With the Fibonacci retracement tool, a trader would have been able to find 2
Fibonacci re-entries on the pullbacks.

[/sociallocker] Using Fibonacci retracements as re-entries in a trade click to enlarge

#2 Support and resistance


Another possibility to use Fibonaccis is to find an AB-Fibonacci move on a higher
timeframe and then go down to your regular timeframe and watch the retracement
levels as support and resistance guidelines.
The first screenshot below shows the Daily timeframe of the current EUR/USD chart. As
you can see, there was a regular A to B move. The screenshot in the bottom shows the
same Fibonacci retracement but on the lower, 4 hour timeframe. As you can see,
throughout the whole time, price reacted fairly accurately to the Fibonacci levels.

Daily timeframe with an


A to B Fibonacci move click to enlarge

Fibonacci levels acting as


support and resistance on a lower timeframe click to enlarge

#3 Fibonacci levels for Take Profits Fibonacci


Extensions
Finally, you can also use Fibonaccis for your take profit orders. Especially the Fibonacci
extensions are ideal to determine take profit levels in a trend. The most commonly used
Fibonacci extension levels are 138.2 and 161.8.
Most trading platforms allow you to add custom levels. Usually, the parameters to add
the Fibonacci extensions are:

-0.618 for the 161.8 Fibonacci extension


-0.382 for the 138.2 Fibonacci extension
The rules for take profit orders are very individual, but most traders use it as follows:

A 50, 61.8 or 78.6 retracement will often go to the 161 Fibonacci extension after
breaking through the 0%-level. A 38.2 retracement will often come to a halt at the 138
Fibonacci extension. The screenshots below show the Fibonacci moves from the
beginning and this time we applied the extensions to the price moves. As you can see,
the extensions provided great places for take profit orders.

A 78.6 retracement goes to the 161


Fibonacci extension click to enlarge
A 50 retracement goes to the
168 Fibonacci retracement click to enlarge

click to enlarge

Conclusion: Fibonaccis are multifunctional


The article demonstrated how to use Fibonaccis efficiently in your trading. However,
dont make the mistake of idealizing FIbonaccis and believing that they are superior
over other tools and methods. Nevertheless, Fibonacci is a great tool to have and can
be used very effectively as another confirmation method. Whether you are a trend
following or a support and resistance trader, or just looking for ideas how to place your
take profit orders, Fibonaccis are a great addition to your arsenal.
http://www.tradeciety.com/how-to-use-fibonaccis-in-your-trading-effectively/

Understand the best chart patterns


in 3 simple steps
I am a big believer in chart patterns and there are a few that can produce very reliable
signals. However, its never about the patterns themselves, but what those chart
patterns tell you about the market dynamics and how traders move price.

In this article I want to explain how to decode any chart pattern so that you will be able
to understand price movements in a much better way. In the second part we will take a
look at the 4 best chart patterns and how you can use them to make better trading
decisions.

The 3 components of chart patterns


All chart patterns, whether its the Head and Shoulders, triangles, wedges, pennants or
the Cup and Handle, are made up of the 3 same components. If you understand how to
read those 3 components, you can make much better trading decisions and understand
price in a new way.

#1 The foundation: highs and lows


Although it sounds very basic, the analysis of how highs and lows shape on your
charts builds the foundation of any chart pattern analysis. We will get into the nitty gritty
soon, but all future chart analysis is based on understanding highs and lows.

Higher highs and lower lows


The first premise is that higher highs signal a healthy uptrend, while lower lows signal a
downtrend. We will soon learn about the nuances of highs and lows and get into the
advanced concept, but this is the starting point.
Lower highs and higher lows
When you see that price fails to make a new high or low, it can serve as an early
warning signal that a change in direction is imminent.

The screenshot below shows that price first stopped making lower lows during the
downtrend and then even started making higher highs and higher lows. This is a classic
trend change pattern and patterns such as the Head and Shoulders or the Cup and
Handle are built upon this principle as we will see later.

#2 Strength of a trend: length and steepness of trend-


waves
The strength of a trend is defined by the individual trend waves that exist between the
highs and lows. Here, you should specifically look at the length/size and
thesteepness of those individual trend waves to get a feeling for trend strength.
Most conventional chart analysis only focuses on the highs and lows themselves, but an
important part is understanding what happens between the highs and lows.

In the screenshot below you can see that the first trend-wave (first black arrow) was
very steep and long. The second wave was less steep and shorter in duration. The final
third trend wave was much shorter and also just barely broke the previous high we
also saw more price wicks which are another rejection and exhaustion signal. Putting all
the clues together, the reversal could have been anticipated by understanding the
concepts of trend-wave length and steepness.

Further reading: How to read the strength of a trend from your charts.

#3 Strength of trends II: depth of pullbacks


Once you have identified that price is in a trend, the pullbacks within that trend can
provide valuable information of what might happen next.

The screenshot below shows an uptrend with many consolidations and retracements in
between. However, just before price reversed into a downtrend, the final retracement
was much larger in size and duration, showing that something had changed in buyer-
seller sentiment and balance.
Whereas a short and shallow retracement means that the ongoing trend is still intact,
when retracements become more frequent and larger in size, it can foreshadow a
potential trend shift as buyer and seller balance is slowly shifting.

Part 2 Understanding the 4 best chart


patterns
Usually, chart patterns are not that clear cut and far from the textbook examples that
youll usually find in trading literature or on other trading websites. Thus, it is even more
important to understand how to decode chart patterns to make the right trading
decisions.

We will now take a look at the 4 most commonly traded and discussed chart patterns
and see how our previous 3 principles apply to each one.
Triangles
A triangle shows a temporary period of consolidation within a trend or at the beginning
of a new trend. During an uptrend, a triangle is formed when the retracements and
pullbacks become smaller and smaller; buyers step in earlier each time to push price
back up. Triangles are much more reliable during established trends as they signal
accumulation of positions before the next trend continuation.
Further reading: Our detailed guide on how to trade triangles.

Head and Shoulders


A Head and Shoulders pattern signals a potential reversal and by decoding the
individual parts of this chart pattern youll quickly see how this pattern describes
sentiment shifts nicely:

From the left shoulder to the head, price makes a higher high. Often, the left shoulder
forms after an ongoing trend and the head is then usually just the last push. Then, the
right shoulder fails to make a new high which is the first indication that the trend might
be over. The break of the neckline then signals that price is going to make a lower low,
confirming the trend reversal.

