Table Of Contents

What Is A Bar Chart? 7

Bar Chart Patterns 8

Inside Bar Pattern 9

Outside Bar Pattern 10

Two Bar Reversal Pattern 12

Three Bar Reversal 13

Key Reversal Bar Pattern 14

Exhaustion Bar Pattern 15

Island Reversal Pattern 17

Summary 18

Reading a Forex Chart with Candlesticks 18

Pros and Cons of Using Candlestick Charts Compared to Line and

Bar Charts 19

Different Types of Candlestick Patterns Convey Different Messages 20

Candlestick Chart Reading Like a Pro 24

Combining Technical Analysis Indicators with Candlestick Patterns 27

Conclusion 28

Technical Analysis in Forex 28

Fundamental Analysis in Forex 29

Advantages of Technical Analysis 30

Disadvantages of Technical Analysis 31

Advantages of Fundamental Analysis 32

Disadvantages of Fundamental Analysis 33

Technical Analysis Tools 34

Popular Tools Used By Technical Analysts 34

Fundamental Analysis Tools 35

Final Thoughts 36

What is the Dow Theory, and How Did it Come About? 36

The Three Primary Dow Theory Assumptions 37

Understanding Dow Theory and Trend Analysis 39

The Three Phases of Dow Theory 41

The Use of Volume in Dow Theory 43

Using Dow Theory Concepts in Forex Trading 43

What is Technical Chart Analysis? 44

Support and Resistance as a Primary Technical Analysis Tool 45

Support Levels 45

Resistance Levels 46

Forex Technical Analysis Using Trend Lines 47

Bullish Trend Line 47

Bearish Trend Line 48

Forex Technical Analysis Indicators 49

Lagging Indicators 49

Leading Indicators 49

Forex Price Action Trading 51

Candlestick Patterns 51

Classical Chart Patterns 51

Conclusion 52

What Are Technical Trading Patterns? 53

What Do Chart Patterns Tell Us? 54

Top Trading Chart Patterns in Technical Analysis 54

Head & Shoulders Pattern (H&S) 54

How to Trade the Pattern 56

Inverse Head & Shoulders Pattern (IH&S) 57

How to Trade the Pattern 58

Double Top Chart Pattern 59

Combining Indicators & Patterns 61

Example of Bearish RSI Divergence with Double Top Pattern 62

Double Bottom Pattern 63

Combining Patterns and Indicators 64

Double Bottom & Stochastics Example 64

Considerations When Trading Chart Patterns 66

What Are Forex Chart Patterns? 66

Type of Chart Patterns 67

Continuation Chart Patterns 67

Reversal Chart Patterns 67

Neutral Chart Patterns 67

Continuation Chart Patterns 68

Pennant Chart Pattern 68

Rectangle Chart Pattern 69

Corrective Wedge Pattern 69

Reversal Chart Patterns 70

Reversal Wedge Pattern 70

Double Top and Double Bottom Patterns / Triple Top and Triple

Bottom Patterns 71

Head and Shoulders Pattern 73

Ascending Triangle Pattern / Descending Triangle Pattern 74

Neutral Chart Pattern – Symmetrical Triangle  75

Trading Chart Patterns 76

Conclusion 77

Technical Trading Oscillators 78

Types Of Oscillators 79

Stochastics Oscillator 80

Momentum Oscillator 82

MACD Oscillator 83

ADX Oscillator 84

Aroon Oscillator 85

Summary 87

Forex Technical Indicators 87

Leading Indicators (Oscillators) 88

Stochastic Indicator  88

Relative Strength Index (RSI) 90

Lagging Indicators 91

ADX (Average Directional Index) 91

Bollinger Bands 92

MACD (Moving Average Convergence Divergence) 93

Parabolic SAR (Stop and Reversal) 94

Conclusion 95
Combining Technical Indicators 95

Why You Should be Combining Trading Indicators? 96

MACD and Stochastics Indicator Combo  100

Final Words 103

Divergence Trading Patterns 103

Bearish Divergence 104

Bullish Divergence 104

Hidden Bullish Divergence 104

Hidden Bearish Divergence 104

Reliable Indicators for Trading Divergences 105

Moving Average Convergence Divergence (MACD) 105

Stochastic Oscillator 106

Relative Strength Index (RSI) 107

Money Management when Trading Divergences in Forex 109

Stop Loss when Trading Divergence 109

Take Profit when Trading Divergence 110

A Complete Forex Divergence Strategy Using the MACD 110

Moving Averages 111

Support and Resistance 113

Price Breakouts 113

Simple Moving Average (SMA) 115

Exponential Moving Average (EMA) 115

Volume Weighted Moving Average (VWMA) 115

Displaced Moving Averages 116

2 SMA Crossover Indicator 116

2 EMA Cross Indicator 116

Other Forex MA Cross Strategy 117

Stop Loss with the MA Crossover Indicator 118

Profit Collection for Your MA Forex Crossover Strategy 119

Elliott Wave Impulse Pattern 122

Elliott Wave Corrective Patterns 125

Zigzag Elliott Wave Pattern 126

Elliott Wave Flat Correction 127

Elliott Wave Triangle 129

Elliott Wave Complex Corrections 130

Summary 132

Harmonic Patterns in Forex 132

Gartley Harmonic Chart Pattern 133

Bat Harmonic Chart Pattern 134

Butterfly Harmonic Chart Pattern 135

Crab Harmonic Chart Pattern 136

Cypher Harmonic Chart Pattern 137

Harmonic Chart Formations Analyzed 138

Trading Strategy Using Harmonic Chart Patterns 139

Stop Loss Order when Trading Harmonic Patterns 139

Take Profit Zones when Trading Harmonic Patterns 139

Adjusting the Stop Loss Order when Trading Harmonic Patterns 141
What Is A Bar Chart?

A bar chart is a charting style that displays the price action during a speci ed
period. Each bar shows that speci ed period’s opening price, high price, low
price, and closing price. This is also referred to as the OHLC prices. Unlike
candlestick charts which were introduced by a Japanese rice trader, bar
charts are an invention of the Western world. They were the primary
charting style used by American and European technicians prior to the
popularity of candlestick charts.

Each bar within a bar chart will display a vertical line and two horizontal lines.
The upper threshold of the vertical line represents the high price of the bar.
The lower threshold of the vertical line represents the low price of the bar.
The horizontal line on the left side of the vertical line represents the opening
price. And the horizontal line to the right side of the vertical line represents
the closing price. Below you will nd an example of a forex bar chart.

Many times the up bar will be represented by a green color bar, and the
down bar will be represented by a red color bar. This color coding makes it
easier for the chartist to quickly analyze the price action and differentiate
between an up bar which represents bullish activity, and a down bar which
represents bearish activity.

It should also be fairly evident that the longer the bar, the greater the range
for that speci c bar. That is to say that long bars represent a wider divide
between the high and low for that speci c bar, while short bars represent a
narrower divide between the high and low for that speci c bar.
As such, longer bars tend to represent higher volatility levels in the market
while shorter bars tend to represent lower volatility levels in the market.

Just as with candlestick charts, bar charts can help traders to better analyze
the price activity on the chart, and make informed decisions about whether
the market is more likely to continue moving in the same general direction,
or to reverse and move in the opposite direction. Bar chart analysis is a
combination of art and science. Price action traders can use the various clues
provided by individual bars and bar combinations to gauge the price
pressures in the market as a result of increased demand or supply at any
given time.

Bar Chart Patterns

Bar chart pattern analysis is an excellent way to gauge short-term sentiment

in the market. Most bar patterns consists of 2 to 3 individual bars that
combine to form a speci c formation. Bar patterns can be classi ed as
continuation patterns and reversal patterns. As the name suggests, a
continuation pattern is expected to move prices in the direction of the
current trend following the completion of the pattern. Along the same lines,
a reversal pattern is expected to retrace or reverse the direction of the
current price movement.

We will discuss some of the most important bar chart patterns that traders
should be aware of. This includes the inside bar pattern, outside bar pattern,
two bar pattern, three bar pattern, key reversal bar pattern, exhaustion bar
pattern, and the island reversal bar pattern.

Now although you can use these various bar patterns on any timescale, they
are far more reliable on higher time frames such as the four hour and above.
They tend to work best on the daily chart, as the daily price bar has special
signi cance in the market. Additionally, the more active a particular market
is in terms of volume, the more reliable the bar pattern will tend to be.

As such, the best use of bar patterns for market analysis occurs when you are
applying them to the daily or weekly charts, and on a very actively traded
market instrument. Some examples of very liquid markets would include
currency pairs such as EURUSD, GBPUSD, and USDJPY. For traders who
participate in the futures market, some examples would include the E-mini
S&P, Crude Oil, Gold, and Treasury Bonds.
Inside Bar Pattern

An inside bar pattern can be a continuation or reversal pattern based on

which side a breakout from the pattern occurs. The inside bar pattern is a
two bar formation that presents a market condition wherein traders are
displaying indecision and reluctance. This is because the rst bar in the
pattern, which can either be, a bullish bar or a bearish bar is relatively normal
in size, and the second bar, the inside bar, is completely engulfed by the rst
bar. As such, there is reduced volatility within the second bar, which is
building energy for a potential breakout.

Let’s look at an example of an inside bar pattern. Below you can see an
illustration of the inside bar.
This example shows a condition wherein the initial bar is a not bar, and the
inside bar is a down bar. But keep in mind, that any scenario with regards to
an up bar or down bar will be acceptable within this formation. The most
important criteria is that the second bar, the inside bar, be completely
engulfed by the rst bar. In other words, the high of the second bar should
be below the high of the rst bar, and the low of the second bar should be
above the low of the rst bar.

Going back to our illustration above, we can see that in this example the rst
bar is an up bar, where the close is above the open. And then the second bar
is a down bar wherein the close is below the open. Notice how the high of
the second bar is lower than the high of the rst bar, and the low the second
bar is higher than the low of the rst bar. As such, this would be considered a
valid inside bar formation.

Typically, the way that you would go about trading and inside bar formation
is to wait for either a break above the high of the second bar to enter long, or
to wait for a break below the low of the second bar to enter short. Once the
breakout occurs either to the upside or to the downside, the price should
follow through in the direction of the breakout for at least several bars or
more.

Outside Bar Pattern

Outside bar formations are commonly referred to as engul ng patterns in

candlestick analysis. Outside bar formations are considered reversal patterns
and will typically occur at the end of an extended price move. A bullish
outside bar formation would generally occur after a downtrend, and a
bearish outside bar formation would generally occur after an uptrend.

The general psychology behind the bullish outside bar formation is that the
current downtrend is beginning to wane, and sentiment is starting to shift
from bearish to bullish. Similarly, within the bearish outside bar formation,
the uptrend is beginning to wane, and the sentiment is starting to shift from
bullish to bearish.

Below you will nd an illustration of a bullish outside bar formation.

Looking at the structure above for the bullish outside bar pattern, we can
see that the following conditions exist. For starters, the second bar opened
below the previous close. The second bar also has a low that is lower than
the previous bar. And nally, the second bar closes above the open of the
previous bar. Thus it is a bullish bar reversal. When these conditions are met,
we can classify the two bar structure as a bullish outside bar pattern.

The bearish outside bar pattern would work the same but in reverse. That is
to say that the second bar within the bearish outside bar pattern will open
above the previous close, and it will also have a high that is higher than the
previous bar. And nally, the second bar will close below the open of the
previous bar. Thus it is a bearish bar reversal.

Since the outside bar formation is a reversal pattern, the implications is for
price to reverse the current trend. What the outside bar does not provide us
with is the extent of the price move that we should expect following the
completion of the pattern. Traders will need to utilize other technical tools to
nd appropriate target points when trading the outside bar pattern.
Two Bar Reversal Pattern

A 2 bar reversal pattern is a commonly seen structure within the nancial

markets. Within the bullish two bar reversal pattern, the initial bar is a
relatively strong bearish bar, and the second bar is a relatively strong bullish
bar.

The implication is that the initial bearish sentiment seen within the rst bar
has been reversed by the opposite, now bullish sentiment within the
second bar.

Within the bearish two bar reversal pattern, the initial bar is a relatively
strong bullish bar, and the second bar is a relatively strong bearish bar.

The implication here is that the initial bullish sentiment seen within the rst
bar has been reversed by the opposite now bearish sentiment within the
second bar. Below you can see an illustration of a bullish two bar reversal
pattern.
Notice how the rst bar displays strong bearish characteristics, as the open is
near the top of the range, and the close is near the bottom of the range.
Then the second bar opens near the bottom of the range, and closes near
the top of the range. Two bar reversals are often seen following a corrective
phase within a larger impulse structure. In other words, they are often seen
at the end of a pullback within the context of a trending market.

And so, it’s common to see a bullish two bar reversal form at the end of a
downward corrective phase, within a larger uptrend. Similarly, it’s common to
see a bearish two bar reversal form at the end of an upward corrective phase,
within a larger downtrend. When this scenario occurs, it would be best to
treat the two bar reversal structure as a possible terminal point within a
minor retracement, and prepare to position in the direction of the larger
trend.

Three Bar Reversal

The three bar reversal pattern is similar to the outside bar pattern in that it
often occurs after an extended market move. However, the three bar
reversal is composed of three bars while the outside bar pattern consists of
only two bars. The 3 bar reversal pattern can be bullish or bearish.

A bullish three bar reversal pattern starts off with a strong down bar, which is
then followed by a relatively narrow bar. This narrow middle bar closes below
the opening of the rst bar. Additionally the middle bar will be the lowest bar
within the three bar structure. The last bar will be a strong up bar and close
above the high of both the rst and second bars. Within the candlestick
terminology, the bullish three bar reversal is classi ed as the Morning Star
pattern.

A bearish three bar reversal pattern starts off with a strong up bar, which is
followed by a relatively narrow middle bar. The shorter middle bar will close
above the opening of the rst bar.

Moreover, the middle bar will be the highest bar within the three bar
formation. Finally, the last bar will be a strong down bar that closes below the
low of both the rst and second bars. Candlestick traders will recognize the
bearish three bar reversal pattern as the Evening Star pattern.

Below you will nd an illustration of the bullish three bar reversal pattern.
Generally, the bullish three bar reversal pattern will occur at the end of a
relatively prolonged downtrend phase. The bullish three bar reversal can
either lead to a minor upward price retracement, or a new uptrend
altogether. Similarly the bearish three bar reversal pattern will occur at the
end of a relatively sustained uptrend phase. The bearish three bar reversal
can either lead to a minor downward price correction, or a new down
trending market phase.

Key Reversal Bar Pattern

The key reversal bar formation is a two bar structure that can signal an
impending trend change. The bullish variety of the key reversal bar will open
below the low of the previous bar and trade higher and close above the
previous bar’s high. The bearish variety of the key reversal bar will open
above the previous bar and trade lower to close below the previous bars low.
In the illustration below, you can see an example of a bullish key reversal bar
pattern.
The best way to trade the key reversal bar pattern is to wait for a break above
the high of the second bar, in the case of the bullish variety, and to wait for a
break below the low of the second bar, in the case of a bearish variety.

The key reversal bar pattern is especially signi cant when it occurs at or near
a xed or dynamic support or resistance level. For example, a bullish key
reversal pattern that occurs at a horizontal support level is considered quite
signi cant. Additionally a bearish key reversal pattern that occurs at the 50
day moving average line would also be considered a signi cant signal.

These are just a few examples of how to combine the key reversal bar
pattern with other technical studies, and there are many other ways to apply
con uence using the key reversal bar, and other bar formations.

Exhaustion Bar Pattern

The exhaustion bar pattern occurs less frequently in the market compared
to most of the other patterns that we’ve described earlier. Nevertheless, it is
a very important reversal pattern that traders should keep an eye out for.
The exhaustion bar pattern typically occurs at the end of a prolonged trend
phase, either to the upside or to the downside. A bullish exhaustion bar
opens with a gap down move, which is then followed by strong upward
movement on high-volume. The price closes at or near the top of the range.
A bearish exhaustion bar opens with a gap up move, which is then followed
by strong downward price movement on high-volume. The price closes at or
near the bottom of the range. Within both scenarios, the gap created
between the rst and second bar remains un lled upon the completion of
the second bar.

