Day Trading Facts -Know before trading
The rectangle is a frequent continuation pattern that indicates that price is consolidating before resumed trending. Price moves in a narrow range, generating highs and lows. A horizontal line can be drawn between the highs and lows, and vice versa. Consider the following scenario:
After a rapid rise higher, pricing began to settle before resuming the previous trend. It trades in a range, with quick up and down moves that create highs and lows that can be linked with horizontal lines. A rectangular pattern must contain at least two highs and two lows in order to be legitimate. In the graph above, the rectangle has two lows and three highs.It is, indeed, a rectangle. We only expect a break of the pattern in the direction of the last impulsive move on the 4h chart because this is a continuation pattern and we only trade with patterns like this that signal that the trend is ready to restart. If the last impulsive move had gone down, we would have had to ignore this pattern because it breaks to the upside and does not match the 4h chart.
Let us see another example:
There are two highs and three lows here, as well as a small upward spike. As I previously stated, this is not something to be concerned about; forex is not an exact science, and patterns rarely resemble those found in textbooks. Things will be fine as long as the price swiftly retraces back inside the pattern and respects the initial high, producing a horizontal resistance line, as it did in this chart.
The following is the logic behind this pattern. The price begins to ping-pong between buyers and sellers.They have equal forces and are in a state of tremendous equilibrium. In this case, purchasers make a big surge higher before beginning to take profits. When the price drops, buyers believe it’s time to restart the previous move and push the price higher, but they don’t have the force to drive it over the level where the seller showed interest the last time. At that point, the seller enters and pushes the price back down, generating the pattern’s second high.
This continues until one side caves in, at which point the pricing pattern splits in either direction. The pattern is simple: buyers and sellers are at odds, and no one is winning. We simply wait and hope that the pattern brakes in the direction of probable trades that we have established.
There are three types of triangle patterns, symmetrical, ascending, and descending. Symmetrical triangle: this is a continuation pattern that contains at least two higher lows and two lower highs. When you connect the higher lows and the lower highs, you obtain two trend lines that converge. Let us see an example:
In this symmetrical triangle, we have two lower highs and three higher lows. The impulsive move on the 4h chart was pointing up; price makes a continuation pattern on the smaller timeframe and then resumes the prior move. As you can see, it is quite similar in shape with the pennant pattern discussed earlier but this symmetrical triangle takes more time to form, has to have lower highs and higher lows, and does not have to be preceded by a sharp move like the pennant pattern.
In this example, we have three higher lows and three lower highs. Price makes an impulsive move up on the 4h chart, then a symmetrical triangle occurs on the smaller time frame (the time frame in the above chart), pattern breaks and continues the trend up. The logic behind this pattern is this: the buyers push the price up making higher lows but at the same time, the sellers push the price down making lower highs. This narrowing trading range can only mean that the buyers and the sellers are losing interest in that price level. As you can see, the pattern starts wide and it begins to narrow when approaching its end.
When the trading range where the battle of buyers and sellers takes place begins to narrow this always means that a big sharp move in either direction is about to emerge after the break of the pattern. This narrowing means low volume of orders in the market at that level; the buyer considers that the price level is unattractive for him to buy. The seller thinks that the level is unattractive for him to sell. However, when price breaks out of that small range, the price starts to move fast in one direction or another. Ascending triangle: this is a bullish continuation pattern. It must have at least two highs and two lows that you can connect with trend lines. The upper trend line must be horizontal;
the lower trend line must be a diagonal one like in the chart below:
This being a bullish pattern we must make sure first that the most recent impulsive move on the 4h chart is also a bullish one. You can see we have two highs and three lows here, pattern breaks on the upside as expected. Here is another ascending triangle:
Here we have another example of how well this pattern performs. The logic behind this pattern is obvious and you have probably figured it out. The sellers are not letting go easily of that level where the horizontal trend line is, but the buyers are very persistent and they start to push the price higher and higher making higher lows. Eventually, the sellers will admit defeat and stop entering sell orders at that horizontal line. They will have no choice because every time they sell the buyers push the price back up to where they sold and trigger their stop losses.
The sellers are outnumbered; the buyers have clear control. After that, the pattern breaks and the buyers resume the trend established by that previous impulsive move up. Descending triangle: this pattern is pretty much the opposite of the ascending triangle. It is a bearish continuation pattern meaning the trend is down, price stops for a while to consolidate forming a descending triangle pattern and then it goes further down resuming the trend.
Here is an example:
There is a minimum requirement of two highs and two lows with this pattern as well. The logic behind it mirrors the one from the ascending triangle. The sellers are the majority, the trend is down, the buyers hold their ground at the horizontal trend line but only for a short period of time. The sellers win and they break the pattern to continue the trend downwards.
