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Chart Pattern Trading Strategy Step-by-Step Guide
Our team at Trading Strategy Guides is launching a new series of articles. They can be found in Chart Pattern Trading Strategy Step-by-Step Guide. These articles will enhance and elevate your trading to a new level. This technique will give you a framework to examine the fight between the bulls and the bears methodically.
By trading the most profitable chart patterns, you can deduce who is winning the fight between the bulls and the bears. This strategy can be used to identify a stock chart pattern. It is also used to identify any instrument that you are planning on using for day trading.
We share this because it will greatly improve your ability to understand the price movements and price breaks. Ultimately, this will make you a much better trader. The key to this style of trading will be to identify how a pattern forms. You’ll also have a greater understanding of market analysis as a whole. This article will introduce several entry-level patterns and then dive into some special patterns.
These patterns are the symmetric triangle and double bottoms. We also believe that it is important to use these with pivot points as well. This type of training will set you apart from the average traders.
To start, I recommend getting some basic stock charting software with some very simple tools, such as moving average and other indicators. This can help you perform market analysis and also help you be in front of the charts when a pattern forms. The ascending triangle will be a valuable pattern in your trading arsenal.
The rounding bottom, head and shoulders patterns, inverse head and shoulders, reverse head and shoulders, triple bottom, cup and handle and the descending triangle, are also valuable. These patterns will help you find trade ideas faster than what the average trader will be able to find. It will help you make sure that you enter the trade at the right price levels.
These types of patterns will allow you to trade any currency pair. The trades are not dependent upon market trends or the economic calendar to find successful trades while day trading. This write up will not be like other blog articles you have read. This is because we are going to give you step by step instructions on how to place trades using the exact price pattern for the strategy.
There are thousands of traders around the world that trade these specific type of formations like the triangle pattern. Famous trader Dan Zenger has turned $10,000 into $42 million in under 23 months by using a chart pattern trading strategy.
To truly succeed in trading, you can simply start to mimic what professional traders do. Begin to test the strategy and then measure the results.
We have dedicated a lot of time to studying price action. You can see some evidence by studying some of the best pure common chart patterns strategies here:
Let’s move forward and define exactly what we are looking at. More importantly, we will define how we can profit from them.
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What are Chart Patterns?
In technical analysis, chart patterns are simply price formations represented in a graphical way.
Without a doubt, this is one of the most useful tools when performing technical analysis of price charts. Chart patterns are a very popular way to trade any kind of market. The most profitable chart patterns give us a visual representation of the supply and demand forces. They also show the relative strength of the specific price levels.
If we’re on the supply and demand topic, we recommend studying more about this subject here: Supply and Demand Trading-Learn about Market Movement.
What makes chart patterns so appealing is that it also brings to light what happens behind the scene. This refers to the buying and selling pressure.
Note* A chart has its own language and it speaks through chart patterns and they leave footprints of the big money or the smart money. These footprints can lead us into highly profitable trades.
Why Are Chart Patterns So Important?
If you remove all your indicators and momentum indicators from the charts, and everything else that might make your chart less clear, and just look at the price action, whether it’s a 5-minute chart, daily chart or similar, it’s your preferred time frame. You’ll actually gain more insights into what happens in the market.
As long as the candlesticks have the variable open, high, low and close; you can use them just to confirm your position or enter a new trade. You can build a really successful chart pattern trading strategy without the need for any other technical indicator. Here is an example of a master candle setup.
There are bullish and bearish chart patterns. What makes them work is that they tend to reoccur over time, making it possible to backtest them and find their probability of success rate.
Types of Chart Patterns:
Throughout this article series, we’re going to discuss how to make money with the most profitable chart patterns. Some of the most profitable chart pattern trading strategies include:
Earlier, we posted a clear price chart of the EUR/USD. But if you look closer and read the chart patterns language, we can identify some of the most profitable chart patterns (see figure below).
It doesn’t matter what time frame or market you trade because chart patterns are present everywhere when there is a battle between buyers and sellers.
Let’s discuss how we can use the trading strategy and make money trading in any market. The key is to look at the lower trend line and try to find a triple bottom show up anywhere on your chart.
Chart Pattern Trading Strategy – Rules
We have developed five step-by-step guidelines that are important to take into consideration when trading any of the chart patterns:
Step 1: Always determine if the market is in trend mode or consolidating.
This step is important because, although some of these simple chart patterns often are forms of consolidation, they are actually continuation patterns of an underlying trend.