Below you can see an illustration of a bullish exhaustion bar pattern.

Typically what’s going on behind the scenes within an exhaustion bar

formation is that the market is trying to make a nal attempt to push prices
in the direction of the current trend. But that attempt eventually fails, and
leads to a sharp reversal.

The best way to trade an exhaustion bar is to wait for a break above the high
of the second bar to go long in the case of a bullish exhaustion bar. And you
would wait for a break below the low of the second bar to go short in the
case of a bearish exhaustion bar.
It’s also worth noting that the closing price prior to the opening gap will
often act as an area of resistance in the case of a bullish exhaustion bar, and
can act as an area of support in the case of a bearish exhaustion bar. As such,
traders should watch the price action closely near this area or consider
exiting a portion of the trade near this level.

Island Reversal Pattern

The island reversal pattern is also a relatively rare bar pattern, not often seen
on the price chart. It is characterized by having a gap on either side of a bar
or set of bars. As with the exhaustion bar pattern, it occurs after a prolonged
price move that has often gone too far too fast. Typically we will see that
there is increased volume on the initial gap and the secondary gap.

An island reversal that occurs near the top of a trend move is often referred
to as an island top. The island top has a bearish implication. An island reversal
that occurs near the bottom of a trend move is often referred to as an island
bottom. The island bottom has a bullish implication.

Below you can see an illustration of a bullish island reversal pattern.

Island reversal patterns are known to trap traders on both sides of the
market. The volatility is often relatively high during this time. Additionally,
these patterns often occur on some unexpected news announcements or
on a highly anticipated earnings report within the stock market. Traders
need to be nimble when trading the island reversal pattern and maintain
strict money management procedures to avoid getting whipsawed. In any
case, the island reversal pattern is a high probability trade set up that should
be on your radar.

Summary

Bar charts are a traditional charting style that has historically been more
popular with Western traders. Over the years, candlestick charts have
become more popular both among Western and Eastern traders. Both types
of charting styles can be useful in analyzing price action, particularly as it
relates to looking at speci c patterns that form within two or three adjacent
bars or candles. In that way, trading bar chart patterns can be very similar to
trading candlestick chart patterns.

We have presented seven of the most important and noteworthy bar

patterns. It would serve a trader well to memorize these formations so that
they can quickly isolate them on the price chart, when they occur.

Reading a Forex Chart with Candlesticks

Learning to read candlestick charts is a great starting point for any technical
trader who wants to gain a deeper understanding of how to read forex
charts in general. As you may already know, Candlestick charts were
invented and developed in the 18th century. The earliest reference to a
Candlestick chart being used in nancial markets was found in Sakata,
Japan, where a rice merchant named Munehisa Homma used something
similar to a modern Candlestick patterns to trade in the Ojima rice market in
the Osaka region.

Although bar charts and line charts were quite popular among Western
traders, Japanese Candlestick charts and additional patterns were
introduced to the Western nancial markets in the early 1990’s, by a
Chartered Market Technician (CMT) named Steve Nison. The popularity of
Candlestick charts has soared among Western market analysts over the last
few decades because of its highly accurate predictive features. Candlestick
charts can play a crucial role in better understanding price action and order
ow in the nancial markets.
Before you can read a Candlestick chart, you must understand the basic
structure of a single candle. Each Candlestick accounts for a speci ed time
period; it could be 1 minute, 60 minute, Daily, Weekly exc.  Regardless of the
time period, a Candlestick represents four distinct values on a chart.

. The opening price at the beginning of the time period

. The closing price at the end of the time period
. The highest price during the time period
. The lowest price during the time period

As you can see in gure 1, when you read a candle, depending on the
opening and closing prices, it will provide you information on whether the
session ended bullish or bearish. When the closing price is higher than the
opening price, it is called a Bullish Candlestick. By contrast, when the closing
price is lower than the opening price, it is known as a Bearish Candlestick.
And the upper and lower shadows of the Candlestick represent the highest
and lowest price during the time period.

Pros and Cons of Using Candlestick Charts Compared

to Line and Bar Charts

Compared to Western line charts, both Bar and Candlestick charts offer
more data to analyze.
Although the same four values are also found in Western-style bar charts,
the bar chart uses horizontal lines on the sides of a vertical line to project the
opening and closing prices. But, a series of Candlesticks on a chart can help
traders identify the character of price action more de nitively, which helps in
the decision-making process.

With Candlesticks, it is much easier to interpret the price action during the
time period because a Bullish Candlestick shows a full body with a pre
designated color and a Bearish Candlestick a full body with a different pre
designated color. As a result, many professional traders have moved to using
Candlestick charts over bar charts because they recognize the simple and
effective visual appeal of candlesticks.

However, while Candlestick charts make it much easier to interpret price

action, it lacks the smoothness of the line chart, especially, when the market
opens with a large gap. Hence, professional traders often end up using a
short time period moving average to get the “feel” of a smooth trend, or lack
of trend, in the market. So, it can be a good idea to add a moving average to
the chart while using Candlestick charts.

Different Types of Candlestick Patterns Convey Different

Messages

Each Candlestick represents an Open, High, Low, and Close value. The
location of the opening price, how high or low price reached during the
candle session, and where the price closed at the end of the time period are
all factors in understanding candlestick charts.

Over the years, Japanese traders had developed various Candlestick

patterns based on historical price movements. Every trader should invest
their time and learn these patterns as it will provide a deeper knowledge
and understanding of reading forex charts in general. Candlestick patterns
can help you interpret the price action of a market and make forecasts
about the immediate directional movements of the asset price.

While there many different patterns, we will discuss some of the most
popular Candlestick patterns that can help in reading a price chart like a
professional trader.

A candlestick reading can provide us with information on the three market

sentiments: bullishness, bearishness, and a neutral or tentative market
condition.
Below are some candle formations that can help us gauge market
sentiment:

Figure 2: Various Types of Simple Candlestick Formations

Referring to the above illustration, A bullish Candlestick like the Big White
Candle indicates bullish trend continuation, while a bearish Candlestick like
the Big Black Candle indicates bearish trend continuation. On the other
hand, a Doji Candlestick represents a neutral or tentative market condition.

So when you are reading candlestick charts, you need to keep in mind
which Candlestick patterns indicate additional bullishness and which ones
indicate further bearishness, as well as which ones indicate a rather neutral
market condition and act accordingly.
The list of simple Bullish Candlestick Patterns include Big White Candle,
Hammer, Inverted Hammer, and so forth. By contrast, the list of simple
Bearish Candlestick Patterns includes Big Black Candle, Gravestone Doji,
Hanging Man, Inverted Black Hammer, etc.
If you are chart reading and nd a bullish candlestick, you may consider
placing a buy order. On the other hand, if you nd a bearish candlestick, you
may choose to place a sell order. However, while reading Candlesticks if you
nd a tentative pattern like the Doji, it might be a good idea to take a step
back or look for opportunities elsewhere.
When you are reading a Candlestick price chart, one of the most important
things to consider is the location of the Candlestick formation. For example,
a Gravestone Doji appearing at the top of an uptrend can indicate a trend
reversal. However, if the same pattern appeared during a longstanding
downtrend, it may not necessarily mean bearish trend continuation.
We will further discuss the importance of location of Candlestick patterns in
some example trades later.
In the next section we will discuss some complex candlestick patterns. Let’s
take a look at the illustration below:
Figure 3: Examples of Some of the More Complex Candlestick Patterns
Once you have mastered the identi cation of simple Candlestick patterns,
you can move on to trading more complex Candlestick patterns like the
Bullish and Bearish 3-Method Formations.
The main difference between simple and complex Candlestick patterns is
the number of Candlesticks required to form the patterns. While a simple
Candlestick pattern, like the Hammer, requires a single Candlestick, the
more complex Candlestick patterns usually require two or more
Candlesticks to form.
For example, the Bullish Harami requires two Candlesticks, the Three White
Soldiers pattern requires three Candlesticks, and the Bullish 3 Method
formation requires 4 candles.
Once again, remember that regardless of the complexity, the location of all
these simple and complex Candlestick patterns is one the most vital
aspects of reading forex charts while using Candlesticks.

Candlestick Chart Reading Like a Pro

By now, you should have a good idea about what a Candlestick is and how to
read simple and complex Candlestick patterns. So, let us now try to read
trading charts to see how we can trade using these patterns.

Figure 4: Forex Chart Reading Using a Simple Engul ng Bullish Candlestick

Pattern
In this example in gure 4 of the GBPJPY daily chart, we can see that the
GBPJPY price was bouncing around a strong support level but failed to break
below it. On the third try, the GBPJPY did penetrate the support level, but
the market swiftly reversed and formed an Engul ng Bullish Candlestick
pattern that signaled further bullishness in the market.
At this point, some beginner traders may recognize the bullish setup and
immediately enter a buy order. However, professional traders are not only
waiting for Candlestick patterns to form around key pivot zones, like this
support level in gure 4, but they will also wait for the proper con rmation to
enter the trade.

The next day, the GBPJPY price penetrated above the high of this Engul ng
Bullish Candlestick, which con rmed that there would be additional
bullishness in the market over the next few days.

Professional traders wait for this con rmation because they understand the
concept of order ow and self-ful lling prophecy.

You see, most large banks and hedge funds also watch key market levels
and price action around critical levels. Once the Engul ng Bullish
Candlestick formed around this crucial support level, it prompted a
signi cant number of pending buy orders just above the high of this
Engul ng Bullish Candlestick. Once the price penetrated above the high, it
triggered those orders, which added the additional bullish momentum in
the market.

Hence, waiting for the price to penetrate above the Candlestick pattern can
help you increase the odds of winning on the trade.

As you can see in gure 4, once the buy order con rmation came, it did
trigger a large uptrend move over the next few days.

As we brie y discussed earlier, the location of the Engul ng Bullish

Candlestick for this particular trade was the most important factor. First, it
formed around a major pivot zone, where the GBPJPY Bears had failed to
break the support area in the previous two attempts.

When you apply Candlestick patterns with additional technical con uence,
it provides for a powerful combination of factors that can help increase your
odds of winning. And this is exactly what professional traders try to do.

If the same Engul ng Bullish Candlestick pattern appeared at the top of a

longstanding uptrend, it would have also signaled additional bullishness in
the market, but that signal would be much less powerful. Since the market
was already in an uptrend, it may not have had the legs to push the price
much higher.
However, on this instance, the market was already trading in a range for
several days. As you may know, when the market consolidates for a while, it is
basically setting up to breakout in one direction or the other. The formation
of this bullish Candlestick pattern provided a signal as to of which way the
market was about to break.

If you knew how to read a simple Candlestick pattern like the Engul ng
Bullish pattern, you could have entered this trade at the right time and
earned a handsome pro t with this high reward to risk ratio setup.

Figure 5: Three White Soldiers Candlestick Trend Reversal Pattern

In gure 5, we can see two different Candlestick patterns triggering two
different trades. On the rst occasion, the Engul ng Bearish Candlestick
pattern appears during a downtrend that provides traders with a trend
continuation signal. On the second occasion, a Three White Soldiers
Candlestick pattern emerges at the bottom of the downtrend, which
triggers a new bullish trend.

In the rst trade, the AUDUSD was already moving to the downside. Once
the Engul ng Bearish Candlestick broke below the support level, it opened
up the possibility of a trend continuation. The next day, AUDUSD price
penetrated below the low of the Engul ng Bearish Candlestick and
con rmed the trade, which triggers the sell order.
It is strongly recommended that beginning traders stick to using Engul ng
Bearish or Bullish patterns to con rm a trend reversal, as those tend to be
higher probability trades. However, this particular example in gure 5
demonstrates that if you know how to use the con uence of support and
resistance levels along with Candlestick patterns, these can be used to
trigger trend continuation signals as well.

In the second trade, the Three White Soldiers Candlestick pattern emerged
near the bottom of this downtrend. At this point, professional traders for
preparing for the market to reverse the prevailing downtrend. The prudent
course of action would be to wait for the market to con rm this signal, which
means that unless the price broke above the high of this Three White
Soldiers Candlestick pattern, you would not have entered the trade.

Combining Technical Analysis Indicators with

Candlestick Patterns

Candlestick chart reading is largely based on the principle of technical

analysis, which assumes that regardless of the underlying fundamental or
economic conditions, the current market price re ects “all known
information” regarding the asset.

Hence, the reason why an asset is moving in a certain direction is often not
necessarily important to technical traders. Instead, they are more interested
in interpreting what the price action is doing at the current moment and
how they can take advantage of that. Furthermore, technicians know that
the underlying reasons for market uctuations over time can be many, and
often the market does not always act “rational.”

Candlestick chart reading can be most useful during these volatile periods of
irrational market behavior.

Traders can apply overbought and oversold technical indicators like

Stochastics or Relative Strength Index (RSI) to nd out when such irrational
market conditions may be present.

For example, by using oscillating technical indicators, a trader will rst wait
for a signal that the market has moved into an overbought or oversold
condition. At that point, they would look for a reversal signal of the prevailing
trend. Many times, this reversal signal will come in the form of a candlestick
formation.
Formation of a simple or complex Candlestick pattern during such market
condition con rms and veri es the impending contrarian price action for the
trader. Placing their order in the market using this combination of technical
factors can signi cantly improve the accuracy of their trades.
Once you learn how to correctly read Candlestick patterns and combine this
skill as part of a broader trading strategy, then you will likely improve the
consistency of your market entries and your overall performance as a trader.

Conclusion

By now, you should be able to see the value of investing your time to learn
how to read a Candlestick chart, and how to interpret the various simple and
complex Candlestick patterns that we discussed. So before you start trading
with Candlestick patterns, it is important to understand why and how these
patterns work.
Once you master the basics of Candlestick chart reading, it can help you
integrate this unique knowledge into your existing trading strategy and lead
to better accuracy and improve your trading performance in the long run.

Technical Analysis in Forex

The two main schools of thought when it comes to market analysis is

fundamental analysis and technical analysis. Though they are not mutually
exclusive, most traders will fall into one category or the other.
From the analysis standpoint, both fundamental and technical analysis
provide their unique advantages and drawbacks. In this lesson, we will
discuss the pros and cons of each of these analytical approaches.
So, what is technical analysis? Technical analysis is a method of forecasting
that is based on the study of past price movements. Often you will hear that
technical analysis is more of an art that a science. This is so because when we
are trying to predict future price movements with technical analysis, there
can be many nuances, which can sometimes lead to different conclusions.
The primary tool for technical analysis is price data.  Regardless of the chosen
timeframe, price data is the most important consideration. Essentially
technical analysis provides a framework where an analyst can make
informed decisions in the market by studying the current price action and
comparing that to previous historical occurrences.
Technical analysis can be applied across many different markets including
stock indices, currencies, commodities, individual stocks, and futures. So
long as a market has a good amount of liquidity, and is not easily prone to
outside in uences, technical analysis can be applied in an effective manner.

One example where technical analysis may not be that effective, due to the
lack of liquidity and propensity for outside in uences to effect price, would
be a very thinly traded penny stock.

The three primary tenets of Technical analysis are the following:

      Price discounts everything else in the market

      Price moves in observable trends
      History tends to repeat itself

Price Discounts Everything –  Technical analysts believe that the currently

traded price re ects all known information available to market participants. 
And any new information that is presented is quickly re ected into the price
of the security.

Price Moves in Observable Trends – Trends exist in the market, and the
technician believes that these trends move in a predictable non-random
fashion that can be observed by the trained eye. A trend tends to emerge
from trading range activity, then as the trend matures, it eventually moves
back into a consolidation phase, before a new trend phase emerges again.

History tends to repeat itself – The markets display a repetitive, recursive

nature within its price data. Although no two patterns within the price
history look exactly the same, there can be quite a resemblance that cannot
be explained away by noise or randomness. These repeating patterns can be
seen in chart formations, candlestick patterns, momentum footprints,
volume and other forms of price related data.   

