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Trend & Pattern Recognition

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Chapter 7

Trend & Pattern Recognition

Description

 

  • Support & Resistance Strategy—
  • Go for the time frame you want to trade on, as a beginner its suggested to trade on 15 min or 1Hr time frame, only to keep your risk under control.
  • Verify whether the price is in bullish trend or bearish trend.
  • You shall make an entry at Support or Resistance break to enter running trend.
  • Below for Bearish Trend; Make an entry at the closing of the current bearish candle that breaks the Support. If you don’t want aggressive but want to make conservative entry then let price comes back to test the resistance & then make entry after the next bearish candle confirms fall in price below the wick / tail end of the lowest low candle that broke the support.
  • Keep a stop loss always at the top wick of the bearish candle that initially broke the Support.
  • Take lot size by risking no more than 1.5% - 2%
  • Set your take profit at 1:2

 

Note—in a reverse format you can trade Resistance during Bullish trend.

 

(Sourced from www.Tradingview.com)

 

 

 

 

 

7.1 Trend Recognition

Trend recognition is an important step to make entry into the market. You just don’t decide one moment based on small or big price movements of the pair to enter the market.

This much simpler to follow what’s said for trends than to be proven wrong in trending markets. “Trend is a friend” so you must recognize the trend for the market.

“Don’t try to catch the falling knife” so if you defy the trend then there are always higher chances for you to be in drawdown.

(1)

So let's remind ourselves of the fundamental mantras of recognizing a trend as described in Chapter 5 “Trend Lines & Trends”

(a)

Trend is time frame specific.

(b)

When the market is making higher highs and higher lows that means the market is trending up; this means the market is bullish or in other words continuous rise in prices in one direction creates a bullish trend.

When the market is making lower lows and lower highs that means the market is trending down; this means the market is bearish or in other words continuous fall in prices in one direction creates a bearish trend

(2)

You can also recognize the trend by using trend lines. How to find a bullish trend, bearish trend and consolidations are clearly described in Chapter 5 “Trend Lines & Trends.

 

(3)

Do you think that institutional trading has some sort of algorithms built from some sci-fi movies? No. Most of them use moving averages and support & resistance based algorithmic trading.

 

You can also recognize the trend by using moving averages, SMA or EMA. As described in Chapter 6 “Moving Averages”. Moving average filters out or smoothes the candle fluctuations and provide an average of the price. You assess the direction of the trend.

The exponential moving average is aligned more closely with candles than SMA as it assigns better weightage to current price movements in the market.

 

 

So if the pair is trading over the 50 EMA then the trend is bullish. Always trade bullish.

So if the pair is trading under the 50 EMA then the trend is bearish. Always trade bearish.

 

We will discuss entries and exists in Chapter 8.

 

7.2 Pattern Recognition

Pattern recognition is the most resourceful skill for your trading.

So what is a pattern? A pattern is a repeat of structure.

So what is a structure? A structure is built-up of expected or tested display or pair price movement with combination candle formations, trends, trend lines, support & resistance, etc. Note- candle formations are a group of candles displaying patterns.

Don’t confuse yourself finding pattern with repeat of structure within a specific time frame in short duration. The market will not throw at you the same patterns in short duration. So you need to be aware of various patterns coming at you.

 

So what’s the purpose of pattern recognition? It provides potentially successful trade entries. So based on the pattern you can extrapolate the market’s next potential move.

A pattern may not be 100% right all the times (& also dubbed fakey) but basic patterns are always found to be stable in providing clues to infer the next move.

 

The idea behind pattern recognition is that once you see a specific pattern forming you can get ready for entry as soon as the pattern is complete then so can enter the market.

Please note only when the pattern is complete you should enter to minimize your drawdown.

 

The best way to apply patterns is that after you studied and understood these patterns then practice making these on your chart with your drawing tools, throughout the charts. Once you draw a pattern go to higher and lower time frame to see how it's displayed as a different pattern on these lower or higher time frames. This will certainly give a clear understanding of patterns to you.

You don’t have to hunt for the pattern formation; once you get to practice enough to create/draw patterns for regular use then you can easily see them forming on the charts with mere looking at charts based on your visual/spacial senses.

You must practice pattern recognition before your jump onto trade entries.

 

Note- Most commonly used patterns are given below in the “Details” section

 

 

 

 

 

 

 

 

 

 

 

 

 

7.3 Trend Retracement, Extension & Trend Reversal

You very well understand that markets doesn’t move in a straight line. It moves in waves: up & down.

