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Technical Indicators – Introduction

Technical indicators are based on mathematical equations that produce values that are plotted on charts. For example, a moving average calculates the historic average price of a share or CFD and plots it on your chart as a line. As your share or CFD chart moves forward, the moving average is revised accordingly. The system then plots new points. As you’ll see, this moving average irons out a lot of the temporary price fluctuations (because it is based on a larger sampling of data) and provides a smooth line that indicates the direction in which the share or CFD is moving (see Figure 1).

We have previously identified some of the key factors in technical analysis and in this lesson we will expand on your knowledge and will cover Technical Indicators and Price Patterns. Technical indicators are the interpreters of the CFD markets. They examine price information and translate it into simple, easy-to-read signals that assist you in determining when to buy and when to sell.

Technical Indicator - Example of a technical Chart

Figure 1 – Technical Indicator: Moving Average

Each technical indicator provides unique information but most traders will have a preference for a particular indicator. It is important to familiarize yourself with all of the technical indicators. The one weakness associated with technical indicators is that it is based on historical price data and there is therefore a lag behind the current market; however, they still provide valuable information.

Technical indicators are divided into the following categories:

 

  • Trending Indicators
  • Oscillating Indicators
  • Volume Indicators
Trending Indicators – Moving Average

Trending Indicators – Moving Average

Trending indicators identify and follow the trend of a share or CFD. Traders are most successful when there is a trend on which they can capitalise. It is critical that you therefore know when a share or CFD is on a trend and when it is consolidating. In this section, we will talk about Moving Averages.

Moving Averages

Moving averages are the most fundamental trending indicator. They indicate the direction in which a share or CFD is going and where potential levels of support and resistance may be. Moving averages themselves can serve as both support and resistance levels because they will be watched by many traders and will be influential.
Regarding moving averages we shall examine three key topics:

  • How moving averages are constructed
  • Moving average trading signals
  • Strengths of moving averages

How a Moving Average is constructed

Moving averages utilise the average closing prices of a share or CFD, plotting these points on a price chart. The result is a fairly smooth line that follows price movements (see Figure 2).
You can influence the volatility of a moving average by adjusting the time-frame the indicator uses to obtain an average price. Moving averages that examine a shorter time are more volatile (and therefore more erratic). Moving averages that examine a longer time-frame are less volatile (and therefore smoother).

 

Technical Indicator - Moving Average

Figure 2–Moving Average

 

Moving Average Trading Signal

Moving averages provide useful trading signals for shares or CFDs that are following trends.

Entry signal – when a share or CFD is enjoying an upward trend and bounces back up after hitting an upward-trending moving average, or when a downward-trending share or CFD bounces back down after hitting a downward-trending moving average.

Exit signal – when you trade in an upward-trending share or CFD you should set a stop-loss below the moving average. As the moving average rises you can move your stop-loss up along with the moving average or use a trailing stop loss which will automatically adjust your stop loss level. If the share or CFD moves below the moving average by your predetermined value, your stop-loss will prompt you to sell.

When you trade in a downward-trending share or CFD, set a stop-loss above the moving average. As the moving average falls, move your stop-loss down along with the moving average. If the share or CFD breaks far enough above the moving average, your stop-loss will prompt you to sell.

Strengths of a Moving Average

  • They identify simple trends
  • They are flexible enough to work in both short-term and long-term time frames

Weaknesses of a Moving Average

  • They lag behind the market. The data used to calculate a moving average is historic, which doesn’t necessarily influence what will happen in the future.
  • They cannot identify trends, or levels of support or resistance, during channelling markets.
Trending Indicators - Bollinger Bands

Bollinger Bands

Bollinger bands are a trend indicator named after their creator, John Bollinger, and they indicate both the direction and volatility of a share or CFDs price movement. There are just two Bollinger bands, an upper band and a lower band, which work above and below a moving average.