For example, a bullish flag pattern – read more about it HERE – is a pattern that forms after a larger move up. The pattern itself is just a brief form of relief, or consolidation, from the underlying trend, before breaking to new highs.
Basically, the bullish flag pattern is a continuation pattern.
We can distinguish mainly two types of chart patterns:
- Continuation Patterns: signals that the trend will continue.
- Reversal Patterns: signals the possible end of a trend and the start of a new trend.
An example of a reversal pattern is the double top pattern highlighted in the figure below:
It’s important to determine whether the market is trading or consolidating. This is because it will reveal what type of chart patterns work best for each trading environment.
Note** The reason why many price action traders fail is because they don’t follow this first rule. They try to trade every pattern regardless of the whole picture.
Step 2: Decide What Chart Patterns You Want to Use.
Do you like to trade reversal patterns or are you more comfortable trading continuation chart patterns?
Figure this out first! When you have decided which way to go, try to master the particular trade setup.
Repetition is the mother of all learning. The more you trade the most profitable chart patterns, the better you’ll become at spotting these chart patterns in real-time.
Our team at TSG is a huge fan of the triple top chart pattern. This is because of the potential profit available once a new trend has developed.
Step 3: Look for the Story in the Chart Patterns.
What you have to do here is to construct a story behind your favorite setups.
What do we mean by that?
Simply, look at the whole price picture, don’t just focus on the chart patterns. What you need is for this story to confirm your price action pattern. Everything else must point in the same direction. Finding the proper direction to place your trades will help you to increase your win rate.
For example, the narrative behind the bullish flag highlighted in Step #1 is easy to spot. We’re moving in an uptrend because we have developed a series of higher highs and higher lows.
Secondly, we broker and close above an old high; no resistance spotted above market price are all good ingredients. They speak volumes in favor of our bullish flag pattern.
Step 4: Trade Chart Pattern Trading Strategy in Confluence With Good Price Location.
Chart patterns work best in conjunction with a good price location which can add confluence to our trade.
What do we mean by price location?
In simple terms, a price location is just an important area on the chart where we normally expect a price reaction. That price location can either be a support/resistance level, swing high/low points or some pivot points. The location can even be technical indicators if you combine the two.
For example, the price channel pattern highlighted in figure 3 worked out because we had confluence with the higher time frame resistance level. The EUR/USD was simply trading in an upward channel, but heading right into a resistance level.
Step 5: Make Non-Subjective Trading Rules for Trading Chart Patterns.
The last step to build a chart pattern trading strategy is not just to have some non-subjective trading rules, but also writing them down and following your plan strictly.
There are many possible ways a trader can profit from these chart patterns.
For example, the bullish flag pattern can enter at the retest of the flag support or the breakout above the flag. You can also trade with the breakout triangle strategy.
Become a master of only one setup and one chart pattern trading strategy. Prove to yourself that you can be profitable trading one pattern before you move on. In simple terms, find a pattern that you like and become very good at that chart pattern trading strategy.
Conclusion – Trading Chart Patterns
We hope you enjoyed this article on trading chart patterns.
We can fast track your career by giving you the most profitable chart patterns, which is easy. But the one thing we can’t give you is screen time and experience. That’s something that you need to gain over a period of time. Below is another strategy called trading volume in forex.
When it comes to chart pattern trading strategy, there are no magic bullets. This is because you’re going to make mistakes. Secondly, you’ll still be having losing trades. The whole idea is to become selective on the chart patterns you trade.
Thank you for reading!
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Triangle Chart Patterns
Spotting chart patterns is a popular hobby amongst traders of all skill levels, and one of the easiest patterns to spot is a triangle pattern. However, there is more than one kind of triangle to find, and there are a couple of ways to trade them. Here are some of the more basic methods to both finding and trading these patterns.
What is an ascending triangle?
The ascending triangles form when the price follows a rising trendline. However, the trend consolidates, failing to make new highs.
Ascending triangles are considered to be continuation patterns. Therefore, a break of the resistance prompts a rally.
The pattern is negated if the price breaks below the upward sloping trendline.
The example below of the EUR/USD (Euro/U.S. Dollar) illustrates an ascending triangle pattern on a 30-minute chart. After a prolonged uptrend marked by an ascending trendline between A and B, the EUR/USD temporarily consolidated, unable to form a new high or fall below the support. The pair reverted to test resistance on three distinct occurrences between B and C, but it was incapable of breaking it.