Being able to interpret highs and lows is all you need when it comes to reading the
Head and Shoulders pattern.
Double Top / Double Bottom
Double tops and double bottoms are reversal patterns as well and, similar to the Head
and Shoulders pattern, the reasons and underlying dynamics are the same:

The second top, which fails to break the first high, signals that there are not enough
buyers to push price higher anymore. Therefore, when you see a double top or double
bottom it often signals a shift in price dynamics. If the double top is then followed by a
break lower and new lows, the trend shift is confirmed.
Cup and Handle
The Cup and Handle pattern is also just a series of highs and lows; the Cup and Handle
formation below shows a slow transition from a downtrend into a new uptrend. First, you
see a series of lower lows, followed by a consolidation at the bottom of the Cup and,
finally, price starts making higher highs. When then price breaks the top of the Cup, the
uptrend is confirmed. A potential Cup and Handle that does not break the previous
highs becomes a double top pattern.
Conclusion: Try to understand what price
tells you
As you can see, you can understand and decode all major chart patterns by looking at
how highs and lows form, how steep and long trend waves are and how deep
retracements are. This knowledge also enables you to estimate the quality of chart
patterns and it will help improve your chart reading abilities as well.

Lets recap what we have learned about the building blocks of chart pattern analysis:

(1) Highs and lows build the foundation of all chart analysis

(2) A first shift in sentiment occurs once price stops making higher highs or lower lows

(3) The length and the steepness of trend-waves define the overall trend strength

(4) The depth of retracement in between trend waves tells you a lot about the balance
between buyers and sellers
Trading the bull trap eliminating
losing traders
Rolf Stop Loss, Technical Analysis 2 Comments 11,113 Views

A bull trap occurs when traders take a long position on a promising setup and then have
price reverse and move lower very sharply. This pattern is called a trap because the
traders were tricked into a long position with usually very obvious bullish signalsas
we will see later.
Bull traps often happen around previous highs where it looks as if price is continuing the
rally. Especially amateur traders often tend to enter too early around such key levels
(read about FOMO here). Its especially dangerous if price rallies for a bit and trapped
traders see some profits because they feel too secure. When price then reverses, they
hold on to their loss too long and/or add to their existing position. As price keeps moving
against them, the loss becomes larger and larger until it hurts so much that trapped
traders are forced out of their trades this accelerates the reversal even further.

Bull trap orderflow What really happens


To fully understand the dynamics of the bull trap and then to use this information to our
advantage, we have to look at the orderflow and the thought process behind a bull trap.
Here are the individual phases:

1) Prelude: a long rally where people missed profit opportunities and/or are becoming
too greedy and want more.

2) Price then sets up a new trend wave that tempts people to enter new positions.

3) Price goes a little in the favor of the trapped traders, creating a feeling of confidence
and security.
4) Price reverses to the downside. People in disbelieve hold on to their trades that are
turning into a loss. Others add to their loss, hoping to average down.

4.1) The professionals are the ones who are aggressively selling and the amateurs are
still happily buying.

5) Price drops further and the trapped long position traders are now facing huge losses.
Most are forced out of their long trades which means that they have to sell which
accelerates the sell-off.

Bull and bear traps work exactly the same way here it is from a bear trap
perspective
Trading with insurance 2 great tips
As reversal traders, it is essential to understand the dynamics of bull and bear traps
because it is one of the most reliable and profitable types of reversal signals. Once you
can see where traders are trapped and how the stops that get triggered on the way
down accelerate a sell-off, you can make much better trading decisions and start trading
against all the losing traders.

However, before we get into the types of bull traps, here are our two insurance concepts
as reversal traders:
1) The late entry
For new and inexperienced traders, this is the hardest concept to follow and principle to
internalize but it will make a huge difference in your trading. Never sell while price is
going up and dont buy when price is doing down. Only sell when price is already
going down and only buy when price is going up.
Ever trade has 3 entries and whereas amateurs are either too early (entry 1
predicting) or too late (entry 3 chasing), professionals enter with confirmation.

2) The tiebreaker 20 SMA


The easiest way to make the concept of insurance work is by applying the 20 period
SMA to your charts and only trading in the direction of it. This means that you only trade
short after a bull trap once price has broken the 20 SMA to the downside and you only
enter a long trade after a bear trap after price has broken the 20 SMA to the upside.

Of course, there is a little more to reversal trading than just trading a break of the
moving average (watch video here), but using the 20 SMA as your filter will
automatically keep you from making the most common mistakes.
Types of bull and bear traps
Now that you understand the dynamics of how traps and squeezes work, we can take a
look at a few different examples because, after all, trading is a game of pattern
recognition and one type of setup rarely only has one way of presenting itself. As you
will see, the bull trap and the squeeze patterns come in different forms and it pays off to
understand the little nuances and dynamics that drive price.

Double top squeeze


This is the most classic pattern where you have two swing points where the second
swing penetrates the prior high and then immediately gets rejected.
Gap squeeze
During a gap-squeeze it looks like price is gaining momentum on the gap and traders
see themselves in profits longer. However, price just as fast gaps into the opposite
direction and squeezes the trapped traders. The reversal on a gap trade is usually much
faster since the squeeze happens suddenly and much stronger.

Engulfing bar squeeze Range squeeze


The engulfing bar and range squeezes are not commonly discussed but they happen
frequently. After a tight range or a slow trend, price suddenly makes a violent move and
many orders will get triggered around the spike.

This type of squeeze works so well because it works in the complete opposite way how
most losing trades think and you can exploit their weaknesses.
Pinbar squeeze
The pinbar squeeze usually happens at the end of an ongoing trend and its similar to
the gap squeeze. Whereas it looks like price will continue the trend, the only purpose of
this squeeze is it to allow the professionals to enter the new trend into the opposite
direction for the best possible price.
Whereas the amateurs sold in the screenshot below, the professionals happily bought
from them for a large discount.