The following three topics are critical in respect of Bollinger bands:

  • How Bollinger Bands are Constructed
  • Bollinger Band Trading Signals
  • Strengths of Bollinger Bands

How Bollinger Bands are Constructed

Bollinger bands are typically based on a 20-period moving average. A moving average is sandwiched between the two bands.

A standard deviation is a statistical term that measures how far various closing prices diverge from the average closing price. The upper band is plotted two standard deviations above the 20-period moving average. The lower band is plotted two standard deviations below the 20-period moving average (see Figure 3).

Therefore, 20-period Bollinger bands tell traders how wide, and therefore volatile, the range of closing prices has been during the past 20 periods. When the price has been volatile, the bands will be wider. When the price has been relatively stable, the bands will be narrower.

 

Trending Indicators - Bollinger bands

Figure 3–Bollinger Bands

 

Bollinger Band Trading Signal

Bollinger bands provide useful breakout signals for shares or CFDs that have been consolidating.

Entry signal – when the bands widen and begin moving in opposite directions after a period of consolidation (see Point A on Figure 4), you can enter the trade in the direction the price was moving when the bands began to widen. Clearly you are trying to capitalize on renewed volatility.

Exit signal – at some point after the breakout occurs, the bands will begin to move back toward each other (see Point B on Figure 4). When this happens, you should set a trailing stop-loss to prompt you to sell if the trend reverses (see Point C on Figure 4 ).

 

Technical Indicators - Bollinger Bands Exit Signal

Figure 4–Bollinger Bands Exit Signal

 

Strengths of Bollinger Bands

  • They help you identify the trend
  • They identify current market volatility

Weaknesses of Bollinger Bands

  • They lag behind the market because the data used to calculate Bollinger bands is historic and cannot predict the future.
  • The bands do not, as is commonly believed, serve as support (lower band) and resistance (upper band) levels.
Oscillating Indicators – Introduction

Oscillating Indicators – Introduction

As their name suggests, oscillating indicators are indicators that move back and forth as prices rise and fall. Oscillating indicators can help you decide how strong a current trend is and warn when that trend is in danger of losing momentum and being reversed.

When an oscillating indicator moves too high, the share or CFD is considered to be ‘overbought’ (too many people have bought it and there are not enough buyers left in the market to push the price higher). This indicates the upward trend is at risk of losing momentum-causing the trend to reverse or the price to stagnate.
When an oscillating indicator moves too low, the share or CFD is considered to be ‘oversold’ (too many people have sold it and there are not enough sellers left in the market to depress the price). This indicates the downward trend is at risk of losing momentum-causing the trend to reverse or the price to stagnate.

The following oscillating indicators are worth examination:

  • Moving average convergence divergence (MACD)
  • Slow Stochastic
  • Relative Strength Index (RSI)
Oscillating Indicators - MACD

Moving Average Convergence/Divergence (MACD)

The moving average convergence/divergence (MACD) is an oscillating indicator developed by Gerald Appel. It can indicate when trading momentum changes from being bullish to bearish and vice versa. The MACD can also indicate when traders are becoming over-extended, which usually results in a trend reversal for the share or CFD.

The MACD is usually plotted below the price movement on a chart.

It is worth looking at the following three aspects of the MACD:

  • How the MACD is constructed
  • MACD trading signal
  • Strengths of the MACD

How the Moving Average Convergence/Divergence (MACD) is Constructed

The moving average convergence/divergence compares a series of moving averages and their relationships. The standard MACD looks at the relationship between the 12-period and 26-period exponential moving averages of a share or CFD. When the 12-period moving average is above the 26-period moving average, the MACD line will be positive. If the 12-period moving average is below the 26-period moving average, the MACD line will be negative (see Figure 5).

The MACD line is accompanied by a trigger line. This line is a 9-period exponential moving average of the MACD line.

 

Moving Average Convergence/Divergence (MACD)

Figure 5–Moving Average Convergence/Divergence (MACD)

 

You can also plot the MACD as a histogram below the chart. When the histogram is above the 9-period signal line (illustrated by a horizontal line on the histogram), it is signalling that the 12-period moving average is above the 26-period moving average (see Point A of Example 1). When the histogram is below the 9-period signal line, it is signalling that the 12-period moving average is below the 26-period moving average (see Point B of Example 1).