Fundamental Analysis in Forex

What is Fundamental Analysis? Fundamental analysis is a form of market

analysis that seeks to determine the underlying value of a security through
the study and assessment of economic data. Within the foreign exchange
market, the fundamental analyst attempts to evaluate the overall conditions
within an economy using various economic data such as GDP, Employment,
In ation, Interest rates and more.
In the forex market, central bank activity is very closely monitored by
fundamental analysts. Upcoming interest rate decisions, meetings, and
speeches by high ranking central bank of cials are extremely important to a
fundamental trader.

Fundamental analysts will try to gauge the overall market conditions using
various economic reports in an attempt to nd mis-pricings that can lead to
trading opportunities. Fundamental traders can be short term traders that
try to capture price moves during potentially high volatile periods such as
US Non-Farm payrolls report or they can be long term macroeconomic
position traders that are more interested in multi month or multi year
trends.

Unlike technicians, fundamental analysts are more concerned with the why
rather than the what. Fundamental traders are looking for answers as to why
the economic conditions are the way they are, or try to justify their forecasts
based on the why factor. The technician on the other hand, is much less
concerned with the why, and much more focused on the price action in
front of them.

One big driver of a currency’s value is the country’s current interest rate.
When a particular country’s interest rate is higher relative to others with
similar economic conditions, foreign investment and capital will ow into the
country with a relatively higher interest rate. Investors are always looking for
higher yields and as such a higher relative interest rate will tend to attract
more capital from the global markets. 

Some fundamental traders often use the forex market to simultaneous buy
high yielding currencies against those offering lower yields. This strategy,
called the carry trade, is quite popular among longer term fundamental
traders and large global investment funds.

Advantages of Technical Analysis

Let’s take a look at some of the bene ts of using technical analysis:

Applicable to Any Timeframe – Regardless of whether you are a short term,

intermediate term or long-term trader, you can apply technical analysis tools
to your decision-making process.

Ability to Analyze Trends – There are many different studies that a technical
analyst can use to analyze the current trend of the market. These include
moving averages, trend lines, channels, swing highs and lows, and support
and resistance, among other things.
Help with Market Timing – The primary job of a trader is to nd the best
trading opportunities available and then apply the right timing in executing
the trade. Technical analysis tools assist traders in entering, managing and
exiting their positions in a methodical and ef cient manner.

 Ideas Can Be Programmed – Many concepts within technical analysis can be

coded and developed into algorithmic trading systems. These types of
automated systems help reduce the negative emotions associated with
trading. Once you have the rules programmed with your trading system, you
can step back and let the algorithm execute your rule-based system in the
market.

Reveals the Mood of the Market – By studying price action and performing
chart analysis, you can gain a better understanding of where sentiment
extremes lye within a particular market. You will be equipped to identity
extremes in investor sentiment both during runups and selloffs. Additionally,
you will gain insights into where future demand and supply exists, so you
can position yourself on the right side of the market before the crowd does.

Simpler and Less Time Consuming – Fundamental analysis often involves

many variables and moving parts, such as Interest Rates, In ation,
Consumer Sentiment, Money Supply and a host of other factors. This can
lead to over complicated models, that only PHDs in economics may be able
to understand. On the other hand, technical analysis models are usually
much more simpli ed and easier to build and implement since the primary
variable or building block is price action.

Disadvantages of Technical Analysis

Here are some drawbacks of technical analysis:

Mixed Signals – There will be instances when your technical analysis tools will
provide mixed or con icting signals. For example, based on your analysis of
support and resistance, you may be getting a buy signal, however, your
complimentary MACD indicator may be suggesting a sell scenario.

This type of scenario does occur from time to time, and can be quite
frustrating. At that point, a trader must decide whether to take the trade or
pass on it based on the con icting analysis.
Analysis Paralysis – This is a condition where traders overanalyze to the point
where they become paralyzed to act. This usually occurs when the trader is
trying to line up all their ducks in a row, which rarely happens in real time
trading. In trading we are dealing in probabilities and not certainties. We
have to act based on incomplete information most if not all of the time. With
so many technical tools available to the trader, some fall into the trap of over
analyzing and not being able to make a trading decision. The best solution to
this problem is reducing the clutter and going back to the basics.

Can be In uenced by our Biases – Although technical analysts rely on price

as their primary analysis tool, certain biases can in uence the way that they
perceive the information that they gather from the charts. For example, if
you have a bullish bias in the EURUSD pair, you will subconsciously look for
and validate long opportunities, while suppressing or ignoring signals that
are pointing to a weakening condition in the EURUSD. Many times, we will
not even be aware that this is happening, and so it’s imperative that we try
to truly keep an open mind while analyzing the charts.

Interpretations can Vary –  As we pointed out earlier, technical analysis is

more of an art than a science. Two technicians can look at the same price
chart, and sometimes come up with two polar opposite interpretations. This
is not all that uncommon, and one of the culprits of this is our internal biases
as we have touched upon earlier. In addition, chart patterns that seem clear
in hindsight can be quite subjective in real time. And so, interpretations can
be different from one technical analyst to the next as the price action is
unfolding.

Advantages of Fundamental Analysis

Let’s take a look at some of the bene ts of using fundamental analysis

theory:

Can Help Explain Price Movements – Major economic news and reports can
quickly drive the market prices in one direction or the other. This is especially
true when the gures for an economic release are unexpected or diverge
signi cantly from the consensus numbers.

Provide Insights into Global Markets – Taking a fundamental approach to

analysis helps the analyst to better understand what is happening in a
particular country’ economy and in other economies around the world. It
provides broad insight into global market conditions.
Finding Valuation – Every nancial instrument or asset has a certain value
associated with it. It is a trader’s job to nd assets where there may be a
discrepancy between the true value of an asset and the currently traded
market price. Fundamental analysis can help a currency analyst in this
regard by studying interest rates, in ation, consumer sentiment, industrial
production, and other relevant factors.

Long Term Trend Analysis – The true power of fundamental analysis is in

helping a trader craft a long-term view of a particular currency pair or asset. 
Most data points within economic reports are typically compared and
analyzed on a relative basis. For example, asking the question, what is the
unemployment gures today compared to last month, last quarter, and last
year? This will help in knowing what the current trend is as it relates to
unemployment, and then we can use that information, along with other
economic data, to predict the potential impact on the price of a currency
pair over the longer term. 

Disadvantages of Fundamental Analysis

Here are some drawbacks of fundamental analysis:

Information Overload – Fundamental analysis is a very broad and deep

subject. There is so much information available to traders and investors that
digesting all of it can be quite overwhelming to say to least. This can
sometimes lead to confusion and result in being counter productive at
times.

Not Well Suited for the Short Term – Although economic data and reports
are released regularly throughout the month, trading the news on a short-
term basis poses many challenges including widening bid ask spreads
around news events and unpredictable volatility spikes. As such many
fundamental traders tend to focus mainly on the larger term horizon.

Lack of Market Timing – Fundamental analysis can provide us insights into

the bigger picture view, but it typically cannot provide us with an objective
and reliable method for timing our entries and exits. And in trading, timing is
everything. You can be right on the direction, but if you are wrong on the
timing, your trade will most likely result in a loss. As such, fundamental
analysts typically need to rely on technicals or some other technique for
entering and exiting trades.
Highly Subjective – Although fundamental data is fairly clear cut, the
assumptions that you can draw from such data can vary greatly among
economists and analysts. For example, one analyst can cite many different
reasons why they believe that rising interest rates will be favorable to the
economy, while another analyst can cite just as many reasons for why they
believe that rising interest rates will have an adverse effect on the economy.

Technical Analysis Tools

Regardless of whether you consider yourself a technical analyst or

fundamental analyst, you must become familiar and pro cient in using
certain analytical tools to assist you in your analysis. Let’s take a look at some
of the primary tools that technicians and fundamental traders use.

Popular Tools Used By Technical Analysts

Currency Correlation Tool – Price movements of certain currency pairs tend

to be related. A positive correlation occurs when the price of two pairs tends
to move in the same direction. A negative correlation exists when the price
of two pairs tends to move in opposite directions. Currency pairs that do not
display any price relationship are said to be uncorrelated.  A currency
correlation table allows a trader to quickly nd these relationships.

It’s important to know the correlation between pairs that you are interested
in trading or already have a position in because it will help to reduce your
overall position risk.

Forex Volatility Tool – A currency volatility tool provides a typical pip range
that can be expected within a speci ed period of time. This could be the
average over a period such as one hour, one day, one week, or some other
speci ed period. Knowing the volatility of a currency pair can help a trader in
selecting the right pairs to trade and in setting realistic pro t targets.

Both the volatility tool, and the aforementioned currency correlation tool can
be found at Mataf.net, a popular site that provides a wide array of tools for
forex traders.
Technical Indicators and Oscillators – This is a favorite among technical
traders. There are many different technical tools available. There are
momentum indicators such as MACD, RSI, and Williams %R. There are trend
indicators such as moving averages, and trend lines. There are volatility
bands, such as Bollinger Bands and Keltner channels. Technicians try to nd
con uence among various technical studies in order to narrow in on high
probability trading opportunities.

Price Action Analysis – Price is the single most important tool within a
technician’s toolbox. The current price re ects the motivations of all market
participants and the supply and demand balance at any given point in time.
Many technical traders rely exclusively on price action analysis, combining
support and resistance levels, and candlesticks to gauge the potential
movements of price going forward.

Chart Pattern Analysis – Chart analysis is also a very popular technique used
by some technicians. Some traditional chart patterns include Head and
Shoulders, Double Top and Double bottoms, and Cup and Handle
formations. There are also Fibonacci based patterns, such as a Gartley, Bat, or
Butter y.

Furthermore, there are candlestick patterns and more advanced technical

analysis patterns such as Elliott waves that can be analyzed as well. As
humans we have a natural tendency towards pattern recognition, and this
translates into our desires to look for patterns within price charts.

Fundamental Analysis Tools

Economic Calendar – One of the key day to day tools for a fundamental
trader is the economic news calendar. There are many different sources that
make this available including Econoday, Forex Factory, and Trading
Economics. A favorite among many forex traders is the Forex Factory
economic calendar. It lists all scheduled economic reports, along with other
important geo-political events. It provides a color-coded system where you
can sort by low, medium, and high impact events. Short term news traders
try to capture intraday pro ts during high impact news events, while macro
fundamental traders rely on it to help them build a longer-term outlook for a
particular currency pair or country.
Financial Newswires – Some professional traders rely on nancial newswires
such as Reuters, Bloomberg, or the Financial Times, in order to get the news
that they need. Many well known nancial newswires, such as these, offer
streaming and real time news as it happens and provides worldwide
coverage through hundreds if not thousands of publications and sources
from around the globe. Many traders and investors that trade fundamentals
rely heavily on these services.

Analyst Reports – Fundamental traders need to keep up with the latest

economic releases and news events of the day, and while and economic
calendar and nancial newswires are essential tools in helping to shape a
view of the market, it also helps to get additional insights and perspectives
from other analysts as well. There are a handful of highly sought-after
fundamental analysts that provide ongoing and timely foreign exchange
and macro-economic analysis.

Final Thoughts

So, you might be asking, technical analysis vs fundamental analysis, what

type is better? Well personally, I prefer to use technical analysis in my trading
as it provides a complete framework from which to analyze, enter, manage
and exit trades. And so, I urge all traders to learn technical analysis, even if it’s
only at a basic level.

Other traders swear by fundamental analysis, and yet another group of

traders use a combination of both. There is no right or wrong answer. You
just have to really learn and apply both approaches for yourself and see what
works best for you.

What is the Dow Theory, and How Did it Come About?

Many of the technical analysis techniques commonly used by modern day

forex traders had their origins in the early part of the last century, and a
leading contributor to technical analysis theory was a famous stock trader by
the name of Charles H. Dow.

You may already know of Dow as the trader who gave his name to the Dow
Jones Industrial Index or DJIA equity index that is still often used as a stock
market barometer in the modern era.
Known as The Charles Dow Theory, or more simply as Dow Theory, the
market concepts and analysis methods historically credited to Dow have
largely been replaced in common usage by later developments. One of the
more popular among these is The Elliott Wave Theory that was developed
by R.N. Elliott to build upon and expand some of the basic trend analysis
concepts in Dow Theory into an overall theory of market psychology and
how it in uences price movements. 

The following sections will explain Dow Theory, discuss its basic tenets,
assumptions and applications, and describe how forex traders can use Dow
Theory to analyze the currency market and make more informed trading
decisions.

The Dow Theory originally evolved out of a series of editorial articles that
stock trader Charles H. Dow wrote for publication in the Wall Street Journal
over the period from 1900 until he died in 1902.  These articles covered topics
related to Dow’s views on how stock market price movements behaved and
how that had implications for the prevailing business environment and its
overall health.

Although Dow never nishing publishing the entirety of his market

movement theory, some of his associates and supporters further expanded
upon and developed what he had started.

Some of the more notable of these literary contributors to Dow Theory

included Robert Rhea, who published “The Dow Theory” in 1932, and Richard
Russell, who wrote “The Dow Theory Today” that came out in 1961.

Dow also originally formulated the Dow Jones Industrial Average or DJIA, as
well as the Dow Jones Rail Index that has since come to be known as the
Transportation Index, because he wished to use them as a gauge of current
business conditions within those economic sectors as part of his analysis.

Although more modern theories of market price movement have largely

taken its place, Dow’s theory was revolutionary at the time it was introduced
and remains relevant to today’s nancial market traders. Many of today’s
predominant market theories were originally based on Dow Theory and use
similar assumptions to derive similar conclusions.  The next section of this
article will explain what exactly the basic assumptions are that make up the
foundation of Dow Theory.

The Three Primary Dow Theory Assumptions

Charles Dow proposed three basic underlying assumptions or tenets upon
which his theory of market price analysis is based.
Note that the very nature of an assumption means that such proposed
market behavior does not necessarily hold true under all market conditions.
Such assumptions are not facts but are instead simpli cations to the actual
market reality faced by traders that tend to hold true and can be used to
create theoretical implications that can in turn be used to base trading
decisions on.
Basically, these tenets should ideally be considered to be general and
simplifying principles that seem to apply in many cases when reviewing
market behavior in which human psychology plays a substantial part in
determining prices. With that key point noted, a discussion of these three
key Dow Theory assumptions can proceed, and they are as follows:
Market prices evolve in three forms simultaneously. – The rst among these
fundamental tenets in Dow Theory is that movements observed in a market
price tend to develop in three forms that occur simultaneously, although not
in a random fashion. These forms are called the primary, secondary and minor
price movements. Having an awareness of the existence of these forms
means that they can be employed by a trader to rst de ne what the
present form is, and to then trade in concert with market trend while it is
developing.
Price discounts all. – The second key component of the Dow Theory tenet is
commonly expressed with the simple phrase: “Price discounts all.”  What this
means is that the market price at which a balance of buyers and sellers
exists in equilibrium has been determined, in theory, by the net overall effect
of all of the information currently available to market participants that seems
relevant to that price.  Such information might include fundamental
economic data, news stories, geopolitical events, and any other information
that might be considered by the market to be relevant to its current
evaluation of the price, including the emotional state of traders and the risk
of rare events occurring, such as natural disasters.
This important assumption notably tends to break down brie y while new
information is being assimilated by the market, such as immediately after
the release of a major economic number that differs substantially from what
was expected by the consensus of market analysts.
Once the new information has been re ected in the market price or
“discounted”, it again tends to re ect the current state of knowledge and
sentiment among market participants.

History repeats itself. –  The third and nal major tenet of Dow Theory can be
expressed brie y as: “History repeats itself”. The implication of this
assumption is that traders can use techniques that have worked well in the
past for market forecasting to estimate the level of market prices in the
future. Market price movements have been closely studied over the events
of the past century or so, and that information is readily available to traders
for them to draw upon when considering the likely impact of future events. 

This tenet might break down when an event occurs that has no recent
historical precedent and for which the previous market impact is therefore
not available to be studied and applied to the present event for predictive
purposes.

Understanding Dow Theory and Trend Analysis

One of the most important parts of Dow Theory involves evaluating and
predicting the direction of the trend that evolves in primary, secondary and
minor trends. Trends in Dow Theory refer to persistent directional market
price movements.