You can see, the bull trap is not a standalone trading system but its a MUST KNOW
price and market dynamic because it is the type of market behavior that exploits the
weakness of the consistently losing traders. There is always someone else on the other
side of your trade and, thus, you should think twice who is buying from you and why do
they want your trade.
5 Ways To Identify The Direction Of
The Trend
Rolf Indicators, Price Action, Technical Analysis, Tradeciety Academy Leave a comment 27,814 Views

Contents in this article [hide]


Intro: The different market phases
1. The simple way: line graph
2. Highs and lows
3. Moving averages
4. Channels and trend lines
5. How to use the ADX indicator
Combining the best trading tools
Trading with the trend is trading with the flow. When the prevailing trend is up, why
would you want to look for short entries when buying might result in much smoother
trades? Many amateur traders, even when facing a long lasting trend that has been
going on for months, cant stop trying to predict reversals, whereas they could have
made so much more money by simply joining the trend.

But even if you are not a trend-following trader, you can combine the concept of trading
with the higher timeframe trend with your regular trading approach: you start on the
Daily timeframe and see if the trend its up, down or sideways and you use that
information on your lower, execution timeframe to time your trades (read here: how to
perform a multi-timeframe analysis). To be able to correctly read price action, trends
and trend direction, we will now introduce the most effective ways to analyze a chart.

Intro: The different market phases


Before we start going over how to identify the trend, we should be first clear what we
are looking for. Markets can do one of three things: go up, go down, or move sideways.
The picture above shows you the three possible scenarios and how markets keep
alternating between the phases. But knowing what has happened after the fact is
always the easy part. The hard part is finding out what is currently happening when
markets are moving in real time and the space on the right is empty thats where this
article comes in. To be clear, the article is not meant to show you how to identify trading
entries, but to understand price and trends in a more efficient way.

1. The simple way: line graph


Most traders only use bars and candles when it comes to observing charts, but
completely forget about a very effective and simple tool that allows them to look through
all the clutter and noise: the line graph. The purpose of bars and candles is to provide
detailed information about what is happening on your charts, but is this really necessary
when it comes to identifying the overall trend? Probably not.

A trader would do well to zoom out from time to time (at least once a week) and switch
to the line graph to get a better and clearer picture of what is currently happening. And
since our only goal is to identify the direction, the line graph is a perfect starting point,
especially when we are on the higher timeframe and just want to identify the overall
market direction.
2. Highs and lows
This is my personal favorite way of analyzing charts and although it sounds so simple, it
is usually everything you need. Conventional technical analysis says that during an
uptrend you have higher highs, because buyers are in the majority and push price
higher, and lows are also higher because buyers keep buying the dips earlier and
earlier. It works the same during a downtrend: lows are lower when the seller surplus
moves price lower and highs are lower because sellers sell earlier and buyers are not
as interested.
Again, it is not too important to get totally lost if you are using the trend direction just as
a filter for your trades. In most cases you should be able to tell relatively quickly whether
you are in an uptrend, in a downtrend or in a range.

Rule of thumb: If you cant tell what is happening on your charts quickly, it is
usually better to stand aside until you can see clearly again.

3. Moving averages
Moving averages are undoubtedly among the most popular trading tools and they are
great to identify the market direction as well. However, there are a few things to be
aware of when it comes to analyzing trend direction with moving averages.
The length of the moving average highly impacts when you get a signal when markets turn.
A small (fast) moving average might give a lot of early and false signals because it reacts too
soon to minor price movements. On the other hand, a fast moving average can get you out
early when the trend is about to change.
A slow moving average might provide signals too late. Or, it can help you ride trends longer
when it filters out the noise.
In the screenshot below we used the 50 EMA which is a mid-term moving average. You
can see that during an uptrend, price always stayed well above the moving average and
once price has crossed the moving average, it entered a range. In a range, price does
not pay too much attention to moving averages because they fall in the middle of the
range, hence average.
If you want to use moving averages as a filter, you can apply the 50 MA to the daily
timeframe and then only look for trades in the direction of the daily MA on the lower
timeframes.
4. Channels and trend lines
Channels and trend lines are another way of identifying the direction of a trend and they
can also help you understand range markets much better.

Whereas moving averages and the analysis of highs and lows can also be used
duringearly trend stages, trendlines are better suited for later trend stages because you
need at least 2 touch-points (better 3) to draw a trendline.
I mainly use trendlines to identify changes of established trends; when you have a
strong trend and suddenly the trendline breaks, it can signal the transition into a new
trend. Trendlines during ranges are ideal when it comes to finding breakout scenarios
when price enters the trending mode again. Also, trendlines can be combined with
moving averages nicely because of the complimentary characteristics.

If you want to learn more about trendlines, take a few minutes and watch our video
here: learn how to draw trendlines.
5. How to use the ADX indicator
The ADX is an indicator that you could use to determine the direction of the trend and
for the strength as well. The ADX indicator comes with three lines: the ADX line that
tells you the strength of the trend (we deleted this line in our example, since we only
want to analyze the direction of the trend), the +DI line which shows the bullish strength
(green line) and the -DI line which shows the bearish strength (red line).
As you can see in the screenshot below, the ADX signals an uptrend when the green
line is on top of the red line, and it signals a downtrend when the red line is higher than
the green line. When price is ranging, the two DI lines are very close together and hover
around the middle.

The ADX can be combined with moving averages nicely and you can see that once the
DI lines cross, price also crosses the moving average. In the video below we explain
how to use the ADX in more detail with the other concepts.
Combining the best trading tools
As we have seen in this article, every tool and concept has its advantages and
limitations nothing will work all of the time. However, it is not necessary that you find a
way to achieve a 100% winrate (which will not happen anyway) as long as your winners
are bigger than your losses.
In the end, it comes down to how well you choose your trading tools, how well you
understand them and how good you are when it comes to applying them to live market
conditions.
Candlesticks Forget Candlestick
Patterns This is All You Need to
Know
Understanding candlestick patterns goes far beyond remembering and recognizing
certain formations. Many books have been written about candlestick patterns, featuring
hundreds of different formations that supposedly provide secret information about what
is going to happen next. Truth be told, it will make no difference to your trading
performance whether you know what the Concealing Baby Swallow, Three Black Crows
or Unique Three River Bottom are. If you learn to how read candlesticks and price
action, you can really take your trading to the next level and understand much better
what your charts are telling you.

Candles Tell You a Story


Candlesticks are just a different way of visualizing what is happening on your charts.
But once you can read why and how candlesticks manifest on your charts, you can act
and trade detached from pre-defined and arbitrary patterns, reading sentiment and
momentum straight from your charts. In the following we take a look at the things that
candlesticks tell you and how to read them.