 

Moving Average Convergence/Divergence (MACD) Historgram

Example 1–Moving Average Convergence/Divergence (MACD) Histogram

 

Moving Average Convergence/Divergence (MACD) Trading Signal

 

The moving average convergence/divergence (MACD) produces trading signals as it crosses the trigger-line.

Entry signal – when the MACD rises above the trigger line, you can buy as the market shifts from being bearish to bullish.
When the MACD falls below the trigger line, you can sell as the market shifts from being bullish to bearish.

Exit signal – when the MACD falls below the trigger line after you buy, you can sell as the market shifts from being bullish to bearish.
When the MACD rises above the trigger line after you sell, you can buy as the market shifts from being bearish to bullish.

Strengths of the Moving Average Convergence/Divergence (MACD)

  • It helps to identify when the momentum of a share or CFD changes.
  • It helps to confirm the strength of current trends.

Weaknesses of the Moving Average Convergence/Divergence (MACD)

  • It lags behind the market because the data used to calculate the MACD is historic and doesn’t necessarily help to predict the future.
  • It can generate misleading signals.
Oscillating Indicators - Slow Stochastic

Slow Stochastic

The slow stochastic is an oscillating indicator. Developed by George Lane , it can alert you to a shift of investor sentiment from bullish to bearish or vice versa. The slow stochastic can also alert you to when traders are becoming over-extended, which usually results in a trend reversal.

The slow stochastic is usually plotted below the price movement on a chart.

The following three aspects of the slow stochastic are worth your attention:

  • How the Slow Stochastic is Constructed
  • Slow Stochastic Trading Signals
  • Strengths of the Slow Stochastic

How the Slow Stochastic is Constructed

The slow stochastic consists of two lines–%K and %D – that oscillate in a range between 0 and 100.

%K reflects the most recent closing price of a share or CFD in relation to the range of historical closing prices.

%D is a moving average of %K.

If the closing price is near to the peak of historical closing prices, then the %K line (followed by the %D line) will rise.
If the closing price is near the bottom of the range of historical closing prices, the %K line (followed by the %D line) will move lower (see Figure 7 ).

 

Trend Signal - Slow stochastic

Figure 7–Slow Stochastic

 

Slow Stochastic Trading Signal

The slow stochastic produces trading signals as it enters its upper and lower reversal zones.
The upper reversal zone is the area of the indicator that is above 80. When %K exceeds 80, the share or CFD may be overbought and could suffer a reversal soon.
The lower reversal zone is the area of the indicator that is below 20. When %K is below 20, the share or CFD may be oversold and could suffer a reversal soon.

Entry signal – when %K dips below 80, you can sell knowing that investor sentiment is shifting from being bullish to bearish.
When %K rises above 20, you can buy knowing that investor sentiment is shifting from being bearish to bullish.

Exit signal – when %K reverses direction after having risen above 20 or fallen below 80, and crosses over %D, you can sell knowing that investor sentiment is changing direction again.

Strengths of the Slow Stochastic

  • It helps you spot when investor sentiment changes
  • It helps you confirm the strength of current trends

Weaknesses of the Slow Stochastic

  • It lags behind the market because the data used to calculate the slow stochastic is historic and doesn’t necessarily have any bearing on the future.
  • It can provide false signals.
Oscillating Indicators - RSI

Relative Strength Index

The Relative Strength Index (RSI) is an oscillator that measures a particular financial instrument’s current relative strength compared to its own price history. The RSI should not be confused with relative strength which rates a financial instrument in relation to a market such as the S&P index.