The price channel is also a continuation pattern that consists of two parallel trend lines, one above and one below the price that take the shape of a channel. If the channel is sloping upwards then it is a bullish pattern, if the channel is sloping downwards then it is a bearish continuation pattern. Like all the other patterns, each trend line must be drawn connecting at least two high and two lows. Let us see an example of this pattern:
This price channel is sloping upwards so it is a bullish continuation pattern. The last impulsive move on the 4h chart should be up for you to consider trading this pattern when it breaks to the upside resuming the trend.
In this example, we have a bearish price channel pattern because its slope points downwards. We also have a downtrend in place because we found on the 4h chart that recent impulsive move down. The logic behind the price channel pattern is the following: when the trend in up, the buyers are in control, price stops to consolidate when they decide to take some profits out of the market but the sellers are nowhere to be found. They don’t even have the strength to correct the trend, to make a small correction move against the trend direction so price just trickles upwards slowly forming a channel before the buyers start to resume the strong trend by breaking this slow moving pattern and continuing the move up. The same thing applies for the bearish price channel but the roles are changed between the buyers and the sellers.
Cup with handle
This is a continuation pattern as well and as the name says, it takes the form of a cup with a small handle. Let us see what I am talking about:
This pattern also has to have at least two highs or lows that you can connect with a horizontal line like in the chart above. You can see that the trend is up, this pattern forms in a correction of the trend but it is no ordinary looking correction. It is in the form of a cup; price goes slowly down and then reverses just as slowly forming a cup shape. When it gets back up to where the correction started price makes another formation against the trend that resembles a handle. It usually looks like a flag pattern on its own but when put together with the cup it forms the cup with handle continuation pattern.
The logic behind it is that the buyers, in this case, have driven the price up for a long period of time making a big uptrend and now, at the level where the pattern formed, they decide it’s time to scale down a big part of their orders and take some well-deserved profits. But because the uptrend was so big that means that there were much more buyers than usual to push the price up for that long period of time so now there are also much more buyers that have to take profits so the correction move is also long in duration.
Because it is long in duration, the sellers have time to gather their forces. The first part of the cup is a classic correction that looks almost like a flag pattern. After that, when the buyers decide that it is time to push the price back up to resume the trend, they face quite a strong resistance from the more and moresellers and they can only push the price up slowly forming the cup. After the price comes back up to where the correction started at that red line, the seller know that this level is their territory as the sold there before so they join forces and sell there again. The move down does not last long and the sellers have to admit defeat as the buyers awake with conviction to continue the Trend.
The wedge can be a continuation pattern and a reversal pattern but we will focus only on the wedge as a continuation pattern as we seek to trade only with the main trend. A continuation wedge pattern is always situated in the correction move against the trend or last impulsive move. Like all other patterns is has to have at least two highs and two lows. A continuation wedge pattern that forms in an uptrend is called a falling wedge; a continuation wedge pattern that forms in a downtrend is called a rising wedge. The slope of the wedge pattern always has to be against the main trend or against the direction that we look to trade in. In addition, the two trend lines have to converge. Let us see a chart with such a pattern:
We have a clear downtrend established by that 4h chart last impulsive move. The trend enters a correction faze and a rising wedge is formed. Yes, I know, it looks like a symmetrical triangle but it is not. The symmetrical triangle has a neutral bias, this rising wedge always has an upwards slope and is valid only in downtrends. Let us see a falling wedge as well:
We have an uptrend, price enters correction faze, a falling wedge takes shape. The logic behind these wedge patterns is pretty much that of the symmetrical triangle except that here we have a bias. In the example above, the buyers start to take profits and a correction move against the trend develops. The trading range starts to narrow which signals that the buyers will soon break the pattern to the upside and resume the trend. Like with the symmetrical triangle, this pattern usually results is some pretty strong moves but there is difference which makes this pattern even stronger.
The symmetrical triangle has no slope, no bias, but in a correction move against the trend, the short- term bias against the trend is a good thing for the health of the trend, it means that the people who drove the price up or down are taking profits and they will continue the trend further. No bias against the trend or neutral bias means that the same people did not take enough profits at that level and they might start to take them later, which implies that the trend will not continue very strongly, or sharply.
Here is something important for you to consider when trading patterns. They develop in the correction phase of a trend and these correction moves usually respect the Fibonacci retracement levels. Not always, but very often they do. It is wise that before considering trading a pattern, to make sure that the correctional move that is in fact the pattern itself has retraced at least to the 38.2% Fibonacci retracement level of the impulsive move. Here is what I mean:
Here we have a big impulsive move up after which the correction retraces exactly to the 38.2% level. This is a good correction and if there had been a pattern there, this would have been a good trade. The idea behind this is to give you a guideline when trading the break of a pattern. If a pattern forms early in the correction move it could not be a good pattern because the correction is not complete and the price can very well break the pattern in your desired direction only to reverse, hit your stop loss and continue the correction move at least to the 38.2% Fibonacci retracement level. This is why I recommend to you that if you see a pattern that you think is going to break in the direction you are expecting, first draw the Fibonacci retracements tool on the impulsive move to see if the correction is big enough.