How to Read Candlestick patterns: The 5 x 5


of Candles
One of the most important things candles tell you is whether Bulls or Bears are winning
the game and, what might even be more important, by how much. But understanding
the story of price goes further than checking whether a candle is black or white; to fully
understand market sentiment you have to analyze the following five elements of
candlesticks:
1. The length of wicks/candles
The length of wicks and candles can give you direct information about volatility. Longer
candles imply greater volatility.

2. The ratio between bullish and bearish wicks


When price moves down and gets pushed back up, it leaves a long wick to the
downside. That can signal that bearish strength is not enough to keep prices down.

3. The position of the body


In addition to the previous point, it is important to analyze the position of the body. Does
the candle have a long wick to downside and is the body at the very top of the candle, it
can signal greater strength than a body in the middle of the candle. In contrast, does the
candle have long wicks to both sides and is the body positioned in the middle of the
candle, it indicates indecision and equal power between Bulls and Bears.

4. The size of the body


A rule of thumb is that the larger the body, the stronger the signal it provides. A large
body indicates that price moved a great distance between the open and the close of the
candle.

5. The ratio between body and wicks


Is the body of the candle large, whereas the wicks are small, it shows that price moved
from the open to the close without much volatility to either side. Small wicks and a large
body are a sign of strength. In contrast, long wicks and a small body indicate indecision
and equal power between Bulls and Bears.

If we combine the previous five points, we find that there are five possible scenarios
what candles could tell us: (1) Strong bullish power, (2) Strong bearish power, (3) Bears
tried to force price down, but Bulls managed to conquer, (4) Bulls tried to force price up,
but Bears managed to conquer (5) Bears and Bulls have equal power.
click to enlarge
All candlesticks formations are made up of these five scenarios, combining the five
previously described elements of candlestick information. By understanding the 5 x 5 of
candle elements, you are well equipped and do not need to remember any candlestick
pattern since they are all a combination of them.

The actual visual formatting of candlestick charts on trading platforms such as MT4,
Ninjatrader and JForex can differ, but the fundamentals of 5 x 5 will equip you with the
ability to understand all scenarios on the charts.

Demystifying Candle Patterns


We showed you that it is not necessary to remember any candlestick formation if you
understand the 5 x 5 candle elements previously discussed. To illustrate further how
candlestick patterns are constructed, see the following graphic. As you see, an
engulfing candlestick formation is therefore nothing but a pinbar/hammer when you add
up the two engulfing candles.

click to enlarge

More important, this is just one example of how candles are created and when you
understand how to read price and candles, you will notice that there is no need to
remember any more candlestick formation whatsoever.
Conclusion: No Need For Candlestick Patterns
With this article we want to show you that you do not have to learn any candlestick
formation. When you understand the 5 x 5 of candlesticks, you know everything you
need to know about candles. The 5 x 5 enables you to read every possible scenario that
you can find on your charts.

7 rejection price patterns you need


to know to make more money
Rolf Price Action, Technical Analysis 3 Comments 10,431 Views

Contents in this article [hide]


1. Double bottom + Squeeze / Bollinger Band spike
2. The demand zone dip
3. Head and Shoulders
4. Exhaustion gap
5. Supply dip and deeper dip
6. Range top and S/R flip
7. Triple top and momentum candle
Being able to understand when a trend is likely to stop and/or reverse is an important
trading skill and it can help traders with exiting trades, riding trends to make more
money or finding trend reversal entries as well. In this article, I will introduce 7 price
rejection patterns that you can see over and over again across markets and timeframes.

1. Double bottom + Squeeze / Bollinger


Band spike
The bottom formation below is very common and after prolonged trends, you can often
see consolidation periods where not much happens. The trigger that signals a new
trend into the opposite direction is the spike outside of that range and the immediate
rejection.

Its a classic trap and the reversals into the opposite direction of the fake spike can be
explosive. Thus, if you are in a trade and you see a rejected spike through the Bollinger
Bands (note that we use 2.5 Std Dev. Bollinger Bands), its a good time to exit your
trade and wait for potential reversal entries.

Read more: How to trade the Bollinger Band squeeze


2. The demand zone dip
Estimating whether a price level will hold or break during a trending move is very difficult
but the demand-dip shows clearly that the trend is likely to be over. In the screenshot
below, price was in a strong downtrend but once price reached the demand
zone marked in green, price first accelerated into the zone and then completely
reversed. Its very common to see an acceleration into a demand zone because it
creates the illusion that the trend is picking up momentum, whereas the smart money is
just creating a trap. The wick to the downside and the bullish candle afterwards are
clear signs that the trend is over.
3. Head and Shoulders
The Head and Shoulders is my absolute favorite pattern of all because it shows
perfectly how the natural trend structure (higher highs or lower lows) is broken and price
slowly transitions from one trend phase into the next.
The screenshot below shows that nicely and the large red candle that then broke the
neckline and confirmed the new trend structure (lower highs and lower lows), was the
final piece to the puzzle and the signal that momentum to the downside is picking up.

It seems such a simple pattern but it works very well and you can see the Head and
Shoulders daily when it signals the rejection of a trend.
4. Exhaustion gap
An exhaustion gap is common in stock trading or on weekly Forex charts where you can
actually see gaps. In the screenshot below you can see how price gapped higher above
the first dotted resistance zone and then even tried to move higher as we see with the
wick. Then, suddenly, the trend completely reversed and whereas previous candles
were mostly small, the large red candle at the top showed a clear change in trend
sentiment.

The gap created the illusion that buyers were pushing price much higher and a lot of
retail traders probably jumped on the train, just to see how they were tricked into the
wrong trade.

note: the marked large red candle at the top opened at the high of the body and then
closed lower, indicating the gap up to the previous small green candle.
5. Supply dip and deeper dip
The screenshot below shows nicely how price consumes unfilled supply and how supply
and demand levels can be used to identify likely turning points. On the far left, the
supply zone was created after price suddenly sold-off very sharply.

The next time price rallied back into the area, it found new sellers at the very low of the
supply zone and turned lower, leaving with an engulfing candle. Afterwards, a new trend
was started to the downside.
The next time, price went into the supply zone deeper and you can see a few more
pushes into the supply zone, every time a little deeper to consume more of the sell
orders and also to trigger stops above that area. The final push wasnt as strong and it
became clear that buyers werent able to push higher again and then price sold off. I
love how charts can tell you such a story.

