Patterns and their application in technical analysis (part 1)
The FxCash blog has already talked about patterns many times. In the Strategies section, you will find several strategies that use candlestick formations as signal confirmation. The “Sniper” strategy is completely built on the non-indicator Price Action technique, although it would seem – how can you build a trading system solely on candlestick combinations? In this review, we will organize information about the types of patterns and introduce you to the most simple recognizable Price Action patterns.
Types of patterns and their application in trading
Patterns (candlestick combinations) are frequently repeated patterns consisting of several candlesticks and determine the further market behavior. On the Internet, you will find dozens of examples of patterns with beautiful pictures drawn in Photoshop that have nothing to do with reality. And the situation with names is even more interesting. To write as many articles as possible, blog authors come up with a wide variety of titles that essentially mean the same pattern. Example: pin bar, hammer and inverted hammer. Their essence is the same, although there are three names.
Another problem is seeing patterns on the chart. And if the signals of technical indicators are obvious (albeit sometimes false), then the formation taken by a person as a pattern may turn out to be a stupid set of candles. That is, the problem is in the very interpretation of the pattern. And if you try to recognize on a real chart the types of patterns offered on most resources, it turns out that there are only a few that are really recognizable and really give correct predictions.
Doji or Dodge is a candlestick that does not have a body, but has shadows (partly a variation of the pin bar, which is discussed below). In other words, for the current period (for example, 5 minutes with the M5 timeframe) the price moved within a certain range (the length of the shadows), but the opening price was almost equal to the closing price. This could mean the following:
- The market came to equilibrium – neither sellers nor buyers were able to place such a volume of orders, which would ultimately move the price in one direction or another. If there was a trend before that (the price was rising or falling), the Doji signals a reversal. An additional signal is a decreasing body of trend candles preceding the doji.
- There is no trade, therefore the price has not changed, this indicates a flat.
Doji patterns have several interpretations. The following candlestick patterns are considered to be a reversal pattern:
- There was a trend ahead of the doji.
- Before the doji, there was a large candlestick, the body of which is larger than the previous ones. This means a strong spurt, after which “the market fizzles out.” Moreover, the color of the doji is not important, it may be the opposite candlestick.
- The Doji has a long shadow in the direction of the trend movement and an almost absent shadow in the opposite direction. This suggests that the Doji market tried to push the price further towards the main direction, but it did not work out.
If the doji has two long equal shadows on either side, this kind of pattern is ignored.
On the first screen, there was also a reverse shadow, but less than the shadow towards the main movement. An example of the fact that ideal models are rare in the real market. So, we are either taking a risk or looking for confirming signals.
2. “Head and shoulders”
Another type of reversal pattern that is well tracked on a line chart. Represents three consecutive extremums, the central one of which is the highest, two lateral ones are located at approximately the same level (although not necessarily). There may be more peaks, but a resistance / support level must be drawn through them.
What you need to know about the formation:
- It is built on long intervals, since on M1-M5 a zigzag movement can mean price noise.
- The pattern can also be searched for on candlesticks, but it is seen faster on a line chart.
- Signal – a breakout of the drawn level after the third peak (following the extreme).
Side extremes are marked with blue ovals, which are not clearly visible, but allow an approximate resistance level to be drawn. The red dot is a signal for a downtrend.
3. “Double Bottom” / “Double Peak”
A kind of pattern that is easier to catch than the previous reversal pattern. It has a psychological nature: after the first serious extreme, a rollback occurs. But the first side does not give up and the price again shows an extremum, after which it finally goes down. The model resembles the letters M and W (for peak and bottom). A level is drawn through the central opposite extremum, upon breakout of which a trade is opened.
This type of pattern is built on timeframes from M30 and higher. Red dot – a signal to open a deal.
Continued in the next part.