To determine the trend’s direction, a trader will rst need to know what
de nes a trend, which can either be considered an up, upwards or bullish
trend if its overall direction is higher, or a down, downwards or bearish trend
if its overall direction is lower.

 What de nes an upward trend is a series of higher market highs or peaks

seen along with a series of higher market lows or troughs. Conversely, a
downwards trend has a series of lower lows and lower highs. Each
movement from a trough to a peak is called a rally, while each movement
from a peak to a trough is called a sell-off.

The schematic diagrams shown in Figure 1 below illustrate the general

directional behavior of upwards and downwards trends that are themselves
made up of successive rallies and sell-offs, or vice versa.
Figure 1: Schematic diagrams showing idealized three phase up and down
trends.
Dow’s particular form of trend analysis typically requires a technical analyst
to rst identify the direction of the primary market trend. This longer term
directional movement tends to last between one and three years at a time,
although this can vary somewhat.
The next form of trend analysis requires the analyst to determine the
secondary or intermediate trend, which generally moves in the opposite
direction of the primary trend and is sometimes referred to as a market
correction.   Thus, if the primary trend for a particular market is higher overall,
the direction of the secondary trend will be lower.

Conversely, markets with a downwards primary trend will show upwards

secondary trends. 

The secondary trend is shorter than the primary trend and tends to last
between three weeks to three months. Also, the corrections seen within this
intermediate trend type tend to range in length from between one third to
two thirds of the primary trend’s preceding movement.

The last phase considered in Dow Theory is known as the minor trend.  The
duration of minor trends is the shortest and tends to extend up to several
weeks in duration. Such minor trends form the small corrections seen within
the secondary trend, and so they generally go in the opposite direction to it.

Although the minor trend is not of the greatest concern to most traders who
use Dow Theory concepts, and often contains a signi cant amount of rather
distracting noise, it should still be observed while rmly keeping in mind the
bigger picture that comprises the secondary and primary market trends.

The Three Phases of Dow Theory

Another important fundamental aspect of Dow Theory involves the three

phases that the market enters into within each primary trend.

Within an upwards trend, these are the accumulation phase, the public
participation phase, and the panic phase. In a downwards trend, they are
called the distribution phase, the public participation phase, and the excess
phase.

An upwards trending or bullish market generally starts with the

accumulation phase that is characterized by the entry into the market of
well-informed investors, also sometimes known as the “smart money”, who
sense value at the bottom or lower turning point of the market and start to
accumulate the traded asset cheaply. This phase comes just after the end of
a downwards move and tends to commence with a price consolidation
period as selling pressure fades, followed by a rise in prices.
The public participation phase comes next as public sentiment about the
market improves along with the release of favorable fundamental
information. This phase typically comes after the market fails to make a lower
low and lower high, so a market reversal seems to be in place. More and
more retail traders, technical analysts and investors start to enter the
market, often pushing prices sharply higher in the direction of the trend.
This phase typically lasts the longest and rises the furthest of all three.

The excess phase then concludes the upwards trend as buying interest
starts to wane and the good news starts to age, although all investors
typically want to buy this market at the outset of this phase. 

Towards the end of it, the smart money begins to reduce their positions,
often selling them to enthusiastic and even irrational retail buyers who are
getting into the market late. Waning market momentum usually
characterizes the top of the market as this nal upwards phase ends and the
start of a primary downwards trend then commences.

The ensuing downwards trend or bear market will begin with the
distribution phase where the well-informed traders start to sell out their
positions into what they see as an overbought market that may also show
signs of price consolidation or a sharp peak followed by a drop. A new down
trend can be con rmed once the previous up trend does not make a higher
high and a higher low, indicating that a market reversal has taken place. 

This tends to lead into the next public participation phase, which then takes
the market considerably lower as the general public becomes aware of the
change in market direction and business conditions look less favorable.
Retail sellers become more numerous than buyers, so the market price falls. 
Technical traders often reverse their positions at this point and go short.

The downwards trend then concludes in the panic phase, where a sharp
market sell-off or crash can take place very quickly in extreme cases. The end
of this phase tends to be characterized by very adverse market sentiment,
negative fundamental information, and a substantial preponderance of
speculative short positions. At that point, the entire cycle begins anew as
the smart money again senses value.
The Use of Volume in Dow Theory

Dow Theory also incorporates the use of several key indicators.  The rst is
the use of indexes. For example, an index like the Dow Jones Industrial
Average could be used as an indicator of overall market direction when
trading in the stock market. 

Another key indicator used by Dow was the volume traded in the market
being analyzed. Trading volume can be used to con rm valid price
movements, as well as to ignore spurious price movements that might have
taken place in very thinly traded markets, like those occurring on major
public holidays, for example.

Essentially, if the trading volume rises as the trend continues, then that
con rms and tends to be supportive of the trend’s additional continuation.
Conversely, when the trading volume falls as the trend continues, then that
fails to con rm the trend and may well signal that a trend reversal is
forthcoming. This is due to the fact that trading activity, as shown by the
volume traded, is no longer actively supportive of that trend.

Just remember to keep in mind the basic fact that the majority of money
traded needs to be moving along with a market price trend in order for it to
continue.

Using Dow Theory Concepts in Forex Trading

Applying the basic ideas contained in Dow Theory in forex trading may
already be familiar to many technical currency traders since they underlie
many of the existing well-known trading techniques.

If you are new to trading, then becoming familiar with and then using Dow
Theory concepts can really help you avoid some of the common pitfalls that
novice traders often fall into, such as buying at tops and selling at bottoms.
In these instances, the smart money is already trading in the opposite
direction to the waning trend.

One good idea might be to perform market analysis using Dow Theory
directly into your trading plan. This can help you avoid taking part in the
especially dangerous excess or panic phases that markets tend to go
through just before a major trend reversal takes place .
While shorter term traders like scalpers and day traders may not nd Dow
Theory particularly applicable to their needs, longer term currency traders
can really bene t from performing a thorough market and Trade analysis
using Dow Theory before pulling the trigger on entering or exiting a position.

As far as the modern relevance of Dow Theory in investment situations is

concerned, one major problem most retail investors have is becoming too
enthusiastic at the top of a market and too pessimistic at the bottom of a
market. Many times this is due to the news media often whipping investors
up into a frenzy. Understanding the key concepts of Dow Theory can really
help these investors learn to trade along with the smart money, instead of
following the crowd during a waning market move.

What is Technical Chart Analysis?

When you trade Forex, you should carefully implement an analytical

approach as part of your trading strategy. If you have been around the
markets for any length of time, you will have heard of technical analysis. This
is one of the two primary forms of currency analysis. And, I believe, the more
essential part of the trader’s arsenal. So in this article, we are going to discuss
what technical analysis is and how you can incorporate it into your trade
analysis for better market timing.

Technical analysis, as it relates to forex, is an on-chart examination of the

respective currency pair in an effort to nd price patterns that can provide
clues into future price movement. Fx technical analysis relies on past Forex
data, which is taken into consideration when determining potential support
and resistance levels. It is commonly accepted that if a Forex pair bounces
from a speci c level or pivot point, the pair is likely to conform to this level in
future.

As such technical trading at its most basic level involves using horizontal and
diagonal lines in an attempt to nd and trade support and resistance zones .
This type of trading is often referred to as pure price action trading. Other
assistant tools, which technical traders sometimes use, are technical analysis
indicators.

By combining different technical tools, Forex traders are able to perform a

detailed chart analysis of Forex pairs to ultimately hone in on the best
trading opportunities on their chosen timeframe.
Support and Resistance as a Primary Technical Analysis
Tool

If you want to learn technical analysis, you should start with understanding
what support and resistance is.

Support and resistance are psychological levels on the chart. These are levels
which the price action tends to conform to. If the price creates a top at a
certain exchange rate, an eventual return to this level often causes the price
action to hesitate. Sometimes the price breaks the level and continues its
progress.

However, in many cases reaching an already created level might cause the
price to bounce. For this reason traders use support and resistance levels for
entry and exit points of their trades. But what is the difference between
support and resistance?

Support Levels

A price support level is a speci c level on the chart, which the price tests
while it is decreasing. In this manner, supports are located below the price
action. If the price meets a support on its way down, there is a good chance
that the price will bounce off in a bullish direction.

On the other hand, if the price breaks a crucial support area on the chart,
then we expect the decrease to continue to the next lower level of price
support.

Imagine you are in a short trade in the EUR/USD and the pair is decreasing in
your favor. Suddenly, the price meets an old support level, which has been
tested and has held on prior attempts.

In this case, the respective support level would be a good exit point. You
would close your trade in anticipation of a minor or major reversal off the
support zone.

Now imagine instead, the price breaks that support. In this case, assuming
that your bias is still to the downside, You can reopen your trade in order to
catch an eventual further price decrease.
Resistance Levels

Resistances on the chart act absolutely the same way as supports, but in the
opposite direction. When the price is increasing and starts hesitating at a
certain level, we say that the price has found resistance. In the case of
another price interaction with this same resistance area, we might expect
another bounce from this level.

Same as with support levels, if the price breaks a resistance level, we expect
a continuation of the rally. As such, resistance areas are used to set entry and
exit points when trading – similar to supports.

Let’s assume you are in a long trade in the GBP/USD, and the price is steadily
increasing. The price action then meets a resistance level on the chart.

In this case, this resistance is a good exit point from the trade. You can exit
the trade in anticipation of a minor or major reversal off the resistance zone.

However, the price might go through this level, right? If this happens, you
can then reopen your trade after the breakout for an attempt to catch a
further price increase.

Let’s look at this price chart below, which illustrates support and resistance
levels in action:

Above you see the H4 chart of the Swissy (USD/CHF) for Feb – Mar, 2016.
Note how the price action is squeezed between two well de ned levels on
the chart. We have the resistance at the level of 1.0000 and the support at
0.9890.
Notice that both levels are many times tested and they both contain the
price action for a relatively long time. At the same time, there are a few cases
where the price manages to go below the two psychological levels, but
proved to be false breakouts. So the bottom line is that the majority of the
price action managed to stay within the corridor formed between 1.0000
and 0.9890. The resistance gets tested approximately 7 times and the
support about 6 times. The 7th time the price tests the support leads to a
real breakout through that level. After breaking the support, the USD/CHF
begins a sideways movement and eventually tests the already broken
support as a resistance. The price then bounces downwards, creating new
lows.

Every price bounce from the support at 0.9890 could be used to open long
trades, which could be closed when the price interacts with the 1.0000
resistance. In addition, every price interaction with the 1.0000 resistance
could be used to open short trades. When the price meets the 0.9890
support you would look to close these trades. Then when you spot the
breakout on the support side, you would prepare to go short on an
assumption for a further decrease.  More aggressive traders would enter on
be breakout candle and less aggressive traders would wait for the retest
before entering into the short position.

Forex Technical Analysis Using Trend Lines

Another important building block when trading with technical analysis in

currency pairs are the use of trend lines. The trend line acts as a diagonal
support and resistance which measures the scope of a price tendency
(trend). A Trend line is an on-chart straight diagonal line, which connects the
tops and/or the bottoms of the price action, depending on the direction of
the overall trend. Let’s now dive into the different trend lines you can use on
the chart.

Bullish Trend Line

The bullish trend line is a straight line, which connects the sloping candle
lows on the chart during an uptrend. In this manner, the bullish trend line is
always located below the price action. Since the bullish trendline is located
beneath, on its way up the price is frequently bouncing from it. Therefore,
the bullish trend line acts as a support for the price movements.
If there is a bullish tendency on the chart, and the price returns to the bullish
trend line and bounces upwards, then we have a nice opportunity for a long
trade. In this case you can buy the currency pair on an assumption that the
price is likely to increase for a new leg up. However, if the price goes through
the bullish trendline, then we say we have a bearish breakout in the trend.
When a bullish trend gets broken, we expect the price to change direction
and begin to move to the downside.

Bearish Trend Line

The bearish trend line acts the same way as the bullish trend line, but in the
opposite direction. Bearish trendlines are used to visualize and measure
the price action during bearish tendencies on the chart.
In this manner, bearish trend lines are located above the price action and
they connect the tops of the candles during downward moves. When the
price is in a down run, it frequently bounces in a bearish direction from its
bearish trendline.
When the price returns to its bearish trend line and bounces from it, we
expect a further price decrease. However, if the price goes through the
bearish trend in a bullish direction, we say the trend is broken upwards. In
this manner, we expect the price to interrupt the bearish tendency and to
reverse to the upside.
Let me now show you how a trend line acts on a chart:
Above you see the weekly chart of the Cable (GBP/USD). The period it covers
is Mar 2014 – Jun 2015. The image illustrates a bearish trend on a chart. The
blue bearish line is the respective trend line of the downward price
tendency. The black arrows on the chart point to the moments when the
trend is being tested. The red circle on the chart shows the moment when
the price creates a bullish breakout through the trend. The last two arrows at
the end of the trend show the moment when the bearish trend turns from a
resistance into a support. The green arrow indicates the reversal in the price
direction after the breakout in the trend.

Forex Technical Analysis Indicators

Many technical traders use indicators in addition to horizontal and trend line
support and resistance lines. There are two types of technical analysis
indicators based on the timing of the signals they give. These are the
lagging and the leading indicators. Let’s now discuss each of these types.

Lagging Indicators

Lagging indicators are also known as trend con rming indicators. The reason
for this is that the signals of the lagging indicators come after the event has
occurred on the chart. In this manner, the signal has a con rmation
character.

The biggest bene t of Lagging indicators is that they provide relatively

high success rate of signals. The negative though is that the
lagging indicators put you in the trade fairly late. Because of this you will
typically miss a relatively big part of the price move.

Some of the most popular lagging indicators are the Moving Averages
(simple, exponential, volume weighted, displaced, etc.), Parabolic SAR and
the Moving Average Convergence Divergence (MACD).

Leading Indicators

Leading indicators are typically the oscillator type. They are considered
leading because these indicators give you a signal before the potential
reversal has actually occurred on the chart. As such their signals tend to lead
the events on the chart. The biggest bene ts of leading indicators are that
they can put you into a potential reversal early.
However, the biggest negative of oscillators is that they can provide many
false signals leading to a relatively lower success rate. This is why leading
indicators are not good single standalone analysis tools for executing trades.
Traders that utilize leading indicators should combine their analysis with
other tools such as candlesticks and support and resistance when
implementing their daily technical analysis in FX.

Some of the most widely used leading indicators are the Stochastic
Oscillator, the Relative Strength Index, and the Momentum Indicator.

Now let me show you one of these indicators in action – the Stochastic
Oscillator. The Stochastic gives two signals – overbought and oversold. In this
manner, the indicator has three areas – an overbought area, an oversold area,
and a middle area. When the indicator enters the oversold area we get a
long signal. When the price enters the overbought area, we get a short
signal. When the price is in the middle area, we get no signals.

Take a look at some of the signals that are provided by the Stochastic
Oscillator:

This is the hourly chart of the USD/CAD Forex pair for Nov 18 – Nov 25, 2015. At
the bottom of the chart we have attached the Stochastic Oscillator.

The red circles on the indicator show three overbought signals that led to
price reversals. The green circles point out the valid oversold signals. Each
signal has its adjoining arrow, which shows the move as a result of the signal.
As you see there is a relation between the indicator signals and the price
behavior. When the Stochastic enters the overbought area, a price decrease
comes afterwards. When we see an oversold signal, we then see the price
increasing.
Forex Price Action Trading

Pure Price Action trading is a subset of technical trading, which relies more
on price and chart analysis than the use of trading indicators. Price action
technical analysis in Forex is based on support, resistance, trend lines, chart
patterns and candle patterns. Since we have already discussed supports,
resistances and trend lines, lets now turn our attention to chart patterns and
candlestick patterns.

Candlestick Patterns

Candle patterns are speci c formations, which are created by individual or

multiple candlesticks on the price chart. There are two main classi cations of
candle patterns – reversal candlestick formations, and continuation
candlestick formations.