The RSI is plotted on a vertical scale numbered from 0 to 100. The formula to calculate the RSI is 100-[100/(1+A)] where A is the average of the “up” closes over the calculation period divided by the average of the “down” closes over the calculation period. Recognia uses the popular 14-bar period in the calculation of the RSI. The “A” for a 14-day period is calculated by dividing the 14-day “up” close average by the 14-day “down” close average. An “up” close or a “down” close is defined as the absolute change in price from close to close.

Trading Considerations

The RSI sometimes shows more clearly than the price chart itself the support and resistance lines for a financial instrument. Failure Swings which are also known as support or resistance penetrations or breakouts can be detected by using the RSI. Failure swings occur when the RSI passes a previous high or falls below a recent low.

Divergences (when market trends go in a different direction than market indicators predicted, usually signifying the onset of a trend change) occur when the price makes a new high (or low) that is not confirmed by a new high (or low) in the RSI. Prices usually correct and move in the direction of the RSI.

A financial instrument is considered to be oversold when its RSI falls below 30 and overbought when its RSI rises over 70.

 

Oscillating Indicator - Relative Strength Indicators - RSI

Figure 8 – Relative Strength Index (RSI)

Volume Indicators - Introduction

Volume Indicators

Volume indicators provide a very different kind of indicator because, instead of relying solely on the price, they take volume into account.

Prices tell you in which direction an investment is moving, but volume can tell you what kind of support is influencing the price. For instance, if you see a price rise accompanied by high volume, then you know that there are a lot of traders who have confidence in this investment. Seeing this support may give you confidence too. On the other hand, if you see the price of a share of CFD rise on low volume, you know that there are only a few investors pushing the price. This may discourage you from buying yourself.

There are two volume indicators that you ought to know about:

  • On-balance-volume
  • Accumulation/Distribution
Volume Indicators - On-balance-volume

On-balance-volume

Developed by Joe Granville, on balance volume is a volume indicator that demonstrates positive and negative volume flow. It can also show you when price movement is not reflected in increasing volume, which usually results in a trend reversal.

On-balance-volume is usually plotted below the price movement on a chart.

There are four aspects of on balance volume which you ought to know about:

  1. How on balance volume is constructed
  2. On balance volume confirmations
  3. Strengths of on balance volume
  4. Weaknesses of on balance volume

How On balance volume is constructed

On balance volume involves a calculation that utilizes today’s volume and the previous trading day’s on-balance-volume level.
If today’s closing price is higher than yesterday’s, you add today’s volume to yesterday’s on balance volume level. You then record the resultant value below the price chart.
Alternatively, if today’s closing price is lower than yesterday’s, you subtract today’s volume from yesterday’s on balance volume level. You then record the resultant value below the price chart.
Connecting each on balance volume value gives you a smooth line that illustrates how volume has, or has not, supported the price movement of the share (see Figure 9).

 

Volume Indicator - On-Balance Volume

Figure 9 – On-Balance-Volume

 

On balance volume Confirmations

Traders need to know whether a trend will sustain its momentum. On balance volume can help you decide if there is enough momentum behind a price to sustain it or continue pushing it higher.

Positive confirmation– on balance volume can provide positive confirmations of both upward and downward trends. If the on balance volume line is in an upward trend while the price is likewise rising, you know there is strong buying support. If the on balance volume line is in a downward trend whilst the price is also falling, you know there is strong selling support.

Negative confirmation– on balance volume can provide negative confirmations of both upward and downward trends. If the on balance volume line is in a downward trend while the price is in an upward trend, you know there is only weak buying support underpinning the upward trend. If the on balance volume line is in an upward trend whilst the price is in a downward trend, you know there is weak selling support underpinning the downward trend.

Strengths of on balance volume

  • It does not rely on price alone in its calculation
  • It helps you to confirm the strength of current trends

Weaknesses of on balance volume

  • It lags behind the market since the data used to calculate on balance volume is historic and will not necessarily reflect what will happen in the future.
  • It can give misleading indications of trends.
Volume Indicators - Accumulation/Distribution

Accumulation/Distribution

Accumulation/distribution line is a volume indicator that reveals the cumulative flow of money into and out of a share or CFD. The accumulation/distribution line can also indicate when price rises are not mirrored by increasing volume, which usually results in a trend reversal.