 

In the figure below, the bullish trend is formed with a higher low is higher than the previous higher low then price moving to the next higher high & this forms a wave ABCD. Where AB is the bullish move up, then BC is called Retracement of the trend, then CD is Extension of the trend. This continues for the bullish trend.

 

Until the new higher high cannot break above the previous higher high (means the bullish extension stays short of the higher high)and trend further makes a lower low that is lower than the previous lower low that shows now potentially the trend is changed onto bearish. This is called Trend Reversal where bearish extension is bigger than the retracement and prices tend to fall down.

 

 

(Sourced from www.Tradingview.com)

 

 

 

 

Details of Most commonly used patterns

 

7.4 Candle Stick Patterns / Candle Formations

Candlestick patterns are used with 2 or more combination/group of candle forms patterns. Following candle patterns/candle formations are mostly used to infer the next move.

 

 

7.5 Doji & Gap

Doji

 

Doji is the only unique formation that has only one candle in its formation for pattern.

You can review Chapter 3 “Candle Sticks / Candle Stick Charts” for details. Doji & Hanging man clearly displays extreme biased sentiment of the market.

 

 

 

 

 

 

 

 

 

 

Hanging Man & Hammer candles

 

 

 

 

A formation such as Doji or Hanging-man has a higher tendency of trend reversal. (note that same is the case with Hanging Man & Hammer candles)--

 

(Sourced from www.Tradingview.com)

 

 

 

 

Gaps—

 

A blank space between the end of the end and start of next candle with a price higher or lower than the last closing price is called Gap.

 

The gaps are not common in forex than what you see in stocks but these do appear sometimes on start of the new trading week as a price difference between interbank trading and retail trading over the weekend or holiday.

 

Now note down a tip on gaps.

 

Myth or not there is always a high potential for the gap to be filled. In rare cases, it does not fill the gap. Some traders trade based on the gap to be filled or not to be filled.

 

Why price fills and does not fill the gap?

 

I don’t know much about this myth but its very simple to analyze this; take a note if the gap to be filled is in the direction of the “Overall Trend; then the gap will be filled else the gap will potentially will not be filled. Sometimes the gap is filled & then market reverses to continue in the overall direction of trend. In either case, there is an opportunity for a profitable trade. Please see below Fig (A) for Gap filled & Fig (B) for Gap not filled.

 

 

 

 

 

 

 

 

 

 

 

 

Fig (A) for Gap filled--

 

(Sourced from www.Tradingview.com)

 

 

Fig (B) for Gap not filled--

 

(Sourced from www.Tradingview.com)

 

 

 

7.6 Engulfing Candle / Engulfing Candle Pattern

When a candle or 2 candles in succession engulfs the previous set of 2-3 trending candles in opposite direction this is called engulfing candle pattern.

When the body of 1 or 2 consecutive Bullish candles covers more than 70% of the body of a set of 2-3 consecutive bearish candles then it's called Bullish Engulfing Pattern.

With the formation of the bullish engulfing pattern, there is a higher tendency that the price will move higher.

When the body of 1 or 2 consecutive Bearish candles covers more than 70% of the body of a set of 2-3 consecutive bullish candles then its called Bearish Engulfing Pattern.

With the formation of the bearish engulfing pattern, there is a higher tendency that the price will move lower.

See the example below GBP/CAD 4HR price went down after Bearish Engulfing Pattern (also called Dark Cloud Cover) & price went up after Bullish Engulfing Pattern.

(Sourced from www.Tradingview.com)

 

7.7 Double Tops / Triple Tops

 

When bodies or wicks of 2 color consecutive candles (OR) bodies or wicks of 2 candles in close proximity touch a high price point then these set of 2 candles is called Double Top or a repeat of this in close proximity by 3rd candle is called Triple Top.

Actually twice stop of rising price at this exact new level tends to form resistance at double top (or sometimes this even gets confirmed by triple top); which in turn is called confirmed level of resistance. Hence you know prices are more likely to fall from resistance.

 

Doble top or Triple tops are referred to as reversal patterns. The price tends to reverse when these patterns are formed.

See below EUR/NZD 1HR clearly shows the Double tops.

 

(Sourced from www.Tradingview.com)

 

 

 

 

 

 

7.8 Double Bottoms / Triple Bottoms

 

When bodies or wicks of 2 color consecutive candles or bodies (OR) wicks of 2 candles in close proximity touch a low price point then these set of 2 candles is called Double Bottoms or a repeat of this in close proximity by 3rd candle is called Triple Bottom.