Reversal candle patterns are candlesticks, which tend to reverse the

direction of the current price. Some of the more reliable reversal candlestick
patterns are: hammer, shooting star, hanging man, engul ng, morning star,
and evening star.

Continuation candle patterns are candlesticks, which tend to continue the

price movement in the same direction. Some of more reliable continuation
candle patterns are: mat hold, deliberation, method, and concealing baby
swallow.

What is important to note is not the actual names of the candle patterns
themselves, but the price action that they create. Once you are able to
recognize the price movements that comprise the formations, you will be
able to take advantage of trading them in an informed manner.

Classical Chart Patterns

Chart patterns are speci c formations, which are created by the general
price action on the chart. Same as the candle patterns, chart patterns are
also classi ed in two types – reversal, and continuation.

Reversal chart patterns are likely to be followed by reversal price movement

on the chart. The most reliable reversal chart patterns in trading are: double
top, double bottom, triple top, triple bottom, and head and shoulders.
Continuation chart patterns are used to predict the continuation of the
general trend. The most popular among the continuation chart patterns are
ags, triangles and rectangles.

The image below shows how price action based technical analysis works:

This is the H4 chart of the USD/CHF for Dec 30, 2015 – Jan 15, 2016. The image
shows a few interesting on-chart events, which lead to potential trading
opportunities.

The image starts with the price moving after a bullish trend line (red).
Suddenly, the trend gets broken in a bearish direction, which creates a short
breakout signal. The price starts to decrease afterwards. Two bottoms are
created on the chart. The second one ends with a Hammer Reversal
candlestick. As you see the price starts reversing to the upside shortly
afterwards. On the way up the blue bearish trendline gets broken.

The two bottoms on the chart create the well known Double Bottom
reversal chart pattern. The yellow resistance on the chart indicates the top
between the two bottoms of the chart pattern. Therefore, the yellow
resistance is the trigger line of the pattern. After the price action closes a
candle above the yellow resistance, we expect a price increase equal to the
size of the formation. So, the trend was bearish (blue line) and a Hammer
candlestick, trendline breakout, and a Double Bottom chart pattern
forecasted the reversal of the bearish movement.

Conclusion
Technical Analysis in Forex relies on analyzing previous price behavior of
currency pairs to determine potential price moves in the future.
The most important tools in technical analysis are:

Support Lines
Resistance Lines
Trend Lines: bullish and bearish

Other trading tools that currency technical analysts use are trading
indicators. They are two types of trading indicators:

Leading Indicators: give the signal before the event has actually occurs
on the chart
Lagging Indicators: gives the signals after the event has actually
occurred

Pure Price Action analysts rely on technical analysis using price and chart
analysis exclusively. Some of the common things that technical Price action
traders utilize include:

Chart Patterns: reversal, and continuation

Candle Patterns: reversal, and continuation
Support and Resistance Lines
Trend Lines

What Are Technical Trading Patterns?

Analysing the Forex markets, and broader nancial markets in general, is an

exciting and captivating endeavour that can be incredibly lucrative when
done correctly. While the internet is full of weird and wonderful ways to
analyse and trade the markets, in general there are two camps when it
comes to trading the markets; fundamental and technical analysis.

Fundamental analysis broadly comprises analysing the markets based on

economic and political inputs. Monitoring economic data releases is key to
this method as is tracking central bank monetary policy. However, the truth
is that trading in this manner can be very hit and miss. It is incredibly dif cult
to consistently gauge how the markets will react to data releases and even
central bank announcements given the nuanced way in which the markets
trade around fundamentals.

In reality, fundamental trading tends to be the domain of institutional

traders given the complex algorithms they have which can track and react
to these data inputs. For most retail traders, the most popular and effective
way of trading the markets continues to be technical analysis.
At its purest level, technical analysis is simply the study of the price charts.
Regardless of what is driving the price action, the technical analyst is merely
concerned with how price is moving and identifying tradable patterns and
outcomes. To do this, the technical analyst relies on a number of different
analysis tools on their technical analysis charts. Of these, trading chart
patterns are among the primary methods used.

Forex trading chart patterns are price structures which have been
established over time and studied and are identi ed as leading to tradable
outcomes. These structures, when identi ed in the market, carry with them
the weight of a potential tradable outcome such as a head and shoulders
pattern leading to a bearish reversal (a decline in price) or a double bottom
leading to a bullish reversal (a rally in price).  As such, trading chart patterns in
technical analysis is an incredibly simple yet effective way of trading the
markets.

What Do Chart Patterns Tell Us?

Far from simply being some pretty decorations on your charts or random
lines drawn in at will, correctly identi ed chart patterns reveal a great deal
about the underlying order ow in the markets and give us hints about
where price might head next. Armed with that information we are then able
to make price forecasts and trading decisions.

So, let’s take a look at the top chart patterns, explain what they tell us about
the markets and how we can trade them.

Top Trading Chart Patterns in Technical Analysis

Head & Shoulders Pattern (H&S)

The rst chart pattern we will study can be considered the grandfather of
forex trading chart patterns; the head and shoulders (H&S).

The H&S pattern is a bearish reversal pattern which alerts us to a potential

reversal lower in price. The pattern is identi ed as follows (and hence the
name).
Firstly, we have an initial price high, giving us our left shoulder, we then have
a higher peak in the middle, giving us, our head and we then have a lower
peak, around the same level as the rst, on the right giving us our right
shoulder. The two low points in the pattern give us our neckline. That is the
H&S pattern, very simple to spot!

So, what is this pattern telling us about the underlying order ow in the
market? This pattern actually reveals a great deal about the underlying
action between buyers and sellers. So, initially we see that buyers are in
control, driving price higher to the rst peak, the left shoulder. From here,
sellers then step in and take price down. However, buyers step back in and
in fuller force driving price back up above the initial peak to give us a new
high, our head.
However, sellers step back in here and drive price rmly lower, all the way
back down to what will become the neckline. From there, buyers then step
in again and drive price back up. However, they are unable to make it past
the point of the rst peak. From here, sellers drive price back lower and this
time price breaks below the neckline of the pattern con rming a bearish
reversal from which, price sells off.
So, essentially what this pattern is revealing to us is a shift in power between
buyers and sellers. Buyers are in control initially, go through a battle with
sellers and are eventually overpowered by selling pressure and the market
reverses lower.

How to Trade the Pattern

So, in terms of how we trade this pattern, the most common way of trading
the pattern is to wait for price to break below the neckline following the sell
off from the right shoulder. As price breaks down through the neckline at
this point, we can enter a sell position.

In terms of stop loss placement, the typical method is to place a stop above
the right shoulder and then target a minimum of twice our risk (distance
between entry and stop loss). Doing this ensures that we achieve a positive
risk reward ratio on our trade and sticking to this over time is a great way of
boosting your chances of achieving and maintaining pro tability.

Inverse Head & Shoulders Pattern (IH&S)

Now, as well as being a bearish reversal pattern, there is also a bullish version
of this pattern, used to highlight a potential reversal higher. This pattern is
called the inverse head and shoulder pattern (IH&S).

So, this time around, we identify the pattern as follows and as you will see,
everything is simply ipped on its head.
We have an initial price low on the left from which price bounces higher,
giving us our left shoulder. Price then reverses lower and trades down to
fresh lows before again rebounding higher, giving us our head. From here,
price trades up to around the previous high and then reverses lower once
again. This time price trades down to around the same level as the rst low
and then reverses and trades higher.

So, this time around the pattern is highlighting a shift between buyers and
sellers where sellers are in control initially, there is a battle and buyers
eventually overpower them and take the market higher.

How to Trade the Pattern

So, this time around, the way we would trade the pattern is that we would
look to enter a buy position as price breaks above the neckline, con rming
the bullish reversal. We know that buyers stepped in with full force at the
low of the pattern (the head) and so once price breaks above the neckline
we can enter our buy position. This time around we would place our stop
below the low of the right shoulder (remember, we are simply doing the
inverse to what we would do with H&S pattern). Once again terms of a target
we would look to target a minimum of twice our risk.

So, hopefully you can see just how useful this pattern can be in identifying
potential reversals within the market and nding great trade locations. This
pattern is fantastic because it can be used in all instruments and assets and
traded on all time frames. So, whether you are conducting intraday chart
analysis or looking to swing trade on the higher timeframes the H&S and
IH&S patterns are a really effective tool for helping you capture reversal
points on your technical chart.

Double Top Chart Pattern

Another top technical chart pattern we are going to look at here is the
double top. The double top is a bearish reversal pattern, just like the H&S
pattern, which highlights a potential reversal lower and offers us the chance
to enter a sell trade.

The pattern is again very easy to identify via the following structure.
So, initially we see price driving higher within a bullish rally taking us up to
our rst peak, where sellers step in and affect a reversal. From here price
trades lower. However, this reversal does not last, and buyers once again step
back in to take price back up. Price then trades back up to test the
resistance level created at the initial high. However, as price tests the high,
sellers once again step in and drive price lower. From here price then
reverses lower and breaks through the initial low (the neckline of the
pattern).
So, as you can see, once again what this pattern is highlighting is a battle
between buyer and sellers where sellers overwhelm buyers and send price
lower, similar to the H&S pattern.

So, in terms of how we trade this pattern, the typical method is to place a sell
trade as price breaks down below the low of the neckline. Once again, the
neckline is the key pivot to watch and as price breaks below here, it con rms
the bearish reversal, offering us the opportunity to sell. In terms of stop loss
placement, we would place our stop above the high of the second peak and
then target a minimum of twice our risk.

Combining Indicators & Patterns

The beauty of trading chart patterns is that you can also combine them with
other charting and technical analysis methods such as technical indicators.
As we have discussed in other articles, one of the most powerful ways of
increasing our chances of success with any given trade is to look for
con uence between different technical signals. So, in this instance we would
look to establish a bearish signal on a technical indicator along with our
bearish double top pattern, giving us extra indication that the market is
likely to reverse lower.

Once such indicator which is very useful in these scenarios is the RSI
indicator. The RSI is a momentum indicator meaning that it measures the
strength of price moves in the market and signals when momentum is
either overbought (stretched to the topside) and vulnerable to a reversal
lower or oversold (stretched to the downside) and vulnerable to a reversal
higher. Now, one particularly powerful way in which we can employ this
indicator in tandem with our double top pattern is to look to establish
bearish divergence on the RSI indicator as the second peak forms.

If you are unfamiliar with the term, bearish divergence essentially refers to a
situation where the moves on the price chart are not supported by the
indicator. So, bearish divergence is identi ed when price is trading higher,
but the indicator is not trading higher. This tells us that bullish momentum
is waning in the market (buying pressure is weakening) and price is
vulnerable to a reversal lower.

So, let’s think about this: we have our double top pattern which we know
suggests a bearish reversal is likely coming and then on top of that we have
the RSI indicator telling us there is bearish divergence in the market. This is a
strong signal that the market is likely to roll over.
Example of Bearish RSI Divergence with Double Top
Pattern
So, in the example above you can see exactly this situation in play. Price
trades up to make the initial high before selling off and trading back down to
what will become the neckline of the pattern. From here, price then trades
back up and retests that initial high. Now, you can see here that as price
tests the level, the RSI indicator is actually putting in a much lower peak.
This tell us that buying pressure is far weaker at the level than it was the rst
time around.

And so, as price reverses from here we know we have a strong signal to set a
short position and capture the reversal. This is a fantastic example of the
power of technical analysis and how we can use chart pattern in
combination with indicators to nd great trade entries.

Double Bottom Pattern

Now, as well as being a bearish reversal pattern, there is also a bullish version
of the pattern which we can use to capture a reversal higher in price; this
pattern is known as the double bottom. As when discussing the H&S and
IH&S patterns, this time around, everything is simply upside down once
again.
So, we identify the double bottom pattern by rst seeing price trading lower
within a bearish move. Price then puts in a low, giving us our initial swing low
before reversing higher. However, sellers then step in once again taking
price lower. Price then trades back down to test the initial low, but once
again, buyers then step in here and take price back up.

So, as you can see, this time around the pattern is highlighting a battle
between buyers and sellers in which buyers overwhelm sellers and take
price higher. So, this offers us the opportunity to set a buy trade as price
breaks above the neckline of the pattern. As with the previous patterns, we
want to enter our buy trade as price breaks the neckline and place our stop
loss below the low of the pattern, targeting a minimum of twice our risk.

Combining Patterns and Indicators

Now, given what we know about this pattern, that it is a bullish reversal
pattern and we are anticipating a break higher in price, one more advanced
way to trade the pattern is to look to get in early as the reversal off the
double bottom support level occurs. Now, this is inherently a slightly riskier
approach as until the neckline has been broken the pattern is not yet
con rmed.

However, once you have spent enough time identifying and trading these
patterns, this is a method which can work very well because the upside is
that you get in much earlier on the move giving you a greater potential
pro t.

One such way to do this is to use the stochastics indicator. Similar to the RSI,
the stochastics indicator is an indicator which measures momentum in the
market and identi es price moves as being either overbought or oversold.
So, one way in which this indicator can be useful is to wait for price to test
the double bottom and look to see the indicator move below the oversold
threshold, telling us that price is overextended to the downside and
vulnerable to a reversal higher. Once the indicator then crosses back above
the oversold threshold, this is our buy signal, suggesting a reversal higher is
coming.

Double Bottom & Stochastics Example

In the chart above you can see an example of this happening. So, price
trades down and tests our double bottom support level which we have
already marked out. As it does so we can see that the stochastics indicator
has gone below the oversold threshold, telling us the move is overstretched.
Then, as price starts to bounce off the level, we see the indicator crossing
back above the threshold, giving us our buy signal. We can once again place
our stop just below the low of the pattern and this time, play for a much
bigger target due to our earlier entry. We still also have the option of adding
an entry as price breaks out above the neckline.

Considerations When Trading Chart Patterns

Hopefully by now you are feeling pretty excited by the potential chart
patterns have to help us analyse and forecast the forex markets. As we
discussed earlier though, these patterns can be used across all asset and
instruments and so the patterns discussed here will be just as useful in
share market chart analysis. When trading these patterns as share market
chart patterns, we look for exactly the same parameters and trade the
patterns in exactly the same way as we do with the forex trading chart
patterns. Many traders use these patterns for share market chart analysis
and again, these can be used on all timeframes.

Ultimately, technical analysis and chart interpretation comes down to

practice and skill. The more time you spend studying the charts and
practising identifying these trading chart patterns, the better you will
become at actually trading patterns using technical analysis.

What Are Forex Chart Patterns?

If you have been around the Forex market for any length of time, then you
de nitely have heard about chart patterns and their importance in technical
analysis. If you want to learn more about chart patterns and their
corresponding signals in trading, then this article will provide you a starting
point from which to increase your knowledge of classical chart pattern
trading. Today we will go through the most important chart gures in Forex
and we will discuss their potential.
Forex chart patterns are on-chart price action patterns that have a higher
than average probability of follow-through in a particular direction. These
trading patterns offer signi cant clues to price action traders that use
technical chart analysis in their Forex trading decision process. Each chart
pattern has the potential to push the price toward a new move. Thus, Forex
traders tend to identify chart patterns in order to take advantage of
upcoming price swings

Type of Chart Patterns

Forex trading patterns are divided in groups based on the potential price
direction of the pattern. There are three main types of chart patterns
classi ed in Forex technical charting.

Continuation Chart Patterns

The trend continuation chart pattern appears when the price is trending. If
you spot a continuation chart pattern during a trend, this means the price is
correcting. In this manner, continuation patterns indicate that a new move
in the same direction is likely to occur. Some of the most popular
continuation chart formations are: pennants, rectangles and corrective
wedges.

Reversal Chart Patterns

The trend reversal chart patterns appear at the end of a trend. If you see a
reversal chart formation when the price is trending, in most of the cases the
price move will reverse with the con rmation of the formation.

In other words, reversal chart patterns indicate that the current trend is
about to end and a new contrary move is on its way! The most popular
reversal chart patterns are: double (or triple) top/bottom, head and
shoulders, reversal wedges, ascending/ descending triangle.