The accumulation/distribution line is usually plotted below the price movement on a chart.

There are four aspects of the accumulation/distribution line which need to be examined:

  • How the accumulation/distribution line is constructed
  • Accumulation/Distribution line confirmations
  • Strengths of the accumulation/distribution line
  • Weaknesses of the accumulation/distribution line

How the Accumulation/Distribution Line is constructed

The accumulation/distribution line is similar to the on balance volume line, but the calculation has one distinct difference. It does not compare the current trading period’s price movement in relation to the previous period’s price movement. Whereas the on balance volume line is calculated based on the closing price in the current period compared to that in the previous period, the accumulation/distribution line shows where the price closed in relation to the mid-point of that period’s price movement.

If the share price closes above the mid-point, you must add a value between 0 and 1 to the cumulative value of the accumulation/distribution line. If the share price closes below the midpoint, you subtract a value between 0 and -1 from the cumulative value of the accumulation/distribution line.

Therefore, if the share price closed at the high for that trading period, you would add 1 to the cumulative value of the accumulation/distribution line. Conversely, if the share price closed at the low for that trading period, you would subtract 1 from the cumulative value of the accumulation/distribution line.

Connecting each accumulation/distribution data point gives you a smooth line that illustrates how volume has, or has not, supported the price movement (see Figure 10).

 

Volume Indicator - Accumulation/Distribution line

Figure 10 –Accumulation/Distribution

 

Accumulation/Distribution Line Confirmations

Traders are always eager to know whether a trend can sustain its momentum. The accumulation/distribution line can help you decide if the momentum behind a price rise is sufficient to continue pushing the price up.

Positive confirmation – the accumulation/distribution line generates ‘positive’ confirmations of both upward and downward trends. If the accumulation/distribution line is soaring whilst the share price is doing likewise, you know there is strong buying support. If the accumulation/distribution line is on a downward trend whilst the price is doing likewise, you know there is strong selling support.

Negative confirmation – the accumulation/distribution line generates ‘negative’ confirmations of both upward and downward trends. If the accumulation/distribution line is diving whilst the share price is rising, you know there is only weak buying support. If the accumulation/distribution line is on an upward trend whilst the price is on a downward trend, you know there is weak selling support.

Strengths of the Accumulation/Distribution Line

  • The calculations do not rely on price alone
  • It helps confirm the strength of current trends

Weaknesses of the Accumulation/Distribution Line

  • It lags behind the market because the data used to calculate the accumulation/distribution line is historic and may have no relevance to the future.
  • It can give false indications of some trends.
Price Patterns - Introduction

Price Patterns

Traders vote with their cheque books. If they believe a share or CFD is going to move higher, they will buy it. If they believe a share or CFD is going to move lower, they will sell it. When their money is at stake, they will do whatever it takes to be profitable. Often, their actions form quite distinctive price patterns on the charts, and it is well worth your while to learn to recognize these.

Price patterns provide an insight into what share and CFD traders are thinking and feeling. Learning to recognize various price patterns will give you an advantage over traders who only use fundamentals or technical indicators.

Imagine having the ability to precisely identify the optimum moment to buy as a share or CFD surges as well as the ability to accurately project how far a share or CFD is going to rise.

Price patterns can give you this ability.

Price patterns are divided into the following two categories:

  • Continuation patterns
  • Reversal patterns
Price Patterns - Continuation Patterns

Continuation Patterns

Share and CFD traders continually ask themselves whether a trend can continue. Deciding whether to invest in the middle of a trend or whether to take your profits is difficult. You can never know if a share or CFD is going to turn around and start moving in the opposite direction.

Continuation patterns give you advanced warning of when a share or CFD is likely to resume its trend after a short consolidation period, and they can also tell you how far the share or CFD is likely to move in that direction. Of course, continuation patterns are not infallible, but they do put the odds of success in your favor.