6. Range top and S/R flip


The support and resistance flip happens ALL THE TIME and probably every trader has
heard that support turns into resistance and vice versa. Below, you can see a great
example, how price went from going higher, to then making a range top where price just
consolidated and market participants were wrestling about the new direction. Once it
sold off lower, into the new support, price then also retested the old support as
resistance. The rejection wick that went into the new resistance was a clear sign that
price is ready to move lower and that buyers arent strong enough to break higher. On
the way down, price kept repeating this break and retest pattern and you can see such
patterns across all markets. Thats why using support and resistance for your trailing
stop works so well too because during a healthy trend, those levels hold while you only
get kicked out of your trades when levels break.
7. Triple top and momentum candle
I am a big fan of momentum candles and momentum shifts because they are a very
obvious signal for the overall trend sentiment. In the screenshot below you can see how
price consolidated in the range after the rally and then suddenly we saw the large red
candle which did not break below the low but it clearly indicated a change in trading
behavior. Momentum candles stick out and are easy to see; they signal that markets are
ready to enter a new direction and start a new trend with an impulsive move. Its
important to wait for the close of such a candle to avoid running into traps
althoughFOMO (Fear of missing out) often makes traders jump onto such candles too
early.
You can see, being able to read rejection patterns is a great skill and if you learn to
listen to the story price tells you, you will be able to read market structure, orderflow and
buyer-seller balance much better by just using price action principles.

Why entries dont matter the 6


phases of a good trade
Rolf Psychology, Tips 1 Comment 2,302 Views

Contents in this article [hide]


Step 1: Planning watchlist and market selection
Step 2: Waiting avoiding bad trades
Step 3: The entry execution
Step 4: Management micro management
Step 5: Exiting & post exit emotional problems
Step 6: Review and improvement
This is a very controversial topic and one that, if understood correctly, can make the
difference between a losing and a consistently profitable trader. So lets get it out right
away: Entries dont matter! This is, especially if you are a new trader, hard to grasp
and many people will not agree keep on reading and it will become clearer. By the
end of this article, everyone will understand why entries are not as important as they
think.
Most traders are always looking for better indicators, new trading tools or change (read:
mess with) their trading rules because they believe that finding better entries will make
them better traders. Let me tell you, the way you define entries has very little to do with
your success or failure as a trader.
But what is it then that you should be looking for to become a better trader?

Every trade has 6 stages and it doesnt matter what type of trader you are, all traders
will go through the same 6 phases the entry is just 1 one them. So let me walk you
through the different phases and explain what they mean and the importance of them.

Step 1: Planning watchlist and market


selection
This is a step most traders miss and they dont know how to select the right chats. You
have to know which market suits your trading style and method. If you are a trend
trader, look for markets with early explosive momentum moves; when you are a range
trader, look for clearly defined boundaries and when you trade reversals, look for signs
of fading momentum after a trend.

Every good trade starts by carefully screening the markets you consider trading,
eliminating the ones that dont show promising conditions and keeping the ones that
could potentially generate a trade soon.

Read here: How to select the right markets and create a watchlist

Step 2: Waiting avoiding bad trades


WAY more important than entries and entering trades is staying out of trades that you
shouldnt be in. Knowing when not to trade is an extension of the previous point and
after you have created your watchlist, you sit back and wait until price generates a trade
on your screened markets.

For most traders, avoiding more trades would greatly benefit their performance. Just
take a look at your past performance and evaluate how your trading performance would
look like if you hadnt taken all the trades you knew you shouldnt be in.
Read more: 9 situations when not to trade

Step 3: The entry execution


If you have done your work prior up to this point, have carefully selected your watchlist
and waited patiently for a signal to occur, all you have to do now is to confirm that you
are seeing a valid signal:

Go over the chart once again and double-check if all criteria are present
Make sure no news are coming up right away
Check for reasonable stop and profit levels
Then set your position size for your risk target.
The trade entry is nothing more than pulling the trigger when your criteria are met. Ask
yourself if you should really be taking the trade. A checklist is the ultimate tool ultimate
tool here that will help you make better trading decisions.
Step 4: Management micro management
Once you are in the trade, you have to continuously make new decisions and evaluate
the situation:

You have to assess whether price is likely to keep going your way
How do you estimate the chance of a turnaround
Do you partially close your trade
Do you add to your trade
Should you move your stop loss?
Will the upcoming news announcement mess with your trade and what can you do about it?
At the same time, you have to avoid micro-management at all costs. Micro-management
means that you keep watching your trade tick by tick and continuously fiddle around
with your trade.

Most traders spend all their time trying to find better entries so that once they are in a
trade, they dont know what to do and then completely mess everything up.

You can probably already see that pre-trade actions (waiting for the right market
selection and conditions) and in-trade decisions (trade management) have a huge
impact on your overall trading performance. Trade entries seem to lose their importance
more and more.

Step 5: Exiting & post exit emotional


problems
Exiting, in the actual sense, is an extension of trade management decisions. However,
there is also an emotional component to exiting trades and the post-trade decisions.

Exiting a losing trade and then seeing price turn around can easily lead to chasing price
and re-entering the market with a less than ideal trade, purely driven by emotions.

Staying in a losing trade too long can eat up your emotional capital and then distort your
perception on your next trade.

Exiting a winner too soon and seeing how much you have missed can create inner
tension and also lead to over-trading. And so on
Thus, its not only important to know what to do before or during a trade, but your
thoughts and feelings after a trade can easily influence your next trading decisions.

Step 6: Review and improvement


If you dont think that this step doesnt belong to the 6 different trade stages, you are
missing out. Whereas most losing traders will never look at a closed trade again after
they have exited the position, the professional understands the importance of post-trade
analysis.

The trader who carefully audits his past trades is less likely to look for a different entry
method because he understands his trading method and performance better. At the
same time, he can make small adjustments based on his past performance which allow
him to continuously improve his method, instead of jumping from one method to the
next and never seeing any kind of consistency.

The goal of a trader has to be to achieve consistency in the way he executes his trades.
Falsely believing that his whole performance is based on the way he enters his trades
can easily lead to wrong assumptions and then cause so-called system-hopping
where he frequently changes method, hoping to find the one thing that will finally give
him the right trade entries.