Neutral Chart Patterns

These are the chart formations which are likely to push the price toward a
new move, but the direction is unknown. Neutral chart patterns may appear
during trends or non-trending periods. You may wonder what value there
may be in neutral chart formations, since we are unable to know the likely
direction.
But actually, spotting a neutral chart pattern is still quite valuable as you can
still trade an upcoming move. When the price con rms a neutral chart
pattern, you can open a position in the direction of the breakout!

Continuation Chart Patterns

Pennant Chart Pattern

The pennant is a corrective/consolidating price move, which appears during

trends. It resembles a symmetrical triangle by shape, as both are bound by
trendline support and resistance lines. The difference is that pennants
typically occur during a trend phase, while triangles can be formed during
both trends and general consolidation periods.

Pennants could be bearish or bullish depending on the trend direction.

When a pennant occurs during a trend, it has the potential to push the price
in the direction of the overall trend. The expected move is usually a
measured move, meaning the target from the breakout point equals the
size of the pennant itself. Below is an illustration of Pennants:

The green lines indicate the size of the pennant and measures the expected
price move, which equals the size of the pennant.

When you trade a pennant you should open your position whenever the
price closes a candle beyond the pennant, indicating con rmation of the
formation. At the same time, your stop loss should be placed right beyond
the opposite level of the pennant.
Rectangle Chart Pattern

The rectangle chart pattern is a trend continuation formation, which

resembles price consolidation within horizontal support and resistance
levels. During a trend, when the price starts moving sideways forming a
rectangle, another trending move is likely to occur once price eventually
breaks out of the rectangle formation. This move is likely to be at least as big
as the size of the rectangle. Rectangles could be bearish or bullish
depending on the trend direction. Take a look at the illustrations below for
the Rectangle formations:

 When you trade rectangles, you should put a stop loss beyond the opposite
extreme of the formation. Notice that this trading pattern is similar to the
pennant, the difference is the swings of the rectangle formation occur
within the same price zone.
Corrective Wedge Pattern

We have a rising wedge when the price closes with higher tops and even
higher bottoms. We have a falling wedge when the price closes with lower
bottoms and even lower tops. Wedges are very interesting chart patterns.
The reason is that wedges could be a trend continuation or trend reversal
formation.
Thus, I decided to distinguish the two types of wedges in order to provide a

more detailed classi cation – So wedges are of two types: corrective wedges

and reversal wedges. There is no difference in overall apperance between

these two types of wedges. They look absolutely the same – for example, a

regular rising wedge and a regular falling wedge. The corrective/reversal

character is determined by the previous price movement.

The corrective wedges form as a retracement opposite to the trend

direction. In this manner, if you have an uptrend and a falling wedge, you

have a corrective falling wedge, which has trend continuation character. If

you have a downtrend and a rising wedge, you have a corrective rising

wedge, which has trend continuation character. If a corrective wedge occurs

during a trend, it has the potential to push the price toward another

trending move equal to the size of the wedge itself. This is how corrective

wedges appear:

When you trade corrective wedges your stop loss should be placed right

beyond the side, which is opposite to the breakout.

Reversal Chart Patterns

Reversal Wedge Pattern

I will start with the reversal wedges because the previous chart patterns we

discussed were the corrective wedges. This way you will see the difference

between these two.

Reversal rising/falling wedges look absolutely the same way as corrective
rising/falling wedges. The difference, though, is the relation between the
wedge and the trend direction.

Every rising wedge has bearish character. This means a rising wedge
reverses bullish trends and continues bearish trends. At the same time,
every falling wedge has bullish character. So, falling wedges reverse bearish
trends and continue bullish trends. Still not getting it? Have a look at the
image below:

You see? The reversal wedges are absolutely the same as the corrective
wedges in appearance. The difference is where they appear in relation to the
trend. When a reversal wedge occurs at the end of a trend, it has the
potential to push the price to an opposite movement equal to the wedge
itself. When you trade reversal wedges you should place your stop loss order
right beyond the level, which is opposite to the wedge breakout.

Double Top and Double Bottom Patterns / Triple Top

and Triple Bottom Patterns
These are another example of reversal chart patterns. We have a double top
pattern when after an uptrend the price creates two tops approximately on
the same level. And on the contrary, we have a double bottom pattern when
after a downtrend the price creates two bottoms approximately on the
same level. It is absolutely the same with the triple top and triple bottom
formations. The difference, though, is that the tops and bottoms here are
three and not two. This is how these formations look:

The green lines here indicate the size of the formation and its respective
potential. We determine the size when we take the highest top and the
lowest bottom of the formation. When we con rm the authenticity of these
trading patterns, we expect a price move equal to the size of the formation.
This is typically referred to as a 1 to 1 measured move.

But how do we con rm the formation? When we trade double and triple
tops and bottoms we need to settle on the signal line for the formation. The
signal line of the double top is the horizontal line which goes through the
bottom between the two tops. The signal line of the double bottom is the
horizontal line, which goes through the top located between the two
bottoms.
With the triple tops and bottoms it’s almost the same. This time, the signal
line goes through the lowest bottom for a triple top formation and through
the highest top in case of a triple bottom formation. When the price closes a
candle beyond the signal line, we have a pattern con rmation. Then you can
open a position and place a stop loss around half the size of the formation or
at the pattern extreme.

Head and Shoulders Pattern

This is one of the most reliable chart patterns in the technical analyst’s
arsenal. Head and shoulders are a reversal formation and indicate a topping
reversal after a bullish trend.

At the same time, this chart pattern has its opposite equivalent – inverted
(or inverse) head and shoulders. The inverted head and shoulders typically
appears after a bearish trend and calls for a bottom in price. Below you will
nd illustrations of this pattern:

As you see, the head and shoulders formation really looks like a head with
two shoulders. After an uptrend, the price creates a top, then it corrects. It
creates a second, higher top afterwards and then it drops creating a third,
lower top – head and shoulder.

It is the same with the inverted head and shoulders but instead of an
uptrend we have a downtrend and instead of tops the price creates
bottoms, as shown on the image above.
The bottoms forming the head are two points which create the signal line of
the formation. This signal line is called a Neck Line. When the price closes a
candle beyond the neck line, the head and shoulder formation is con rmed
and we can enter the market with the respective position. This position
should be short in case of head and shoulders and long in case of inverted
head and shoulders. Your stop loss should be placed right above the last
shoulder of the formation.

Ascending Triangle Pattern / Descending Triangle

Pattern

The ascending triangle has tops, which lay on the same horizontal line and
has higher swing bottoms. The descending triangle has bottoms, which lay
on the same horizontal line and lower swing tops.

Although many people consider these chart patterns as neutral, their

chance to reverse the trend is a bit higher. Thus, I put them with the trend
reversal chart patterns. This is how the ascending and the descending
triangles look:

As you see, ascending and descending triangles are very similar to the rising
and falling wedges. The difference is that rising wedges have higher tops
and falling wedges have lower bottoms, while ascending triangles have
horizontal tops and descending triangles have horizontal bottoms.

When an ascending/descending triangle is con rmed, we expect a reversal

price movement equal to the size of the formation.
Neutral Chart Pattern – Symmetrical Triangle 

Symmetrical triangles have two sides, which are approximately the same
size. Since the two sides of the triangle are usually the same, this creates a
technical force equivalency, which creates the neutral character of the
formation. The image below shows how a symmetrical triangle appears:

When a symmetrical triangle occurs on the chart, we expect the price to

move in an amount equal to the size of the formation. However, the
direction of the breakout is typically unknown due to the equivalency of the
two sides of the triangle. Thus, price action traders tend to wait for the
breakout in order to con rm the potential trade direction of the formation. If
you trade a symmetrical triangle, you should place a stop loss right beyond
the opposite end of the breakout side.
Trading Chart Patterns

Now that I introduced you to the most important patterns for chart reading
it is now time to show you an example of the chart patterns in action. Have a
look at the image below:

This is the daily chart of EUR/USD for Oct 29, 2012 – Apr 12, 2013. Our chart
analysis shows seven successful chart patterns. The green lines show where
we could open our positions. The red lines show where stop losses should be
placed.

First, we start with a double bottom formation. The green line is the signal
line of the gure and the moment where we would go long. The red line is
the stop loss, which is approximately in the middle of the formation. The
EUR/USD price increases to 187 pips in 5 days.

The price increase turns into a rising wedge afterwards. Since the wedge
comes after a price increase, it has a reversal character. The lower level of the
wedge gets broken in bearish direction and would be a potential short on
the EUR/USD. The could be closed after two days when the price reached
the size of the formation. The pro t gain would have been 190 pips.

Then the price starts a new increase which leads us to a symmetrical

triangle. Look how the sides are approximately the same size and under the
same angle. Since the symmetrical triangle has neutral character, we wait for
a breakout. And here it is in bearish direction. We could have shorted the
EUR/USD and placed the stop loss right above the gure. In the same day
the price completes the size of the formation – 137 pips that same day.
The decrease after the symmetrical triangle leads us to the rst bottom of a
double bottom formation. When we spot the second bottom, we would put
the signal line right above the top between the two bottoms. The price
breaks the signal line and a long trade is con rmed. We would place the stop
loss around the middle of the gure. In this particular case, one could have
stayed in the market for twice the size of the formation!

Soon afterwards, price starts consolidating. Notice how the consolidation

resembles a rectangle? Indeed! This is a bullish rectangle! The price breaks
the upper level of the rectangle and a buy setup occurs in this EUR/USD
Forex pair. We could manage to stay with this long position more than the
potential of the rectangle, because we get no bearish behavior after the
bullish potential is ful lled. The price starts hesitating afterwards and we see
some bearish attitude on a lower time frame chart (H4). Furthermore, on our
daily chart the price closes a Doji candle which has a potential reversal
character.

Suddenly, the price nally starts to drop. Do you see something? See the
black lines on the image above. The last double bottom followed by the
bullish rectangle creates a shoulder and a head. The following decrease
creates a second shoulder afterwards. This is a nice head and shoulders
formation. In order to con rm the setup, we need price to break and close
beyond the neck line of the formation. So, we connect the two bottoms
which create the head and we get our neck line. A shorting opportunity in
the EUR/USD occurs right after the price breaks the neck line. We could sell
the EUR/USD and put a stop loss right above the last shoulder of the gure
as shown on the image. We would want to stay with the short position until
the price completes the size of the gure.

Then a corrective rising wedge appears. It is up to you if you are going to

close the head and shoulders position and then open another short position
to trade the rising wedge. The other option is to stay with the head and
shoulders short position until the wedge is completed. In both cases you
would have generated solid pro t from the head and shoulders pattern.

Conclusion
Forex chart patterns are technical on-chart patterns which clue us in on
eventual price moves.
 Chart patterns are classi ed within three types:
Continuation Chart Patterns
Reversal Chart Patterns
Neutral Chart Patterns
Some of the most important trend continuation chart patterns are:
Pennants
Rectangles
Corrective Wedges
Some of the most important trend reversal chart patterns are:
Double/Triple Top/Bottom
Head and Shoulders
Reversal Wedges
Ascending/Descending Triangles

One of the most popular neutral chart pattern is the Symmetrical Triangle

All these chart patterns have a tendency for a price move equal to the size of
the formation itself. This is referred to as a measured move price potential.

Technical Trading Oscillators

Technical based trading is extremely popular among both novice and

professional traders. There are countless technical methodologies that can
be implemented in the market. One such method includes the use of
technical oscillators, which will be the focus of this article.

An oscillator is a technical study which traders can use to help them in

determining whether a market is trading within an expected range or is
trading outside of an expected range such that the market can be
considered as overbought or oversold. While some oscillators help in
gauging the extremes within a market, others can be used as trend
identi cation oscillators. Trend identi cation oscillators provide clues as to
whether a market is displaying trending characteristics or otherwise.

There are quite a few different names that traders use for oscillators
including technical oscillators, trading oscillators, momentum oscillators,
forex oscillators, and oscillator indicators. You should not become confused
by these different terms as most of them tend to refer to the same thing.
Oscillators are often combined with other technical studies such as moving
averages, support resistance, and candlestick analysis. Technical oscillators
can and do work quite well by themselves in certain market conditions,
however, they tend to work even better when combined with some of these
other technical elements.
Technical oscillators can provide a myriad of trading signals. Depending on
the type of oscillator, this could include signaling an overbought or oversold
market condition, a crossover signal indicating that the market is
transitioning from bullish to bearish, or bearish to bullish.

Additionally, technical oscillators can be quite useful in determining the

terminal points of a price trend. Speci cally, they can be used to spot
momentum divergences within a nancial instrument. Some more
advanced traders also utilize technical oscillators in conjunction with Market
pro le, Elliott wave, or Fibonacci analysis to determine potential in ection
points.

As such there is a multitude of ways that a trader can incorporate technical

oscillators into their trading methodology. Many of the more conventional
methods are presented within traditional technical analysis textbooks and
are known to most traders.

Although the traditional methods do work, a trader can gain a better edge
by implementing their own twist or method which the majority may not be
aware of or have picked up on. This can provide an additional edge that can
help boost your overall trading performance. As such, it’s always wise to
experiment with different oscillator trading techniques and re ne as needed
to stay ahead of the game.

Types Of Oscillators

There are scores of different technical oscillators available to traders. Most

charting platforms these days provide free access to a multitude of different
technical oscillators. However, it’s important to understand that most
oscillators tend to fall into one of two buckets.

For example, there are oscillators that are centered around a focal point or
line. Within these centered oscillators, the oscillator indicator line will move
above and below the centered line. Centered oscillators are helpful in
determining trend direction and the momentum within a trend.

For example, when the indicator line within a centered oscillator is

registering a reading above the centerline, that is generally indicative of a
bullish market condition. Conversely, when the indicator line within a
centered oscillators registering a reading below the centerline, that is
generally indicative of a bearish market condition.
Obviously, we are generalizing greatly to make a point here, however, this
should provide you a 30 foot view of what centered oscillators can be used
for. Two of the more popular oscillators that fall within this category include
the MACD and the Momentum indicator.

On the other hand, there are oscillators known as banded oscillators. Banded
oscillators move between a certain upper threshold commonly referred to as
an overbought area, and a lower threshold commonly referred to as an
oversold area.

Most momentum oscillators that traders use are actually banded oscillators.
These include the popular Relative Strength Index, Stochastics, and Williams
%R. Keep in mind that the upper and lower thresholds as de ned by each
banded oscillator may differ.

For example, the upper threshold indicating an overbought market within

the RSI indicator would be at or above 70, while the Williams %R indicator
should register a reading of 90 or above for it to indicate an overbought
market environment. Within the Stochastics oscillator, it would signal and
overbought market when its indicator line reaches a threshold at or above
80. So, as you can see, banded oscillators though similar in their general
theme, can and do provide unique signals.

Stochastics Oscillator

The Stochastic oscillator is a banded type momentum based indicator that

helps identify overbought and oversold conditions within the nancial
security.

The stochastic oscillator can be seen as two lines that oscillate between 0
and 100. The slower line is referred to as the Percent D line, and the faster
line is referred to as the Percent K line. The default settings of the Stochastic
oscillator includes a 14 period lookback, and the %D line is smoothed by
three periods. Below you can see an example of the Stochastic oscillator
shown below the price action.
Notice on the price chart above the blue line represents the percent K line,
the faster line, while the red line represents the D line, the slower line. The
upper dotted horizontal line represents the 80% threshold, and the lower
dotted horizontal line represents the 20% threshold. Whenever that percent
D line moves into or above the 80% threshold, we can say that the market is
in overbought territory. Similarly, when the percent D line moves into or
below the 20% threshold, we can say that the market is in oversold territory.
Referring back to the price chart, notice how prices revert back to the mean
as the percent D line moves above the 80% threshold, pushing prices lower
afterwards, and when the percent D line moves below the 20% threshold,
pushing prices higher afterwards. Some traders often use the crossover
above the 80% threshold as a signal to go short, and a crossover below the
20% threshold as a signal to go long.
The Stochastic oscillator tends to work best in a range bound market
condition where there is a clear upper and lower boundary of resistance and
support respectively. Traders need to be careful of using the stochastic
oscillator as a mean reversion signal, when the markets are trending strongly
in one direction or another. This can often create what is known as a
stochastics pop, wherein the stochastic indicator remains above the 80%
threshold for extended periods of time during a bull run, or below the 20%
threshold for extended periods of time during a bear run.
Momentum Oscillator

Let’s now turn our attention to the Momentum oscillator, and see what we
can learn from this trading indicator. The momentum oscillator is a fairly
simple technical tool that oscillates between zero and 100, and generally, has
a centerline marked as zero. The zero level is considered the midpoint level,
and when the indicator value is above that level, the market can be said to
be bullish, while a bearish sentiment exists when the indicator value is below
that level. It’s important to keep in mind that the momentum oscillator does
not necessarily provide overbought and oversold levels in the conventional
sense.