Actually twice stop of falling price at this exact new level tends to form support at double Bottom (or sometimes this even gets confirmed by triple bottom); which in turn is called confirmed level of support. Hence you know that prices are more likely to rise from support.

 

Doble bottom or Triple bottom are referred to as reversal patterns. The price tends to reverse when these patterns are formed.

See below EUR/NZD 1HR clearly shows the twice the Double Bottoms & third touchpoint at the price confirmed the support to reverse the price.

 

(Sourced from www.Tradingview.com)

 

 

 

 

 

7.9 Shooting Star

 

Candlestick with a small body and long upper wick. This is formed during uptrend signaling a reversal of the trend. This is similar to an inverted hammer; the only difference is that shooting star has a gap from the previous candle. A perfect shoot star has a gap from both preceding and succeeding candles thus named shooting star. Always wait for confirmation of reversal. A gap with succeeding candle is a stronger confirmation

(Sourced from www.Tradingview.com)

 

 

 

 

 

 

 

7.10 Morning Star

Candlestick with a small body and long upper wick. This is formed during downtrend signaling a reversal of the trend. A morning star has a gap from preceding candle thus named Morning star. Always wait for confirmation of reversal.

 

(Sourced from www.Tradingview.com)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7.11 Evening Star

Candlestick with a small body and long upper wick. This is opposite to Morning Star. This is formed during uptrend signaling a reversal of the trend. An evening star has a gap from preceding candle thus named Evening star. Always wait for confirmation of reversal.

(Sourced from www.Tradingview.com).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7.12 Inside Bar

 

When the body of a candle is constrained within the size of the body of the previous candle this is called inside-bar. Inside bar displays market tendency for continuation of trend. Also note that there could be a gap in the starting price of inside-bar making it perfect inside the body of the previous candle. There can be 2-3 inside bars in succession; that has no effect.

Inside bar happening at the support or resistance will signal the reversal in market trend. It acts as an engulfing candle pattern.

Most successful Inside bars are seen on 4hr or Daily.

 

Inside-Bar Trend Reversal--

(Sourced from www.Tradingview.com)

 

 

 

Inside-Bar Trend Reversal--

 

(Sourced from www.Tradingview.com)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7.13 Pin Bar (in Price Action)

 

A pin bar is formed when the market retracts back to very close the opening price leaving a long wick on the side. The wick shall be at least 3 times the body of the candle. As discussed in the candlestick chapter, these are also referred to as Hammer, Hanging Man or Inverted Hammer.

It defines a reversal of trend. If this is formed close to the support during downtrend then its considered reversal of bearish trend and shall be verified by next bullish candle. Potentially Trend continuation if it's formed at the top of the bullish trend close to resistance. Always wait for the confirmation with the next candle.

 

 

Now take a special note why this mentioned again in pattern recognition & especially close to Inside / outside Bar article. A Pin bar (Inverted Hammer) that is inside bar leaving a long wick close to resistance in bullish trend and a pin bar (Hammer, Hanging Man) that is inside bar leaving a long wick close to support in bearish trend with next confirmation candle has a very potential for trend reversal otherwise when it has a very high potential for trend continuation.

(Sourced from www.Tradingview.com)

 

7.14 Outside Bar

When the body of a previous candle is constrained within the size of the body of the current candle this is called outside-bar. Outside bar displays market tendency for continuation of trend. Also note that there could be a gap in the starting price of outside-bar making it perfect for the previous candle to be within the body limits of the current candle. There can be 2-3 outside bars in succession; that has no effect.

Outside bar happening at the support or resistance will signal the reversal in market trend. It acts as an engulfing candle pattern.

Most successful Inside bars are seen on 4hr or Daily.

 

 

 

 

 

 

 

 

 

 

7.15 Ascending Triangles

 

A bullish trendline making triangle formation close to resistance is called ascending triangle. Bulls continue to keep the pressure up. There are higher chances of continuation of the bullish trend.

Look for price breaking the triangle as confirmation before entry is made.

 

 

 

 

(Sourced from www.Tradingview.com)

 

 

7.16 Descending Triangles

 

A bearish trendline making triangle formation close to support is called descending triangle. Bears continue to keep the pressure down. There are higher chances of continuation of bearish trend.

Look for price breaking the triangle as confirmation before entry is made.

