Technical and fundamental traders agree with at the very least one thing: price developments are not totally accidental.
Since if they were, neither keeping with the news, nor examining charts or using technical indicators would make any sense.
Being a technical trader, you could these days let the technical indicators do everything when it comes to forecasting future price movements, but many thriving traders have learned to identify certain patterns in the charts on their own.
By understanding forex charts on your own, you will not only get more of a perception for the normal price development of a particular currency pair, but will also acquire a much more profound comprehending of it. Just like Cipher tells Neo in The Matrix, as traces of green code run down the screen: “I don't even see the code anymore, all I see is blonde, brunette, redhead.”
One look at a random forex chart is excellent for a treasure trove of facts. For example, take a look at the candlestick chart of the EUR/USD from December 2009 to March 2010 (each candle is 1 week). It will not cost you lots of effort to notice that the rate of the EUR/USD fell significantly during the initial months of 2010. The chart won't tell you why it took place obviously, but it does give a decent picture of how it did.
The flow of currency pair is triggered by human action. Traders, hedge funds, multinationals, governments and banks all put on positions on the forex and the sum of those positions establishes which way the rate of the currency pair moves. And while human actions are partially ambivalent, psychological and exaggerated, they are not accidental. In the long term, human actions on the forex are logical, because everybody is striving to earn or save money through their positions on the currency market.
If the price progression of a currency pair is not arbitrary, it indicates there must be patterns; patterns that are, basically, nothing more than the translation of human habits into prices on a chart. A typical illustration of such a pattern is the double top/double bottom. With a double top pattern, the price first attains a new high, then drops back. Somewhat later, it goes up to the same high but fails again to shift higher still, after which the price deflates. The reason for this pattern is that the buyers (a.k.a the bulls) relinquish interest in the product, thus making a sellers (or bear) market.
This pattern is frequently the harbinger of a great, lucrative trade. It's generally clearly visible and regarded as a dependable signal. The head-and-shoulders pattern is recognized as a reversal pattern, because it's usually a sign that the present trend is ending and price progression will head in the different direction.
The head-and-shoulders pattern contains four elements: two shoulders, a head and a neck line. The structure is said to be validated when the neck line is ruined. Traders spotting a head-and-shoulders pattern normally plot their entry order just under the neck line, once the pattern is validated.
You don't need to have much imagination to look at the head-and-shoulders pattern as the graphic example of a short-lived climax in the lasting battle among the bulls and the bears. First, the bulls, the buyers, attain a new high (first shoulder). Sadly for them, they are incapable to hold on to the top, and the price falls back yet again. After a while, they make one more attempt and reach an even greater peak (the head).
But the price sags once more, until it reaches the neck line (the horizontal line in the chart). Again the bulls drive the price up, but this time, it doesn't achieve beyond the first peak (second shoulder). This is a indicator of significant weakness, since it displays that the new push packs far less of a punch than the previous one.
There's likewise such a thing as the reverse head-and-shoulder pattern. Look at the chart below for an example of this pattern.
Double Top / Double Bottom
This is one more easily discernable pattern. With regards to the double top, the price attempts to continue in an upwarding pattern. But after having unsuccessful twice, the bulls lose spirit and the price sags like a unsuccessful soufflé. The similar applies for the double bottom pattern, only this time the other way around.
The initial phase of the double top is for the price to achieve a new high. However, this high becomes too challenging to crack, and the price declines.
Throughout the second phase, the price rises again, aiming once more for the top it had to forego before. But, just like last time, it does not bust through and the price falls again. Bear in mind that the price doesn't automatically have to hit the high, so long as it comes close.
The second failure is much more significant than the first one, given that it confirms earlier signals that this particular reluctance might be hard to infringe. (a common rule of thumb holds that resistance and support i.e the highs and lows become more powerful with every attack they endure).
It's crucial not to get in the trade too speedily when finding a double top/double bottom pattern. Open the position strictly after the price has actually cracked the support level. You need to hold back since it is likely that the price will start varying between support and top for some time, before the actual breakout happens
This is one of the most intriguing patterns. There are fundamentally three types of triangle patterns:
1. Symmetrical triangle
2. Rising triangle
3. Falling triangle
When a symmetrical triangle takes shape, neither the bulls nor the bears can seriously get a regulating grip on the market. The outcome is falling highs and rising lows, leading to the price movement to reduce.
Look over at the next chart. The market is constantly making lower highs and higher lows. The highs and lows are drawing ever nearer to one another, until there's barely any variation in price. Such a symmetrical triangle (a.k.a flag pattern) can usually result in a profitable trade, when the price breaks away from the flag pattern, be it upwards or downwards.
In such a scenario, no trader can foresee in which path the price is likely to breakout, but that doesn't mean much. The goal is to enter once the breakout has began, whatever the direction.
The best trading tactic in a circumstance like this is to put two entry orders (an order that's triggered only when the price gets to a specific level): one placed just over the falling resistance line and one just under the rising support line. This way you'll have a fairly good chance to ride the wave of the breakout, whichever direction it's taking.
Stops need to be placed sensibly tight with trades like this, such as just within the triangle itself. Because when the price moves back within the triangle swiftly, the entry signal simply turned out to be false.
In the event of a rising triangle, the price creates ever higher lows, but is not capable to pierce a certain opposition on the other side. This pattern looks rather like the double top pattern, only not having a clear support level at the bottom end. The bears are obviously losing strength, since the lowest price level remains to rise, but the bulls aren't able to take full benefit of the circumstance.
With a rising triangle, a breakout happens on the upside more frequently than on the downside. (bear in mind though that more often does not mean always; breakouts to the downside do occur with rising triangles). As with the symmetrical triangle, put an entry order both over the resistance line along with beneath the rising support line. This way the direction of the breakout is irrelevant. (you can set your stops quite tight here too, to limit potential losses)
The most crucial signal for the rising triangle is the rising support line, since this is what's displaying the bears are losing the battle. When the sellers lose heart totally, the buyers (the bulls) take control and push the price past the resistance level.
A rising triangle is often beat by an upward trend, but can likewise arrive from a falling trend.
The reverse of a rising triangle (if you hadn't considered it yet) is as expected the falling triangle. The highs go lower and lower, while the price does not quite achieve breaking a certain support level on the other side. The disparities between highs and lows become smaller and smaller, till either the bears or the bulls. In the event of the falling triangle generally the bears have obtained enough strength to push the price through the support or resistance level.
An extremely applied set-up for the falling triangle is as with the symmetrical and rising triangle ? to put two entry orders, one over the falling resistance line and one over the support line.