The formula for calculating the momentum oscillator is relatively

straightforward. More speci cally, the momentum indicator takes into
account the current closing price of an instrument and compares it to
another closing price. The other closing price can be any time period,
however the default value used within this indicator is 10. And so, when
looking at the momentum oscillator on the daily chart, it is comparing the
current closing price to that 10 periods ago.

As noted, the most important line within the momentum oscillator is the
centerline. Let’s take a look at an example of the momentum oscillator
plotted on the price chart.

On the price chart above you can see the momentum oscillator plotted
below the price action. The blue line represents the actual momentum
oscillator readings at any given point in time. The green horizontal line is the
midpoint line and represents the value of zero. Notice how prices began to
move lower after the momentum line crosses below the center zero line.
This is because the market is transitioning from a bullish to bearish market
condition and thus the trend favors the bears. Similarly, you will note how
prices begin to move higher after the momentum line crosses above the
centerline. When this occurs, it indicates that the momentum in the market
is moving from bearish to bullish, and thus favoring a bullish stance.

MACD Oscillator

The moving average convergence divergence oscillator, also known as

MACD is a widely used technical study that can be helpful in analyzing
market trend and momentum. The MACD indicator is generated using two
separate moving averages, and the differential between these two moving
averages is what creates the actual histogram.

Essentially, the shorter-term moving average is calculated using the 12 day

exponential moving average, and the longer term moving average is
calculated using the 26 day exponential moving average. The resultant
MACD is the difference between the 12 day EMA and the 26 day EMA. Finally,
a 9 day moving average is applied to the MACD line for a further smoothing
effect.

The MACD oscillator is best seen as a histogram. Moreover, when the MACD
line crosses above the nine-day signal line, the histogram will appear to be
green and in positive territory. Conversely, when the MACD line crosses
below the nine-day signal line, the histogram will appear to be red and in
negative territory. This uctuation higher and lower will occur along the zero
centerline. When the MACD histogram is above zero or in positive territory,
we can consider that as a bullish sign, whereas when the MACD histogram is
below zero or in negative territory, we can consider that as a bearish sign.

Aside from the simple cross up or down of the centerline, there is another,
arguably better use of the MACD oscillator. More speci cally, the MACD
oscillator is an excellent tool for spotting divergences that occur on the price
chart. A bullish divergence occurs when the price is making lower lows, while
the MACD is making higher lows.

Along the same lines a bearish divergence occurs when the price is making
higher highs, while the MACD is making lower highs. Essentially, a
divergence signal indicates that the market is weakening in the direction of
the current trend, and thus a reversal is likely to occur. Let’s look at the chart
image below for an example of a bearish divergence signal on the MACD
oscillator.
Notice on the chart above, the price is in a clear uptrend. We can see that an
initial peak formed toward the center of the chart which was followed by a
minor retracement, and a second top formation which was higher than the
initial top. Notice now the behavior of the MACD oscillator during the same
time period. We can see that the rst peak in the MACD oscillator is higher
than the second peak in the MACD oscillator. As such, this is a clear bearish
divergence signal between the price and the MACD oscillator, indicating
that we should expect lower prices to ensue.

ADX Oscillator

Identifying the trend in the market is one of the most important things that
a trader must do before executing a trade. A trader needs to ask himself
whether a market is trading sideways, and likely to continue consolidating,
or whether a market is trading directionally, and likely to continue moving in
that direction.

Trading with the trend will generally be the best course of action, as you are
following the path of least resistance. Think about the concept that
something set in motion will stay in motion until acted upon by another
force. The same concept applies in the markets, and so, it’s imperative that
you gauge the current environment.

One of the best tools for identifying a market trend is the Average
Directional Index, or the ADX indicator. The ADX indicator moves along a
range from 0 to 100. When prices move above the 25 level from below, that is
indicative of a market moving from a non-directional state to one that favors
a trending market condition.
Now it’s important to note that the ADX oscillator does not provide the
direction of the trend, but rather, provides information on the trendiness of a
market. In other words, we would need to use some other tool, or simply just
eyeball the price chart to know whether the ADX line is signaling trend
strength to the upside or to the downside.

ADX is best used when the markets have been consolidating in a low
volatility environment for some period of time. Often during these lull
periods, the ADX line will be below the 25 level threshold for a relatively long
duration. The breakout above the 25 threshold would then provide an
excellent signal for a new emerging trend. Let’s look at an example of this on
a price chart.

On the chart above, we can see that the ADX oscillator is plotted below the
price action. The red line within the ADX oscillator is the ADX line. The green
horizontal line within the oscillator study is the 25 level threshold. We can
see starting at the far left of the price chart that the ADX oscillator has been
registering a reading below the 25 level for quite some time, and the price
action clearly shows a low volatility market environment with minimal
directional price movement. But notice what happens as the ADX line
creeps higher and crosses the 25 level threshold. A solid trend to the upside
emerges.

Aroon Oscillator

The Aroon oscillator was developed by Tushar Chande. The Aroon oscillator is
a trend based indicator that can provide clues on the strength of the current
trend, and the likelihood of a continuation or reversal. The Aroon oscillator is
comprised of two lines. The rst is the Aroon up line, which is often shown as
a green line, and the second is the Aroon down line, which is often shown as
a red line.
The Aroon up line is calculated using the following formula below:

((number of periods) – (number of periods since highest high)) / (number of

periods) x 100

The Aroon downline is calculated using the following formula below:

((number of periods) – (number of periods since lowest low)) / (number of

periods) x 100

The number of periods input is generally defaulted to 25. Essentially what

the Aroon up and down is measuring is the number of periods since the last
25 period high or low.

The best Aroon oscillator signals include those wherein the Aroon up line
crosses above the Aroon downline. This is indicative of a bullish market
condition and favors an upward price move. Conversely, when the Aroon
downline crosses above the Aroon up line this is indicative of a bearish
market condition and favors a downward price move. Let’s look at an
example of the Aroon oscillator in action.

Notice on the chart above the Aroon oscillator is shown on the lower pane
below the price. The Aroon up line is shown in green, while the Aroon
downline is shown in red. Notice what happens when the red Aroon
downline crosses above the green Aroon up line. The prices begin to move
lower creating a bearish price trend afterwards.
Now let’s scroll over to the far right of the price chart. Here we can see that
the green Aroon up line has now crossed above the red Aroon downline. In
this case if we were short this market this opposing signal could act as our
exit signal. Otherwise, we might consider a new long position using this
particular buy signal.

Summary

By now you should be quite familiar with what a technical oscillator is and
some of the best practices in applying it in the markets. We’ve highlighted
some of the best oscillators for trading here, speci cally the Stochastics,
Momentum, MACD, ADX, and Aroon  oscillators. It’s a good idea to
experiment with each of these to get a sense for which one suits your
trading style. But keep in mind, these are just the tip of the iceberg, and you
should do your own research into this area and nd your unique
combination of tools.

Forex Technical Indicators

Have you ever wondered what technical trading indicators to use in your
forex trading? If you are, then this article will surely appeal to you. When you
decide on your technical analysis trading strategy, you should carefully
choose your trading weapons! And though my personal style of trading
involves more pure price action analysis rather than the use of indicators
themselves, I do believe that they can be very useful when applied correctly.
Today we will go through some the top technical analysis indicators for Forex
trading. We will discuss the signals we can get from these indicators and the
way you can incorporate them into your own Forex trading approach.

The technical analysis indicators, we will be discussing could be leading or

lagging based on the time at which they provide a signal.

Leading indicators are also called Oscillators. These are the Forex technical
indicators which give you an entry/exit signal before the actual occurrence of
the respective event.

Lagging indicators are typically Trend-Con rming Indicators. Lagging

indicators give con rmation signals after the actual occurrence of the event.
These are the trading indicators, which would give you a con rmation signal
that the trend on the chart is underway.

Let’s now go through the best technical indicators for Forex Trading:
Leading Indicators (Oscillators)

Leading indicators are the indicators, which manage to give you a

preliminary signal. This means, that a leading indicator could put you in the
market in advance of the potential move, Keep in mind that even though
leading indicators can get you into a trade at the beginning of a new leg,
many times you can and will get false signals along the way.
Therefore, traders often combine more than one leading indicators in order
to eliminate as many fakeouts as possible. Let me now show you two of the
most widely used leading technical indicators in Forex! These are the
Stochastics indictor and the RSI indicator.

Stochastic Indicator 

The Stochastics indictor was created by George Lane, and is one of the most
popular indicators around. I, myself, had the pleasure of meeting George
Lane back in the late 1990’s and spent about a week learning his trading
methods. But that’s a story for another day. In essence, the stochastic
indicator is used to determine overbought and oversold conditions in the
market. In other words, the Stochastic can sometimes tell you that there is
too much buying in the market and prices could be due for a correction. If
the signal is oversold, then the Stochastic is telling you that maybe there are
too many selloffs with this currency, and a possible rebound is due.
The Stochastics indicator consists of two lines which move together and
interact with each other at some point. In addition the indicator has an
upper and lower zone .The upper area is the overbought area and the lower
area is the oversold area.
When the two lines enter the lower area, the Stochastic is giving us an
oversold signal. In this case, we can buy the currency pair when the two lines
cross upwards on their way out of the oversold area. If the two lines enter the
upper area, the Stochastic is telling us that the Forex pair might be
overbought. Then we can sell the pair when the two stochastic lines cross
downwards on their way out of the overbought area. These are the two basic
signals which the Stochastic Oscillator gives us.
However, the Stochastic is also very useful for divergence trading. If you do
your technical analysis using the Stochastic, you will often notice that the
indicator is moving upwards and the price is moving downwards, or the
opposite. These are bullish and bearish divergences. If there is a bullish
divergence between the price and the Stochastic, we can anticipate a
possible price increase. The opposite is in force for bearish divergence. Now
let’s take a closer look at the Stochastic Oscillator:

This is the H4 chart of the EUR/USD for the period Dec 16, 2015 – Jan 20, 2016.
On the bottom of the chart you will see the Stochastic Oscillator.

The rst black arrow shows us the Stochastic in the oversold area.
Stochastic breaks upwards and the price starts increasing.
Then we have an overbought signal. A decrease comes right afterwards.
A new oversold signal sets the beginning of a new bullish trend.
The next overbought signal leads to the biggest decrease on this chart.
On its way down the Stochastic gives us one false oversold signal.
Then we get the real thing – an oversold signal which puts us in a big
long position.
The next signal is tiny and it hints for an overbought market. The price
move is tiny too.
Then we get a new overbought signal and we get a better downward
move.
On its way down the Stochastic gives us a false signal.
Finally we get the last signal – oversold. We get a small upward move.
Relative Strength Index (RSI)

The RSI is another effective leading indicator. It is similar to the Stochastic

Oscillator as it provides clues on overbought and oversold conditions, and
also divergences. However, the RSI has only one line, which enters an upper
and a lower area on the indicator. These are the overbought and the
oversold areas.

When the RSI line enters the upper area usually above the 70 reading, we
get an overbought signal. This puts us into a position to short the Forex pair
when the RSI line gets out of the overbought area. When the RSI line enters
the lower area usually below 30, we get an oversold signal. Then we can buy
the Forex pair when the RSI line gets out of the oversold area.

Divergences could be seen with the RSI the same way as with the
Stochastic Oscillator. Sometimes the tops and bottoms of the price and the
RSI will diverge, giving us bullish and bearish divergences. Bullish
divergences are likely to forecast potential upward moves, while bearish
divergences indicate potential downward moves.

Let’s take a closer look at RSI in action:

Above we have the H4 chart of GBP/USD for the period Sep 1 – Oct 2, 2015. At
the bottom of the chart you will see the Relative Strength Index (RSI)
technical indicator. The image simply shows two signals in a row for an
oversold and an overbought market coming from the RSI. After the rst
signal, which was in oversold territory, the price starts a strong and a steady
increase, which lasts for about two weeks. Then we get the overbought
signal on this GBP/USD Forex pair. The RSI breaks the overbought area and
the price starts a strong decrease, which lasts for two weeks more.
Lagging Indicators

From the name you can tell that these are the indicators which lag. This
means that the signal comes after the event and it acts like a con rmation,
rather than a forecast. In this manner, we should emphasize that the biggest
advantage of lagging indicators is that they typically give you LESS false
signals than the leading indicators. On the other hand, their disadvantage is
that they put you in the trend later. Let’s now discuss some of these types of
technical indicators:

ADX (Average Directional Index)

The Average Directional Index (ADX) is a technical indicator used for trend
analysis. It shows how strong and reliable a trend is. Do not confuse this with
trend direction. The ADX indicator does not show trend direction. It only
provides hints as the strength of a trend. The ADX indicator is considered to
be one of the best trend indicators. The reason for this is that it shows the
trend force with higher accuracy and it is very easy to understand.

The ADX is just a curved line, which moves between 0 and 60 for example.
Traders consider ADX values above 35-40 as signals for very strong trends.
This is when we want to be in the market trading that strong move! And on
the contrary, values above 20 and below 30  are considered as indications of a
developing trend. When the ADX value is below 20, it is usually an indication
of a non-trending market condition. This is important to remember as most
of the fakeouts happen during these low ADX values. Thus it is typically
recommended to stay out of the market if the ADX is lower than 20, unless
you are trading some sort of rangebound strategy. The image below will
show you how the ADX indicator works:
This is the Daily chart of USD/JPY for the period Jul 29, 2014 – Feb 17, 2015.
Below you will see the ADX indicator with its 40.0 level line. As you see, a
couple of times the ADX moves above 40.0. In that exact moment, the
strength of the bullish trend increases. Since the ADX gives no information
about the trend direction, it is up to us to decide where the trend is going. In
this case, and usually in most cases, a quick glance at the chart, will make
this crystal clear.

Bollinger Bands

Bollinger Bands are a technical indicator based on price volatility. It consists

of an upper and a lower band, and a Simple Moving Average in the middle.
The upper and the lower bands are used as support and resistance levels
and the SMA is often used as a position trigger.

When the two bands are closer to each other, this means the currency pair is
in a low volatility environment. When the bands start expanding, this means
the Forex pair has experienced increased momentum and price volatility.

Take a look at the chart below:

This is the USD/CHF on the H4 chart. The period is Jan 12 – Feb 11, 2016. We
also put a Volume Indicator at the bottom of the chart, so you would be able
to see why the Bollinger Bands lines expand. As you see, from January 12
until February 3, 2016 the Bollinger Bands lines have been pretty close to
each other.

This means that the trading volumes by the USD/CHF are relatively low and
the Swissy is rather ranging than trending. We placed a line on the Volume
Indicator, which shows the average volumes of the Swissy until February 3.
On February 3, 2016 Bollinger Bands begin to expand, with unusually high
Swissy volumes. At the same time, the price drops. This is when one should
consider shorting the USD/CHF. The Volume Indicator con rms the trading
expansion by the USD/CHF.

MACD (Moving Average Convergence Divergence)

The MACD is an indicator that takes two moving averages of two moving
averages of the price, then it smoothes them by two other moving averages.
In addition to the two moving averages of the indicator, there is also a
histogram, which displays the difference (distance) between the two moving
averages. As you probably guess, there is a relatively high amount of lag
behind the MACD. Nevertheless, this is one of the most widely used Forex
technical indicators.

The basic MACD signals are:

Go long when the two MACD lines cross upwards.