The ascending triangle pattern formed once a horizontal resistance and ascending support lines acted as buffers for the price action. Finally, EUR/USD breached resistance at E, signaling a potential bullish breakout.
How can you trade ascending triangles?
Typically you want to buy after the pattern breaks resistance, as it did at E. It is good practice to set a stop-loss just below the last significant low, which in this example is at D.
Look at the chart below, a continuation of the EUR/USD. Once the ascending triangle formation is formed, we wait for a confirmation candle to signal a breakout. Since the following candle (at F) continued to advance higher, we enter the position at 1.4160, while placing our stop-loss slightly below the previous significant low at 1.4110 (a 50-pip difference from the buy price).
The EUR/USD rallies upward in line with our desired direction. The pair advances roughly 100 pips before consolidating once more at G, providing us with a 2:1 reward-to-risk ratio.
What is a descending triangle?
Not surprisingly, the descending triangle is the opposite of the ascending triangle. It forms when the price follows a downward trendline and then consolidates, failing to make new lows or break a downward trendline.
Descending triangles are considered continuation patterns. Therefore, a break in the support prompts the price to fall.
The pattern is negated if the price breaks the downward sloping trendline.
The example above of the NZD/USD (New Zealand Dollar/U.S. Dollar) illustrates a descending triangle pattern on a five-minute chart. After a downtrend which followed a descending trendline between A and B, the pair temporarily consolidated between B and C, unable to make a new low. The pair reverted to test resistance on two distinct occurrences, but it was incapable of breaking out to the upside at D. The pattern formed a horizontal support while descending resistance lines acted as buffers for the price action. Finally, the NZD/USD breached the resistance at E, signaling a potential bearish breakdown.
How can we trade descending triangles?
Typically you want to buy after the pattern breaks resistance, as it did at E. It is good practice to set a stop-loss just below the last significant high, which in this example is at D.
Look at the chart below, which is a continuation of the NZD/USD chart above. Once the descending triangle formation is completed, we wait for a candle to breakout from the pattern, as it did at E. We sell short NZD/USD at 0.6375, while placing our stop-loss slightly above the previous significant high at 0.6405 (a 30-pip difference from the sell price). NZD/USD tumbles in our desired direction.
The pair descends roughly 90 pips before consolidating once more at F, providing a 3:1 reward-to-risk ratio. Considering this is a five-minute chart, the profits and risks are generally smaller than if the pattern appeared on a larger timeframe.
What is a symmetrical triangle?
The pattern is identified by two discrete trendlines. The first trendline connects a series of lower peaks, while the second trendline connects a series of higher troughs.
Symmetrical triangles generally form during consolidation and the volatility tends to decline as the pattern progresses.
Symmetrical triangles tend to be neutral and can signal either a bullish or a bearish situation. Therefore, a breakout from the pattern in either direction signals a new trend.
The example above of the NZD/USD illustrates a symmetrical triangle formation on a 15-minute chart. After a rapid uptrend, the pair consolidated between A and B, unable to find a distinct trend. During the consolidating state, the pair continued to form a series of lower peaks and higher troughs. Volatility dropped off considerably, if compared to the beginning of the formation. Ultimately, the pattern ended when both of the trendlines came together at C.
How can we trade symmetrical triangles?
Since bias upon the conclusion of the pattern pointed higher, we look for an opportunity to buy the pair. Given the candle following the conclusion of the trend rallied at D, we bought NZD/USD at 0.6240. We place our stop-loss slightly below the most recent significant low at 0.6215 (a 25-pip difference from the buy price). The pair continued to consolidate prior to rallying approximately 80 pips at E. Considering this is a 15-minute chart, the profits and risks are generally smaller than if the pattern appeared on a larger timeframe.
Chart patterns for trading
Chart patterns are a classical approach to analysis of the financial markets. It was widely used in the XXth century and is still used due to visual simplicity of chart patterns. However, is it wise to use today what was good long ago?
- the rating of reliability of chart patterns;
- advantages and disadvantages of chart patterns;
- how to improve reliability of chart patterns with the help of the modern cluster analysis.
Start to use ATAS absolutely free of charge! The first two weeks of use of the platform give access to its full functionality with 7-day history limit.
“The fundamentals always looked good, but the technicals were signaling a trend change just as I was about to pull the trigger” Thomas N. Bulkowski.
“How to identify a reversal chart pattern for achieving success?” Thomas wondered. He lost his job at the age of 36 and started to study trading. This sharp U-turn in his life brought him success and he became one of the most competent authors of valuable hands-on books for traders.