(Sourced from www.Tradingview.com)

 

 

 

7.17 Rising Wedge

 

This is similar to ascending triangle (with a common factor that the bullish trend line at the bottom of the higher lows is same) but the big difference is that in ascending triangle top trend is close to horizontal resistance, but in case wedge the trend line is making higher highs (ascending) but rising price range are slowly contracting giving it a shape of rising wedge. Because the bulls are slowly losing the power to maintain continuous higher highs, this is signaling that the bears are getting a higher chance to jump at any time & reverse the trend.

 

So with rising wedge, there are higher chances of trend reversal for prices to go down close to a smaller range of the wedge. Always wait for confirmation once the price breaks the bullish trendline (higher lows trend line).

 

(Sourced from www.Tradingview.com)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7.18 Falling Wedge

This is similar to descending triangle (with a common factor that the bearish trend line at the top of the lower highs is same) but the big difference is that in descending triangle bottom trend is close to horizontal support, but in case of wedge the trend line is making lower lows (descending) but falling price range are slowly contracting giving it a shape of falling wedge. Because the bears are slowly losing the power to maintain continuous lower lows, this is signaling that the bulls are getting higher chance to jump in any time & reverse the trend.

So with a falling wedge, there are higher chances of trend reversal for prices to go up close to a smaller range of the wedge. Always wait for confirmation once the price breaks the bearish trendline (lower highs trend line).

(Sourced from www.Tradingview.com)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7.19 Flags / Channels

During a trend, a channel is formed, when an all the way through line connecting highs is approx. parallel to an all the way through line connecting lows, in a range based falling or rising consolidation. Once again the consolidation range stays the same creating parallel lines of the channel. A confirmed break of any of these lines by price displays a tendency for the market to move in the direction of break. This means the market can break in any direction but has a higher tendency towards original trend continuation.

 

 

(A) Bullish Flag / Channel

It is formed as a retracement of up-trending price. The pair price is trending down as a channel in a certain range; price is expected to break upwards in the direction of the original trend. It advised us to keep an eye on resistance on one higher time frame, for entry.

The channel itself can be traded. The entries can be placed at one lower time frame in the direction of channel, after confirmation candle but existing before the price reaches the down trend line. Entry can also be placed bullish for confirmed break of the channel in the bullish direction.

Channel is quite common formation. A steep price increase acting as a pole at the start of the channel makes it a bullish flag. It gives a higher indication of continued bullish trend.

 

 

 

 

 

 

 

Fig for Bullish Flaf Channel on chart--

(Sourced from www.Tradingview.com)

 

 

 

(B) Bearish Flag / Channel

 

It is formed as a retracement of down trending price. The pair price is trending up as a channel in a certain range; price is expected to break downwards in the direction of the original trend. This advises us to keep an eye on support on one higher time frame, for entry.

The channel itself can be traded. The entries can be placed at one lower time frame in the direction of channel, after confirmation candle but existing before the price reaches the up trend line. Entry can also be placed bearish for confirmed break of the channel in the bearish direction.

Channel is quite common formation. A steep price drop acting as a pole at the start of the channel makes it a bearish flag. It gives a higher indication of continued bearish trend.

 

 

                                   

(Sourced from www.Tradingview.com)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

7.20 Pennants

 

Pennants are formed when the consolidation range is decreases or increases instead of staying the same as in the case of channel.

These are 3 types of Pennants- Contracting Pennants, Expanding Pennants, Diamond Pennants

 

a) Contracting Pennants

In this consolidation range is initially big but keeps getting smaller and smaller. The breakout is usually in the direction of the previous original major trend. Trading entries shall be at the confirmation of the break of any of the resistance or support lines.

 

(Sourced from www.Tradingview.com)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

b) Expanding Pennants

In this consolidation range is initially small but keeps getting bigger and bigger. The breakout is usually in the direction of the previous original major trend. Trading entries shall be at the confirmation of the break of any of the resistance or support lines.

 

 

 

(Sourced from www.Tradingview.com)

 

 

c) Diamond Pennants

In this Pennant, the consolidation range is initially expanding and then starts contracting becoming smaller and smaller ready for the breakout. The breakout is usually in the direction of the previous original major trend. Trading entries shall be at the confirmation of the break of any of the resistance or support lines. Please see the figure below.

 

Once again a confirmed break of any of these lines of consolidation by price displays a tendency for the market to move in the direction of the break. This means the market can break in any direction but has a higher tendency towards original trend continuation.

 

(Sourced from www.Tradingview.com)

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