Bollinger Bands Explained The


best trading indicator for different
purposes
Rolf Indicators, Price Action, Technical Analysis, Tradeciety Academy 9 Comments 25,098 Views

Contents in this article [hide]


Bollinger Bands explained 101
Trend-trading with the Bollinger Bands
Finding tops and bottoms with Bollinger Bands
The role of the moving average
Bollinger Bands are among the most reliable and potent trading indicators traders can
choose from. Bollinger Bands can be used to read market and trend strength, to time
entries during range markets and to find potential market tops. Bollinger Bands are a
dynamic indicator which means that they adapt to changing market conditions and,
thus, have benefits over other standard indicators which are often perceived as
lagging. In this article, we show you how to use Bollinger Bands to improve your chart
reading skills and to identify high probability trade entries.

Bollinger Bands explained 101


As the name implies, Bollinger Bands are price channels (bands) that are plotted above
and below price. The outer Bollinger Bands are based on price volatility, which means
that they expand when price fluctuates and trends strongly, and the Bands contract
during sideways consolidations and low momentum trends.

By default, the Bollinger Bands are set to 2.0 Standard deviations. However, we
suggest setting the Bollinger Bands to 2.5 Standard Deviations to make them wider and
capture more price action. With the 2.5 standard deviations, 99% of all price action falls
between the two bands, which means that a violation of the outer bands becomes a
much more meaningful signal as we will see (watch the video at the end for more
info about that).
The center of the Bollinger Bands is the 20-period moving average and the perfect
addition to the volatility based outer bands.

Trend-trading with the Bollinger Bands


In contrast to most other indicators, the Bollinger Bands are non-static indicators and
they change their shape based on recent price action and accurately measure
momentum and volatility. Thus, we can use the Bollinger Bands to analyze the strength
of trends and get a lot of important information this way. There are just a few things you
need to pay attention to when it comes to using Bollinger Bands to analyze trend
strength:

During strong trends, price stays close to the outer band


If price pulls away from the outer band as the trend continues, it shows fading momentum
Repeated pushes into the outer bands that dont actually reach the band show a lack of
power
A break of the moving average is often the signal that a trend is ending
The screenshot below shows how much information a trader can pull from using
Bollinger Bands alone. Let me walk you through the points 1 to 5:

1) Price is in a strong downtrend and price stays close to the outer bands all the time
very bearish signal.

2) Price fails to reach the outer band and then shots up very strongly, even showing an
engulfing pattern. This is a classic reversal pattern where the bearish trend strength
faded.

3) 3 swing highs with lower highs. The first swing high reached the outer band whereas
the following two failed fading strength.

4) A strong downtrend where price stayed close to the outer band. It tried to pull away,
but bears were always in control.

5) Price consolidates sideways, not reaching the outer band anymore and the rejection-
pinbar ended the downtrend.

As you can see, the Bollinger Bands alone can provide a lot of information about trend
strength and the balance between bulls and bears.
Finding tops and bottoms with Bollinger
Bands
After setting your Bollinger Bands to 2.5 standard deviations, you will see that price
reaches the outer bands less often. At the same time, the meaning of such signals
becomes much more important because it shows significant price extremes.

We highly recommend combining the Bollinger Bands with the RSI indicator its the
perfect match. There are two types of tops that you need to know about:
1) Price spikes into the outer Bollinger Bands which get rejected immediately >>
Reversal signal

2) After a trend move, price fails to reach the outer Band as the trend becomes weaker.
This signal is usually accompanied by an RSI divergence >> Continuation signal
The screenshot below shows both scenarios: the first is the market top after a
divergence see how the trend became weaker and lost momentum and then
eventually failed to reach the outer Band before reversing. I marked the second spike
with an arrow this was a trend continuation signal as price failed to break higher
during the downtrend. The strong spike that was followed by a fast rejection showed
that bulls lacked power.
The role of the moving average
During trends, the moving average holds very accurately and a break of that moving
average is usually a meaningful signal that the sentiment has shifted. The screenshot
below shows nicely how price trended between the outer bands and the moving
average both on the way up and down. During the trend, the moving average could
have been used as a re-entry signal to add to existing positions during pullbacks.
Furthermore, the moving average can be used as a trade exit signal where a trader
does not close his existing positions unless price has broken the moving average. By
combining the Bollinger Bands with the moving average, a trader can already create a
robust trading method.

You can see, the Bollinger Bands are a multi-faceted trading indicator that can provide
you with lots information about trend, buy/seller balances and about potential trend
shifts. Together with the moving average and the RSI, Bollinger Bands make for a great
foundation for a trading strategy.
Understand the best chart patterns
in 3 simple steps
I am a big believer in chart patterns and there are a few that can produce very reliable
signals. However, its never about the patterns themselves, but what those chart
patterns tell you about the market dynamics and how traders move price.

In this article I want to explain how to decode any chart pattern so that you will be able
to understand price movements in a much better way. In the second part we will take a
look at the 4 best chart patterns and how you can use them to make better trading
decisions.

The 3 components of chart patterns


All chart patterns, whether its the Head and Shoulders, triangles, wedges, pennants or
the Cup and Handle, are made up of the 3 same components. If you understand how to
read those 3 components, you can make much better trading decisions and understand
price in a new way.

#1 The foundation: highs and lows


Although it sounds very basic, the analysis of how highs and lows shape on your
charts builds the foundation of any chart pattern analysis. We will get into the nitty gritty
soon, but all future chart analysis is based on understanding highs and lows.

Higher highs and lower lows


The first premise is that higher highs signal a healthy uptrend, while lower lows signal a
downtrend. We will soon learn about the nuances of highs and lows and get into the
advanced concept, but this is the starting point.
Lower highs and higher lows
When you see that price fails to make a new high or low, it can serve as an early
warning signal that a change in direction is imminent.

The screenshot below shows that price first stopped making lower lows during the
downtrend and then even started making higher highs and higher lows. This is a classic
trend change pattern and patterns such as the Head and Shoulders or the Cup and
Handle are built upon this principle as we will see later.