Take some time to become acquainted with the following price continuation patterns:

  • Pennants
  • Flags
  • Wedges
  • Triangles

Pennants

Pennants are continuation patterns that form as the price of a share or CFD moves into a tighter and tighter consolidation range. Pennants can be either bullish or bearish, depending on what the trend was before the pennant began to form. If a share or CFD was on an upward trend before the pennant began to form, then it is a bullish continuation pattern.

Alternatively, if a share or CFD was on a downward trend before the pennant began to form, then it is a bearish continuation pattern.

Pennants usually form over short periods of time. All have the following five characteristics (see Figure 11 ):

  • A: Resistance level – there is downward trend in the level of resistance as it converges with the support level.
  • B: Support level – there is an upward trend in the level of support as it converges with the resistance level.
  • C: Flagpole – this identifies the trend preceding the formation of the pennant. The flagpole spans the distance from the beginning of the trend to the highest point of the pennant (for a bullish pennant). Or, the flagpole spans the distance from the beginning of the trend to the lowest point of the pennant (for a bearish pennant).
  • D: Breakout point – this the point at which the share or CFD breaks up above the downward-trending level of resistance (for a bullish pennant), or the point at which the share or CFD breaks down below the upward-trending level of support (for a bearish pennant).
  • E: Price projection – this is the price to which the share or CFD will most likely fall after it has broken out of the pennant formation (in a bearish pennant), or the price to which the share or CFD will most likely rise after it has broken out of the pennant formation (in a bullish pennant). The distance the share or CFD is projected to move is equal to the height of the flagpole.

Technical Analysis - Pennants

Figure 11 – Pennant

 

Flags

Flags are continuation patterns that form as the price of a share or CFD pulls back from the predominant trend in a parallel channel. Flags can be either bullish or bearish, depending on what the trend was before the flag began to form. If a share or CFD was on an upward trend before the flag began to form, it is a bullish continuation pattern. If a share or CFD was on a downward trend before the flag began to form, it is a bearish continuation pattern. Flags usually form over short periods of time.

Flags all have the following five characteristics (see Figure 12 ):

  • A: Resistance level is the downward-trending level of resistance that is parallel with the support level (for a bullish flag), or an upward-trending level of resistance that is parallel with the support level (for a bearish flag).
  • B: Support level is a downward-trending level of support that is parallel with the resistance level (for a bullish flag), or an upward-trending level of support that is parallel with the resistance level (for a bearish flag).
  • C: Flagpole is the trend preceding the formation of the flag. The flagpole spans the distance from the beginning of the trend to the highest point of the flag (in a bullish flag), or the flagpole spans the distance from the beginning of the trend to the lowest point of the flag (in a bearish flag).
  • D: Breakout point is the point at which the share or CFD breaks up above the downward-trending level of resistance (in a bullish flag), or the point at which the share or CFD breaks down below the upward-trending level of support (in a bearish flag).
  • E: Price projection is the price to which the share or CFD will most likely fall after it has broken out of the flag formation (in a bearish flag), or the price to which the share or CFD will most likely rise after it has broken out of the flag formation (in a bullish flag). The distance the share or CFD is projected to move is equal to the height of the flagpole.

 

Technical Analysis - Flags

Figure 12 – Flag

 

Wedges

Wedges are continuation patterns that form as the price of a share or CFD pulls back from the predominant trend and moves into a tighter and tighter consolidation range. Wedges can be either bullish or bearish, depending on what the trend was before the wedge began to form. If a share or CFD was on an upward trend before the wedge began to form, it is a bullish continuation pattern. If a share or CFD was on a downward trend before the wedge began to form, it is a bearish continuation pattern. Wedges usually form over short periods of time.