The second edition of his complete encyclopedia of chart patterns with statistical data was published in 2005. In this edition, Bulkowski managed to use the data of the bearish market that started in 2000. The author had done an outstanding job – the total number of chart pattern samples he found was 38,500! He tested the samples in the charts of 500 American companies from 1991 until the middle of 1996 and charts of different 500 companies from 1999 until 2004.
Bulkowski calls chart patterns the footprints of the smart money and divides them into:
- bull market patterns;
- bear market patterns;
- event patterns – price changes that take place after publication of a financial report, change of the owner or taking over another company.
Let us consider the general rating without dividing the market into the bull and bear ones, since identification of periods of the explicitly expressed bullish or bearing movement is a rather subjective and conditional process.
By the way, the chart patterns are symmetrical , which means that there is always a reversed analogue. The same patterns can have different percentage of failures and movement potential in the bear and bull markets. To cut a long story short, we will consider the tops only. Remember that the reversed patterns are also meaningful.
The head-and-shoulders top – a reversal pattern.
Look for three peaks in a chart. The middle one should be higher than the other two. The neck line connects the peaks. It could slope upward or downward. The shoulders could be of various heights and non-symmetrical.
Bulkowski explains emergence of this pattern through action of the smart money and slow minor traders. Based on a fundamental analysis, the smart money buy an asset in the beginning of the left shoulder formation. Their actions cause the price increase and attract minor investors. The smart money partially close the position at the first peak since they made profit. The price goes down and again attracts those investors who either failed to buy in due time or waited for a correction in order to buy when the retrace stops. The third shoulder is formed in order to act against those sellers who were smart enough to recognize the bear reversal, but were imprudent to place a stop order too close.
The maximum volume, as a rule, is in the head and left shoulder. The head and shoulders takes the first place in the bull market and the sixth place in the bear market according to the Bulkowski rating.
The pattern example. Here is a day chart of a Brent oil futures. Numbers 1, 2 and 3 mark the left shoulder, head and right shoulder. The movement potential is bigger or equal to the distance from the head to the neck level.
The chart shows one more pattern – a falling wedge.
The Falling Wedge chart pattern
The falling wedge could be either a reversal or continuation pattern depending on the breakout direction. The failure rate of this pattern is rather high. In the Bulkowski rating it takes the 18th place in the bull market and 21st place in the bear market. Two trend lines pass along the upper and lower candlestick shadows. When building the pattern, it is advisable to have at least 5 crossing points from each side. The movement potential is equal to the wide part of the wedge.
The Picture shows a falling wedge from the Thomas book. What action is hidden in this pattern of the trend continuation?
- On the one hand, the cunning market involves traders into dangerous short positions with a pretended downward movement.
- On the other hand, a series of lower lows breaks stop losses of the buyers before the coming upward breakout.
The Pipe Bottom chart pattern
A short-term reversal pattern. It shows the best results on weekly charts. The failure rate is about 18% in day charts. In the Bulkowski rating, it takes the 2nd place in the bull market and 3rd place in the bear market. The classical pattern consists of two candles and looks as follows.
The pattern example . The US passed sanctions on a number of Russian companies on April 9, 2020, and the stock market sharply fell down. In those days the pipe bottom pattern could be found in the charts of practically all liquid stock, since the market came back fast after a negative influence of the news.
Below is a day chart of the Gazprom stock futures (GZ).
Chart patterns are marked with numbers
1, 2 and 3 – head-and-shoulders top
4 – broadening wedge
The Broadening Wedge chart pattern
It could be either a reversal or continuation pattern depending on the breakout direction. Its shape resembles a loudspeaker and could slope upward or downward. It takes the 6th and 10th places in the rating in the bull and bear markets respectively. We connect lower and upper candlestick shadows with the trend lines. When building the pattern, it is preferable to see at least 5 touches from each side. Partial rise or fall and a failure to touch the opposite line warn about the trend change.
The Diamond Top chart pattern
It could be either a reversal or continuation pattern depending on the breakout direction. It takes the 7th and 10th places in the bull and bear markets respectively in the reliability rating. The head-and-shoulders top is one of particular cases of the diamond top. Support and resistance lines are built by extreme lower and upper points. The movement potential is measured by the widest part.
The Flags chart pattern
Flags is a continuation pattern. Reliable flags emerge during rapid and sharp trends. The flags are bounded by parallel trend lines. Ideal flags continue for several weeks and slow down the price movement. Bulkowski specifies several types of flags.
