Pattern Recognition

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Pattern Recognition

Technical Analyst set up trading decisions based on continual exposure

to repeated patterns. You will eventually be able to visualise and see these patterns as they are developing.

However, before this you must firstly understand the concepts behind these patterns and what type of patterns to

look for.

Over time you will be able to identify these more freely in hindsight, the true

strength of a great trader is to be able to see these evolving in real time.

Pattern Recognition

Identifying recognisable patterns (trends) within the price movements helps in a couple of ways:

They can give more clues as to how the market may move in the future

They can be used generate price objectives for potential future moves

Continuation Patterns Reversal Patterns

Pattern Recognition

Continuation Patterns

3 Triangles

Pennants

Flags

Pattern Recognition

Triangles

As the name suggests, triangle formations involve the price action trading in a narrowing range to form the shape of a triangle.

3 types of triangle:

AscendingAscending

DescendingDescending

SymmetricalSymmetrical

Symmetrical:

Pattern Recognition

Triangle Rules

It is a continuation pattern so it is likely to break out of the pattern in the direction of the prevailing trend (down in this example)

You only establish your position after the break out at point X on the diagram (you would short your position here)

Your target and minimum price objective (MPO) is the height of the pattern (measured at point Y), projected from the breakout, X

The price must break out between ½ and ¾ way through the pattern.

Your stop should be placed inside the triangle, tracking the triangle support line. Especially as price often retraces back to support line before continuing the breakout.

XX

MPO

YY

Pattern Recognition

Pennants

Pennants are formed over a shorter time scale than triangles - up to a few hours.

As far as the shape of the pattern is concerned, pennants are identical to symmetrical triangles.

Pennants, unlike triangles, rarely reverse price action. However, you do not trade them until they have broken.

Pattern RecognitionPennant Rules

Previous area of congestion

There should be an area of price congestion followed by a sharp move in one direction

The price then forms a sideways pattern like a continuation triangle

The price will then break out and move sharply again in the original direction

This pattern is difficult to trade because the moves are explosive and it is difficult to establish the position following the break out of the pattern.

The advantage of a pennant is that the target is the height of the “flag pole” rather then the height of the consolidation, giving a larger comparable profit potential.

Pattern Recognition

Flags

Flags are continuation patterns which can occur between the short and medium term -

they do not usually form over much more than a week.

Flags consist of a channel of price action moving against the direction of the prevailing trend, followed by a break in the direction of

the trend.

Pattern RecognitionFlag Rules

x

x

y

The target is the height of ‘x’ projected from the break-out point at ‘y’.

This is generally a very short term pattern and would be traded in a similar fashion to a triangle.

Pattern Recognition

Reversal Patterns

Double Tops / Bottoms

Triple Tops / Bottoms

Wedges

Head & Shoulders

Pattern Recognition

Double Tops & Bottoms

Easy to detect

Only trade on a double top when price the action breaks below the reaction low

The minimum price objective for this pattern is derived by projecting the height of a-b from the breakout at c

The double bottom is the exact opposite but is a bullish reversal pattern

Pattern Recognition

Triple Tops & Bottoms

Target

Stronger than Double Tops and Bottoms but less common as a third test of the high or low is required

Always wait for the breakout before trading

The Japanese call this a three mountain top

A triple top is bearish and a triple bottom is a bullish reversal pattern.

Pattern RecognitionRising Falling Wedge

Minimum Price Objective

A rising wedge is a top reversal pattern (bearish) where the trend becomes less steep and the range of the market becomes narrower

Following the break out from the support line the wedge may trade back up to this line so it is important to put your stop inside the wedge

The target is calculated by projecting the height of the pattern at its widest point from the breakout point

The falling wedge is a bullish reversal pattern.

Pattern RecognitionHead and Shoulders

H

SS The Head and Shoulders pattern was first discovered in the 17th Century by Sokyu Honma and was called the Three Buddha pattern.

As its name implies, the ‘Head and Shoulders’ formation consists of two ‘shoulders’ with a higher ‘head’ in the middle.

Classically the Head and Shoulders pattern is a long term reversal pattern, however it does also work over a shorter time frame.

Pattern Recognition

Broken Trend Line

Lower High

Return Move

Broken Trend Line

Minimum Price Objective

Highs start to top out

Prior Trend Required

Possible Oscillator Divergence may occur

S S

H

Prior Trend in Place Divergence in Oscillator

Head and Shoulders Top

Pattern Recognition

Summary

Continuation Patterns Reversal Patterns

Double Tops / Bottoms

Triple Tops / Bottoms

Wedges

Head & Shoulders

Triangles

Pennants

Flags

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