Wedges all have the following five characteristics (see Figure 13 ):

  • A: Resistance level is a downward -trending level of resistance that converges with the support level (in a bullish wedge), or an upward-trending level of resistance that converges with the support level (in a bearish wedge).
  • B: Support level is a downward -trending level of support that converges with the resistance level (in a bullish wedge), or an upward-trending level of support that converges with the resistance level (in a bearish wedge).
  • C: Flagpole is the trend preceding the formation of the wedge. The flagpole spans the distance from the beginning of the trend to the highest point of the wedge (in a bullish wedge), or the flagpole spans the distance from the beginning of the trend to the lowest point of the wedge (in a bearish wedge).
  • D: Breakout point is the point at which the share or CFD breaks up above the downward-trending level of resistance (in a bullish wedge), or the point at which the share or CFD breaks down below the upward-trending level of support (in a bearish wedge).
  • E: Price projection is the price to which the share or CFD will most likely fall after it has broken out of the wedge formation (in a bearish wedge), or the price to which the share or CFD will most likely rise after it has broken out of the wedge formation (in a bullish wedge). The distance the share or CFD is projected to move is equal to the height of the flagpole.

 

Technical Analysis - Wedge

Triangles

Triangles are continuation patterns that form as the price of a share or CFD hits a flat level of support or resistance and begins moving into a tighter and tighter consolidation range. Triangles can be either bullish or bearish, depending on what the trend was before the wedge began to form. If a share or CFD was on an upward trend before the triangle began to form, it is a bullish continuation pattern. If a share or CFD was on a downward trend before the triangle began to form, it is a bearish continuation pattern. Triangles usually form over long periods of time.

Triangles all have the following five characteristics (see Figure 14 ):

  • A: Resistance level is the horizontal level of resistance (in a bullish, or ascending triangle), or a downward-trending level of resistance that converges with the support level (in a bearish, or descending triangle).
  • B: Support level is the upward-trending level of support that converges with the resistance level (in a bullish or ascending triangle), or a horizontal level of support (in a bearish or descending triangle).
  • C: Flagpole is the trend preceding the formation of the triangle. The flagpole spans the distance from the beginning of the trend to the highest point of the triangle (in a bullish or ascending triangle), or the flagpole spans the distance from the beginning of the trend to the lowest point of the triangle (in a bearish or descending triangle).
  • D: Breakout point is the point at which the share or CFD breaks up above the horizontal level of resistance (in a bullish or ascending triangle), or the point at which the share or CFD breaks down below the horizontal level of support (in a bearish or descending triangle).
  • E: Price projection is the price to which the share or CFD will most likely fall after it has broken out of the triangle formation (in a bearish or descending triangle), or the price to which the share or CFD will most likely rise after it has broken out of the triangle formation (in a bullish or ascending triangle). The distance the share or CFD is projected to move is equal to the height of the flagpole.
Price Patterns - Reversal Patterns

Reversal Patterns

Share and CFD traders continually ask themselves the question whether a trend can continue. Deciding whether a trend is over is difficult. You can never know for sure if a share or CFD is going to turn around and start moving in the opposite direction.

Reversal patterns give you advanced warning when a share or CFD is likely to turn around and begin a new trend. They also indicate how far the share or CFD is likely to move in the opposite direction. Of course, reversal patterns are not infallible, but they do increase the likelihood of you correctly anticipating the market.

Take some time to become familiar with the following price reversal patterns:

  • Double-tops/bottoms
  • Triple-tops/bottoms
  • Head-and-shoulders top/bottoms

Double-Tops/Bottoms

Double-tops and double-bottoms are reversal patterns that form as the price of a share or CFD hits a support or resistance level two times before the share or CFD turns around and moves in the opposite direction. Double-tops are bearish reversal patterns and double-bottoms are bullish reversal patterns. If a share or CFD is on an upward trend, it will form a double-top. If ashare or CFD is on a downward trend, it will form a double-bottom. Double-tops and double-bottoms both usually form over long periods.