A flag pattern example . Let us consider a pattern in the gold futures (GD) day chart.
In this case, the flag pattern is a sample of continuation of the bearing trend. The price decrease started in the middle of April and the flag pattern was formed at the level of support of the February range. It involved the buyers, who expected a growth from support, into longs, but they were wrong. This failure of the buyers added a bearish potential to the downsloping trend, which lasted until the middle of August.
The Double Top chart pattern
The double top is a pattern of a short-term reversal. Bulkowski specifies 4 types of double tops depending on the peak shapes and their symmetry. An example of a double top in the RTS index futures (RI) day chart. There is one more falling wedge marked with number 1.
Chart pattern samples or modern trading and analytical systems?
Below is a symmetric triangle in the RTS index futures (RIZ9) chart, which was broken upwards at 17:30. A symmetrical triangle is a continuation pattern. Let us compare trading possibilities with a set of different instruments.
The Delta type chart and Dynamic levels , Volume indicators are placed to the left. This chart type means that a new candle is built in the chart at the moment of changing the delta on 500 contracts and it does not depend on time. The number 500 is adjustable, that is, more convenient values could be chosen for different instruments. Numbers 1,2 and 3 mark possible entry points into a long position before the triangle is broken. These entry points are confirmed by bullish candle engulfing and are at the level of the maximum volume. Bullish engulfing cases are outlined with black rectangles and the green candles fully overlap the red candle bodies, confirming the buyers intentions. The stop loss in point 1 could be placed at the previous level of the maximum volume. The stop loss in point 2 could be placed below the bottom boundary of the triangle or the previous minimum in point 1. The stop loss in point 3 could be placed at the previous level of the maximum volume.
A standard 30 minute candle chart and Dynamic levels , Volume indicators are placed to the right. Working with this chart we find only one point of entry for breaking the triangle. A possible entry point is marked with the level. The stop loss could be placed immediately after the previous minimum or below the lower boundary of the triangle, which increases the risk.
Let us consider a chart pattern example – a pipe bottom in the S&P mini ESH9 chart
There is a 15-minute candlestick chart to the left. The pipe bottom patterns are marked with numbers 1 and 2. The movement potential is approximately equal to the heights of these bars.
There is a Bid*Ask Volume Profile cluster chart to the right, which shows the order flow and selling volume at each price level in the real time mode:
- the Cluster statistic indicator shows information about the delta, volume and percentage ratio of the delta in the volume. Information in this indicator could be adjusted – it is reflected in the cluster mode only.
- the Daily HighLow indicator shows dynamic movement of the day high and low. These levels are important, since the price stops at them, turns around or breaks this level.
We can see the following features of a possible trend change in the cluster chart:
- number 3 marks drying out of the buying volume in the candlestick high at the day high;
- the negative bar delta marked with number 3 emerged at the day high;
- decrease of the level of the maximum volume in the bar marked with number 3 if compared with the previous bar.
We can see a successive reduction of the maximum volume level of each of the subsequent bars and an arrow marks the beginning of this movement. The buyers try to hold the price and even push it upwards at 16:00 and a positive delta emerges, however, the volume is less than in the previous bars. The bounce effort does not find continuation. The peak of aggressive sells falls at 16:45. We observe the biggest volume and explicitly expressed negative delta. However, buyers appear in the subsequent bars marked with number 4. The aggressive behavior of the sellers did not find its continuation. And we again face the features of a short-term trend change – a positive delta on the day low, increase of the maximum volume level in the bar and drying out of sells in the candlestick low.
Advantages and disadvantages of chart patterns
- There is no need in modern software;
- You can calculate take profit and stop loss levels approximately, just measuring the pattern.
- Subjectivism. Some patterns look contradictory even for experienced traders;
- The patterns often fail on small timeframes. The movement potential is higher in the day charts.
Chart patterns exist for a long time and have their followers, who confirm efficiency of following the chart patterns by their careers. One of such competent followers is Peter Brandt, the author of the “Diary of a Professional Commodity Trader” bestseller. His Twitter account has a quarter of a million of subscribers and his favorite pattern is head-and-shoulders, from which we started this article.
We do not know whether Peter uses the cluster analysis. But you can easily do it by yourself. Try ATAS free of charge in order to increase your chances from trading by chart patterns, as it is shown in a simple example above.
Perhaps, someone as well-known as Thomas Bulkowski is, would write in the year 2058: “the technical analysis always worked perfectly, but the cluster one allows seeing what happens in momentum” .
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