#2 Strength of a trend: length and steepness of trend-


waves
The strength of a trend is defined by the individual trend waves that exist between the
highs and lows. Here, you should specifically look at the length/size and
thesteepness of those individual trend waves to get a feeling for trend strength.
Most conventional chart analysis only focuses on the highs and lows themselves, but an
important part is understanding what happens between the highs and lows.

In the screenshot below you can see that the first trend-wave (first black arrow) was
very steep and long. The second wave was less steep and shorter in duration. The final
third trend wave was much shorter and also just barely broke the previous high we
also saw more price wicks which are another rejection and exhaustion signal. Putting all
the clues together, the reversal could have been anticipated by understanding the
concepts of trend-wave length and steepness.

Further reading: How to read the strength of a trend from your charts.

#3 Strength of trends II: depth of pullbacks


Once you have identified that price is in a trend, the pullbacks within that trend can
provide valuable information of what might happen next.

The screenshot below shows an uptrend with many consolidations and retracements in
between. However, just before price reversed into a downtrend, the final retracement
was much larger in size and duration, showing that something had changed in buyer-
seller sentiment and balance.
Whereas a short and shallow retracement means that the ongoing trend is still intact,
when retracements become more frequent and larger in size, it can foreshadow a
potential trend shift as buyer and seller balance is slowly shifting.

Part 2 Understanding the 4 best chart


patterns
Usually, chart patterns are not that clear cut and far from the textbook examples that
youll usually find in trading literature or on other trading websites. Thus, it is even more
important to understand how to decode chart patterns to make the right trading
decisions.

We will now take a look at the 4 most commonly traded and discussed chart patterns
and see how our previous 3 principles apply to each one.
Triangles
A triangle shows a temporary period of consolidation within a trend or at the beginning
of a new trend. During an uptrend, a triangle is formed when the retracements and
pullbacks become smaller and smaller; buyers step in earlier each time to push price
back up. Triangles are much more reliable during established trends as they signal
accumulation of positions before the next trend continuation.
Further reading: Our detailed guide on how to trade triangles.

Head and Shoulders


A Head and Shoulders pattern signals a potential reversal and by decoding the
individual parts of this chart pattern youll quickly see how this pattern describes
sentiment shifts nicely:

From the left shoulder to the head, price makes a higher high. Often, the left shoulder
forms after an ongoing trend and the head is then usually just the last push. Then, the
right shoulder fails to make a new high which is the first indication that the trend might
be over. The break of the neckline then signals that price is going to make a lower low,
confirming the trend reversal.

Being able to interpret highs and lows is all you need when it comes to reading the
Head and Shoulders pattern.
Double Top / Double Bottom
Double tops and double bottoms are reversal patterns as well and, similar to the Head
and Shoulders pattern, the reasons and underlying dynamics are the same:

The second top, which fails to break the first high, signals that there are not enough
buyers to push price higher anymore. Therefore, when you see a double top or double
bottom it often signals a shift in price dynamics. If the double top is then followed by a
break lower and new lows, the trend shift is confirmed.
Cup and Handle
The Cup and Handle pattern is also just a series of highs and lows; the Cup and Handle
formation below shows a slow transition from a downtrend into a new uptrend. First, you
see a series of lower lows, followed by a consolidation at the bottom of the Cup and,
finally, price starts making higher highs. When then price breaks the top of the Cup, the
uptrend is confirmed. A potential Cup and Handle that does not break the previous
highs becomes a double top pattern.
Conclusion: Try to understand what price
tells you
As you can see, you can understand and decode all major chart patterns by looking at
how highs and lows form, how steep and long trend waves are and how deep
retracements are. This knowledge also enables you to estimate the quality of chart
patterns and it will help improve your chart reading abilities as well.

Lets recap what we have learned about the building blocks of chart pattern analysis:

(1) Highs and lows build the foundation of all chart analysis

(2) A first shift in sentiment occurs once price stops making higher highs or lower lows

(3) The length and the steepness of trend-waves define the overall trend strength

(4) The depth of retracement in between trend waves tells you a lot about the balance
between buyers and sellers
How to trade triangles a step by
step guide
Rolf Indicators, Price Action, Technical Analysis, Tradeciety Academy 2 Comments 8,264 Views

Contents in this article [hide]


What is a triangle telling you?
Triangles in the world of trading
Triangles and losing momentum 3 case studies on how to trade triangles
How not to trade triangles
Wrapping things up how to trade triangles
Triangles are a very popular price action concept but there are a lot of misconceptions
about what they really show and how to interpret triangles correctly. Triangles can tell
you a lot about market dynamics, momentum shifts and the balance between bulls and
bears if you know what you are looking for.

What is a triangle telling you?


A triangle tells you a lot about the market and the current situation. The easiest way to
understand triangles is by looking at an example outside the world of trading. When you
throw a ball it will bounce, but each bounce will be lower than the previous bounce. The
ball is losing momentum and gravity takes over until the energy of the ball is completely
gone and it does not bounce anymore.
Triangles in the world of trading
In trading, it works almost the same. There are different kinds of triangles, but we will
focus on the most important one the asymmetrical triangle. The screenshot below
shows that each bounce has a lower high. At the same time, the higher lows are not
moving up with the same strength; clearly, the highs are coming down faster. Price
is losing the bullish momentum and each time price tries to move higher, it is being
pushed down earlier.
Triangles are a manifestation between the fight (imbalance) between long and short
positions. Knowing how to interpret such a scenario can help your decision-making
process and deepen your understanding about market dynamics.

Of course, there are also asymmetrical triangles that signal bullish strength as the
screenshot below shows. It is obvious that price is moving into the resistance area with
strong force. Each time price moves down, the bulls take over sooner and drive price
back into the resistance area. This is not to be confused with a double top pattern which
can look very similar.
Triangles and losing momentum 3 case
studies on how to trade triangles
The screenshot below illustrates how a triangles shows losing momentum. Each time it
touches the support level, the following bounce back up becomes smaller as the MACD
indicator shows. Just before broke price broke the support level, it tested the upper
trendline multiple times but failed to break it. Combining all those points gave some
early indications that a break to the downside was more likely than a break to the
upside.
The next screenshot below shows another example of how the momentum to the upside
is building up each time price moved into the resistance level. Back then, everyone was
watching the 10,000 price level at the DAX and you could read about people expecting
a reversal to the downside every day. The final triangle clearly supported a breakout to
the upside. Price had been moving into the resistance area multiple times and each
time the bounce to the downside become shallower. At the same time, the RSI
indicator confirmed the losing momentum to the downside.
Yes, shorting into the 10,000 would have provided some good trading opportunities as
well, but the real money was mad after the break of the triangle.
Reminder: profitable trading is about connecting the dots and combining the clues your
chart patterns provide to build sophisticated trade scenarios. Profitable trading is not
only hunting for signals but understanding market dynamics.