Double-tops and bottoms all have the following four characteristics (see Figure 15 ):

  • A: Resistance level is the horizontal, or slightly angled, level of resistance.
  • B: Support level is the horizontal, or slightly angled, level of support.
  • C: Breakout point is the point at which the share or CFD breaks up above the horizontal level of resistance (in a double-bottom), or the point at which the share or CFD breaks down below the horizontal level of support (in a double-top).
  • D: Price projection is the price to which the share or CFD will most likely fall after it has broken out of the double-top formation, or the price to which the share or CFD will most likely rise after it has broken out of the double-bottom formation. The distance the share or CFD is projected to move is equal to the distance between the support and resistance levels.

 

Technical Analysis - Double Top/Bottoms

Figure 15 – Double-top

 

Triple-Tops/Bottoms

Triple-tops/bottoms are reversal patterns that form as the price of a share or CFD hits a support or resistance level three times before the share or CFD turns around and moves in the opposite direction. Triple-tops are bearish reversal patterns and triple-bottoms are bullish reversal patterns. If a share or CFD is on an upward trend, it will form a triple-top. If a share or CFD is on a downward trend, it will form a triple-bottom. Triple-tops and triple-bottoms usually form over long periods.

Triple-tops and bottoms all have the following four characteristics (see Figure 16 ):

  • A: Resistance level is the horizontal , or slightly angled, level of resistance.
  • B: Support level is the horizontal, or slightly angled, level of support.
  • C: Breakout point is the point at which the share or CFD breaks up above the horizontal level of resistance (in a triple-bottom), or the point at which the share or CFD breaks down below the horizontal level of support (in a triple-top).
  • D: Price projection is the price to which the share or CFD will most likely fall after it has broken out of the triple-top formation, or the price to which the share or CFD will most likely rise after it has broken out of the triple-bottom formation. The distance the share or CFD is projected to move is equal to the distance between the support and resistance levels.

 

Technical Analysis - Triple Top

Figure 16 – Triple-top

 

Head-and-Shoulders Tops/Bottoms

Head-and-shoulders tops are reversal patterns that form as the price of a share or CFD hits a resistance level (forming the first shoulder), then breaks through the first resistance level and hits a higher resistance level (forming the head) and then hits the first resistance level again (forming the second shoulder).

Head-and-shoulders bottoms are reversal patterns that form as the price of a share or CFD hits a support level (forming the first shoulder), then breaks through the first support level and hits a lower support level (forming the head) and then hits the first support level again (forming the second shoulder).

Head-and-shoulders tops are bearish reversal patterns and head-and-shoulders bottoms are bullish reversal patterns. If a share or CFD is on an upward trend, it will form a head-and-shoulders top. If a share or CFD is on a downward trend, it will form a head-and-shoulders bottom. Head-and-shoulders tops/bottoms usually form over long periods.

Head-and-shoulders tops/bottoms all have the following five characteristics (see Figure 17 ):

  • A: Left shoulder is the horizontal , or slightly angled, level of resistance (head-and-shoulders top), or a horizontal, or slightly angled, level of support (head-and-shoulders bottom).
  • B: Head is the higher horizontal, or slightly angled, level of resistance (head-and-shoulders top), or a lower horizontal, or slightly angled, level of support (head-and-shoulders bottom).
  • C Right shoulder is the horizontal, or slightly angled, level of resistance that is in line with the left shoulder (head-and-shoulders top), or a horizontal, or slightly angled, level of support that is in line with the left shoulder (head-and-shoulders bottom).
  • D: Neckline is the horizontal, or slightly angled, level of support (head-and-shoulders top), or a horizontal, or slightly angled, level of resistance (head-and-shoulders bottom).
  • E: Breakout point is the point at which the share or CFD breaks up above the neckline (head-and-shoulders bottom), or the point at which the share or CFD breaks down below the neckline (head-and-shoulders top).
  • F: Price projection is the price to which the share or CFD will most likely fall after it has broken out of the head-and-shoulders-top formation, or the price to which the share or CFD will most likely rise after it has broken out of the head-and-shoulders-bottom formation. The distance the share or CFD is projected to move is equal to the distance between the head and the neckline.