The final example shows another multi-bottom and a trendline that is moving down.
Especially interesting are all the candle wicks that are sticking out to the top. Multiple
failed attempts to break to the upside fooled amateur traders and also showed the lack
of bullish support. Although everything pointed to a break to the bottom, the final signal
did not come until price broke the support level with the large red candle.
How not to trade triangles
Triangles are a great trading concept, but they will fail often. However, the biggest
mistake traders make is that they enter BEFORE the break of the triangle happened.
Take a look at the screenshot below based on the previous triangles and momentum
analysis, one would have expected a break to the downside; the highs were coming
faster and price moved into the bottom trendline rapidly. But it did not happen and price
broke out of the triangle to the upside.

This highlights that triangles are not the Holy Grail and they will fail. And secondly, the
real signal of a triangle happens when the trendline has been broken not before.
Furthermore, a break of the trendline is only valid after price closed outside the triangle
AND stayed outside it. Waiting for a full candle to form outside the triangle will make you
miss some runaway trades, but it will keep you from taking some failed breakoutsas
well.

Wrapping things up how to trade


triangles
Here are the most important points and tips when it comes to understanding and trading
triangles:
Analyze the slope and the angle of trendlines
The angle and the formation of highs and lows are a manifestation of the (im)balance
between bulls and bears
A triangle typically shows losing momentum to one side
Double tops and/or failed breakouts before the triangle forms are great tells
RSI or the MACD can help measure the momentum in triangle patterns
Triangles will fail very often. They key is to wait for a confirmed breakout

An Introduction To Price
Action Trading Strategies
Price Action describes the characteristics of a securitys price movements. This movement
is quite often analyzed with respect to price changes in the recent past. In simple terms,
price action is a trading technique that allows a trader to read the market and make
subjective trading decisions based on the recent and actual price movements, rather than
relying solely ontechnical indicators.

Since it ignores the fundamental analysis factors and focuses more on recent and past price
movement, the price action trading strategy is dependent on technical analysis tools.

What tools are used for price action trading?

Since price action trading relates to recent historical data and past price movements,
all technical analysis tools like charts, trend lines, price bands, high and low swings,
technical levels (of support, resistance and consolidation), etc. are taken into account as per
the traders choice and strategy fit.

The tools and patterns observed by the trader can be simple price bars, price bands, break-
outs, trend-lines, or complex combinations involving candlesticks, volatility, channels, etc.

Psychological and behavioral interpretations and subsequent actions, as decided by the


trader, also make up an important aspect of price action trades. For e.g., no matter what
happens, if a stock hovering at 580 crosses the personally-set psychological level of 600,
then the trader may assume a further upward move to take a long position. Other traders
may have an opposite view once 600 is hit, he or she assumes a price reversal and hence
takes a short position.

No two traders will interpret a certain price action in the same way, as each will have his or
her own interpretation, defined rules and different behavioral understanding of it. On the
other hand, a technical analysis scenario (like 15 DMA crossing over 50 DMA) will yield
similar behavior and action (long position) from multiple traders.

In essence, price action trading is a systematic trading practice, aided by technical analysis
tools and recent price history, where traders are free to take their own decisions within a
given scenario to take trading positions, as per their subjective, behavioral and
psychological state.

Who uses price action trading?

Since price action trading is an approach to price predictions and speculation, it is used by
retail traders, speculators, arbitrageurs and even trading firms who employ traders. It can be
used on a wide range of securities including equities, bonds, forex,
commodities, derivatives, etc.

Steps used in price action trading:

Most experienced traders following price action trading keep multiple options for recognizing
trading patterns, entry and exit levels, stop-losses and related observations. Having just one
strategy on one (or multiple) stocks may not offer sufficient trading opportunities. Most
scenarios involve a two-step process:

1) Identifying a scenario: Like a stock price getting into a bull/bear phase, channel range,
breakout, etc.

2) Within the scenario, identifying trading opportunities: Like once a stock is in bull run, is it
likely to (a) overshoot or (b) retreat. This is a completely subjective choice and can vary
from one trader to the other, even given the same identical scenario.

Here are a few examples:

1) A stock reaches its high as per the traders view and then retreats to a slightly lower level
(scenario met). The trader can then decide whether he or she thinks it will form a double
top to go higher, or drop further following a mean reversion.

2) The trader sets a floor and ceiling for a particular stock price based on the assumption of
low volatility and no breakouts. If the stock price lies in this range (scenario met), the trader
can take positions assuming the set floor/ceiling acting as support/resistance levels, or take
an alternate view that the stock will breakout in either direction.
3) A defined breakout scenario being met and then trading opportunity existing in terms of
breakout continuation (going further in the same direction) or breakout pull-back (returning
to the past level)

As can be seen, price action trading is closely assisted by technical analysis tools, but the
final trading call is dependent on the individual trader, offering him or her flexibility instead of
enforcing a strict set of rules to be followed.

The popularity of price action trading

Price action trading is better suited for short-to-medium term limited profit trades, instead of
long term investments.

Most traders believe that the market follows a random pattern and there is no clear
systematic way to define a strategy that will always work. By combining the technical
analysis tools with the recent price history to identify trade opportunities based on the
traders own interpretation, price action trading has a lot of support in the trading
community.

Advantages include self-defined strategies offering flexibility to traders, applicability to


multiple asset classes, easy use with any trading software, applications and trading portals
and the possibility of easy backtesting of any identified strategy on past data. Most
importantly, the traders feel in-charge, as the strategy allows them to decide on their
actions, instead of blindly following a set of rules.

The Bottom Line

A lot of theories and strategies are available on price action trading claiming high success
rates, but traders should be aware of survivorship bias, as only success stories make news.
Trading does have the potential for making handsome profits. It is up to the individual trader
to clearly understand, test, select, decide and act on what meets his requirements for the
best possible profit opportunities.

Read more: An Introduction To Price Action Trading Strategies |


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