Go short when the two MACD lines cross downwards.
Bearish Divergence – when MACD is moving downwards and the price
upwards
Bullish Divergence – when MACD is moving upwards and the price
downwards

Now let me show you the MACD indicator in action:

Above you see the daily chart of the AUD/USD. The period is Apr 7 – Oct 23,
2015. At the bottom of the chart you see the MACD with its histogram.
 The rst green arrow on the MACD shows a bullish cross in the MACD
lines – long signal. The price increases afterwards.
The rst red arrow on the MACD shows a bearish cross in the MACD
lines – short signal. The price drops afterwards.
Second green arrow – bullish MACD signal. The price does a slight
increase, but then it drops turning a potential trade into a losing one.
Second red arrow – bearish MACD signal. The Aussie does a big drop.
Third green arrow – bullish MACD cross. AUD/USD increases slightly.
Third red arrow – bearish MACD signal. The price decreases again.
Fourth green arrow – bullish MACD cross. Price increases but then
drops forcing the MACD lines to interact just for a ash. This trade is a
loser.
Fifth green arrow – bullish MACD cross. Price increases again.

Parabolic SAR (Stop and Reversal)

The Parabolic SAR indicator was created by Wells Wilder, who also created
the RSI indicator. Visually it places little dots on the chart above and below
the candles. When candles are closing upwards, the dots are below the
candles. When candles start closing downwards, the dots switch above the
candles. In comparison to some other indicators, Parabolic SAR is equally
effective for entry and exit signals, but many traders use it mainly for its exit
signal.

One Parabolic SAR rule that can be used is, buy when there are three dots
below the candles and sell when there are three dots above the candles.

The image below will show you how exactly the Parabolic SAR works:

This is the H4 chart of the USD/CAD Forex pair. The period is Dec 30, 2015 –
Feb 2, 2016. The black dots represent the Parabolic SAR indicator.
Conclusion

Trading with indicators is one of the most popular ways to approach the
Forex Market.

 Indicators should be used in context with current market conditions in

order to minimize false signals.

Technical analysis using indicators can be implemented in order to set more

accurate entry and exit points on the charts.

There are two types of indicators:

Leading Indicators
Lagging Indicators
The most popular leading indicators are:
Stochastic
Relative Strength Index (RSI)
The most popular lagging indicators are:
Average Directional Index (ADX)
Bollinger Bands
Moving Average Convergence Divergence (MACD)
Parabolic SAR (Stop and Reversal)

Combining Technical Indicators

One of the most interesting and alluring aspects of Forex trading is that
there are so many different approaches. Some traders prefer to focus on
fundamentals, making trading decisions based on their economic
assessments and in reaction to news releases and or political events. Other
traders prefer to focus on technicals, studying the charts to gain a better
understanding of how markets move and the different elements they can
use to measure and interact with these reactions.

Even within the realm of technical trading there is a diverse range of

different areas to focus on. Technical elements such as support and
resistance, Fibonacci trading methods, trend lines and channels, price action
reading and harmonics, are all popular forms of technical analysis. However,
perhaps the most popular form of technical trading is the use of technical
indicators.
Now, if you aren’t familiar with technical indicators what we are referring to
are built in tools on your trading platform that help traders analyse price
movements. There is a wide list of traditional technical indicators measuring
aspects such as volume, trend direction, momentum and so on.

Indicators such as RSI, MACD, Stochastics and Moving averages are all
popular technical indicators used by amateurs and pros alike.  If technical
indicators aren’t an area you are familiar with, then I certainly suggest doing
some extra research as they can be an incredibly effective way of analysing
and trading the markets.

Now, while a lot of traders will tend to focus on just one technical indicator,
typically traders will get the best results by merging different indicators.
Combining trading indicators is a straightforward way of creating an effective
trading system. The great news is that there is a diverse combination of
technical indicators to choose from.

In this article we are going to focus on some of these combinations and

show you how to get the best from trading using multiple technical
indicators.  Before we dive in, however, let’s just quickly walk through why
we should use an indicator combination and what the bene ts are of
multiple trading indicators.

Why You Should be Combining Trading Indicators?

When it comes to technical trading, it is the job of the trader to seek out
high probability entries. One of the best ways of doing this is through
establishing con uence. Trade con uence simply refers to the overlapping
of two technical elements at the same price and time point, giving the same
signal. For example, a bearish pin bar at a resistance point would be
con uence.

When it comes to combining trading indicators, we establish con uence

through identifying two or more technical indicators giving the same signal.
Now, the bene t here is that we can increase our conviction for taking a
trade. If we have two or more non-correlated technical indicators or studies
giving us a trading signal, the chances of it working are increased. 

Additionally, in terms of creating a trading system, the use of two or more

indicators gives us an enhanced set of criteria to satisfy before taking a trade.
For example, if we are waiting to sell and one indicator says sell but the other
doesn’t, then we don’t have con uence and therefore have no trade to take.
This is really useful for avoiding taking bad trades and learning to stick to a
strategy.
So, now we’ve explored the bene ts of combing indicators, let’s take a look
at some of the best combination of indicators.

The rst one we are going to kick off with is a moving average combination.
Moving averages are a fantastic technical indicator, very simple to use and
very effective. The line plotted on the chart simply displays the average price
over the last X periods or sessions. It updates automatically as each new
session unfolds, hence the name “moving average.  While moving averages
are very good on their own, they are excellent when you combine moving
averages of different length.

On the daily chart, some classic combinations are 9 & 21, 50 & 100, 100 & 200,
50 & 200. The way these combinations work is that when the shorter moving
average crosses above the longer moving average, this is a bullish signal for
the trader to buy. Similarly, when the shorter moving average crosses below
the longer moving average, this is bearish signal for the trader to sell.

Of these combinations perhaps the most famous is the 50 & 200 moving
averages. When the 50 MA crosses above the 200 MA, this is known as a
Golden Cross and is a strong bullish signal. When the 50 MA crosses below
the 200 MA, this is known as a Death Cross and is a strong bearish signal.
In the chart above you can see a great example of a Golden Cross. Price is
trading below the moving averages to start with and then trades higher. As it
does so, the 50 moving average crosses above the 200 moving average,
giving us a our bullish Golden Cross, and as you can see, price trades rmly
higher from there. This is a great example of how to use the moving average
combination.

Now, when it comes to trading the cross you have two choices. You can
either enter as the cross happens, or you can use the cross as a bullish guide
to then look to buy based on other signals.

If simply entering a buy trade at the crossover, the typical way to manage
the trade is to place your stop below the last swing low that occurred before
the crossover. You can then either look to target 2 or 3 x your stop loss (so if
your stop is 100 pips, target 200 or 300 pips) or you can look to stay in the
trade until the 50 crosses back below the 200. Looking at the chart you can
see that had you stayed in the trade until the 50 crosses back below the 200
you would have caught a very large trending move.

It is important to note the trades don’t always play out in such a fashion and
so it is important to practice with the system and work out which methods
suits you best. Another option is to close out a portion of the trade at a target
level (such as 2 or 3 x your stop) and then hold the remainder until the exit
crossover occurs, which allows you to still take advantage of a big trending
move, in case it happens. 
In the chart above you can see an example of the bearish Death Cross. As
you can see price is trading above the moving averages to begin with and
then trades lower. As it does so, the 50 moving average cross below the 200
moving average giving us our bearish signal.

Now, as with the bullish crossover, when it comes to trading this, we can
either use it as a bearish guide to take other sell signals or we can simply
enter a sell trade as the crossover occurs. If we enter as the crossover occurs,
we place a stop above the last high that occurred before the crossover and
then look to target either 2 or 3 x our risk or hold the trade until the moving
averages crossover again.

So, as you can see, combining moving averages is a really great way to
identify powerful trading opportunities. The beauty of the method is that it is
incredibly simple to use and the indicators essentially tell you when it is time
to trade.

Now, we mentioned earlier that you can use the moving average crossover
to act as a guide, telling you whether you should be looking for bullish
signals or bearish signals. In this instance we would establish a signal via the
moving average crossover and then look to use another technical indicator
for our entry point.
MACD and Stochastics Indicator Combo 

When we’re looking to combine the moving average crossover with another
technical indicator there is actually a better indicator we can use; the MACD.

The moving average convergence divergence indicator basically tracks two

moving averages but displays them in a different format. The indicator
shows you whether there has been a bullish crossover or a bearish crossover
and whether the crossover is expanding (trend is growing) or contracting
(trend is weakening).  The MACD is a great indicator because not only does it
show us the trend direction but it also shows us the strength of the trend.

So, let’s take a look at another combination of indicators that we can use if
we go down this route.

So, this time around we are going to use the MACD with another great
indicator, the Stochastics indicator. The stochastics indictor is a technical
indicator which measures momentum in the market. It tells us whether
momentum is heading downward or upwards but just as important it tells
us when this momentum is overstretched and at risk of a reversal.

For example, once the stochastics indicator moves above the upper
threshold, the bullish momentum in the market is overstretched and at risk
of a reversal lower. Similarly, if the stochastics indicator crossed below the
lower threshold, this tell us that bearish momentum is overstretched and
vulnerable to a reversal higher.

So, the premise of this strategy is that we rst of all look to identify a
directional signal on the MACD and then an entry signal on the stochastics
indicator. So, for a bullish trade we look to see the MACD turning bullish
(histogram bars switching from red to green), this tells us the 50 moving
average is now above the 200 moving average, telling us to look for buy
entries.

At this point we then look to our stochastics indicator. So, because we know
we are looking to buy, we want to identify periods when the stochastics
indicator crossed below the lower threshold, telling us that bearish
momentum is overstretched and likely to reverse higher. We can then place
our buy trade as the indicator moves back above the lower threshold.
So, looking at the chart above you can see a great example of this indicator
combination in action. To begin with, we can see that the MACD crossed
bullish which tells us to be on the lookout for buy entries. So, looking at the
stochastics indicator then, you can see there are two instances where the
indicators cross below the lower threshold and then crosses back above,
giving us our buy entry.

So, essentially what you can see here is the MACD indicator telling us we
have a bullish trend. We then look for periods within the trend where price
corrects lower and we use the stochastics indicator to time the point at
which the correction is exhausted and likely to fail and the resume the bull
trend.

In terms of how to manage the trade, given that we are entering a bullish
trend, the best approach is to place our stop below the last low that
occurred before the entry point. We can then look to target a minimum of
two or three x our risk. Alternatively, we can hold the trade until the MACD
turns bearish.

Once again, the beauty of this strategy is that it is very straightforward and is
based on sound logic. Looking for with-trend entries is a great way to trade
and can be applied on any timeframe. This is a great indicator combination
for intraday trades and works just as well on the higher timeframes. It is also
highly effective in different asset classes. Moreover, it is a great forex
indicator combination but also works just as well in equities or commodities.
In the chart above you can see a great example of a bearish version of this
strategy. So, this time around we can see rst of all that the MACD indicator
has crossed to red from green, telling us that the 50 moving average has
crossed below the 200 moving average and the market is now in a bearish
trend and we should be on the lookout for sell trades.

So, then looking at our stochastics indicator we know that we need to wait
for a point where the market is correcting higher and the stochastics
indicator crosses above the upper threshold. Looking at the chart you can
see the point at which this occurs. The indicator crosses above the upper
threshold and then moves down beneath it, giving us our sell entry and
from there you can see the correction ends and the bear trend resumes.

In terms of managing this trade then, because we are entering a bearish

trend this time we want to place our stop above the last high that occurred
before our entry point at the crossover.

As with the bullish trade, we want to target at least 2 or 3 x our risk.

Alternatively, we can look to hold the trade until the MACD turns bullish.
Final Words

So, hopefully by now you are feeling excited to get onto the charts and test
out some of these strategies. As with all trading methods and setups,
practice makes perfect so make sure to spend a good amount of time
studying these indictors on the charts and practicing these techniques.

The beauty of using these strategies is that because the setups work on all
asset classes and timeframes, there is a wealth of opportunities with these
trades. This means that you don’t have to force a trade. If you open a chart
and you can’t nd a setup, you simply wait for the setup to occur and in the
meantime you can look elsewhere.

This is incredibly useful because it prevents you from taking any

unnecessary trades and ultimately should reduce the number of bad trades
you take. The strategies outlined here rely on two layers of con rmation,
which is very useful for keeping you out of choppy market conditions. Then
once a chart starts to trend, it can help you nd a great entry point.

Feel free to try out your own combination of technical indicators to see what
the best combination of indicators is for you. Merging different indicators is
much more robust way of approaching the market and is a great way to
become disciplined in your trading, which should ultimately aid in your
success.

Divergence Trading Patterns

When trading forex, many traders use different indicators in order to get
additional con rmation for their signals. The primary indicator that a trader
should use is Price itself, because Price action will provide you the clearest
picture and get your closest to what’s happening in the market at any given
time. Having said that, there are times when you should combine price
action analysis with traditional technical indicators. Typically, you would look
for clues between the indicator and price action in order to make a decision.
One of the most powerful trading signals that combines price action analysis
with the use of indicators is the Divergence signal, and that’s what we
intend to discuss in this lesson.

The name of this pattern speaks of its character. We have a divergence when
the price movement is contrary to the indicator movement. This type of
Regular Divergence pattern comes in two forms:
Bearish Divergence

This is when price creates higher tops on the chart, while your indicator is
giving you lower tops. After a bearish divergence, price usually makes a rapid
bearish move. Notice that this happens despite the previous bullish attitude
in the price.

Bullish Divergence

The bullish divergence has absolutely the same characteristics as the bearish
divergence, but in the opposite direction.  We have a bullish divergence
when the price makes lower bottoms on the chart, while your indicator is
giving you higher bottoms. After a bullish divergence pattern, we are likely
to see a rapid price increase.

However, there is a third kind of a divergence, which does not fall into the
regular divergence group. This is the Hidden Divergence pattern.

Hidden Bullish Divergence

We have a hidden bullish divergence when the price has higher bottoms on
the chart, while the indicator is showing lower bottoms.

Hidden Bearish Divergence

As you probably guess, this type of divergence has the same character as the
hidden bullish divergence, but in the opposite direction. We con rm a
hidden bearish divergence when the price is showing lower tops, and the
indicator gives higher tops.

The regular divergence pattern is used to forecast an upcoming price

reversal. When you spot a regular bullish divergence, you expect the price to
cancel its bearish move and to switch to an upward move. When you see a
regular bearish divergence, you expect the price to cancel its bullish move
and switch to a downward move.

Divergence trading is an extremely effective way to trade Forex. The reason

for this is divergence formations are a leading signal. This means that the
divergence pattern is likely to occur before the actual move. This way, traders
are able to anticipate and enter a trade right at the beginning of the new
emerging move.
Reliable Indicators for Trading Divergences

Since we discussed the four types of divergence patterns, we will now talk
about the importance of the divergence indicator. As I said, you need an
indicator on your chart in order to discover divergence. The reason for this is
that the price has to be in a divergence with something. It is simply
impossible to trade divergence without having an extra indicator on the
chart. So the question becomes, which indicator or indicators are best for
divergence trading? Well let’s nd out.

Moving Average Convergence Divergence (MACD)

The MACD is a moving average based indicator, where a signal could be

taken on a crossover. In this manner, the indicator basically has a lagging
character. However, the lagging character of the MACD concerns only its
primary signal – the crossover signal.  The indicator also has two leading
functions.

The rst one is its ability to spot extended market conditions when the lines
are approaching overbought / oversold readings.

The second one concerns MACD for divergence trading. When the MACD
tops/bottoms are in the opposite direction from the price’s tops/bottoms,
we have a divergence. Although the MACD is a lagging indicator in general,
the divergence signal it gives us, is considered to have a leading character.
Thus, we can get an early entry based on a MACD divergence, and then
con rm the signal with a MACD crossover for example. The image below will
show you how MACD divergence trading works.
Above you see the daily chart of the most highly liquid Forex pair – the
EUR/USD. At the bottom of the chart we have the MACD indicator, which is
used to spot a bullish divergence. The blue lines on the chart show the
divergence itself.

Notice that on the chart the EUR/USD closes with lower bottoms. At the
same time, the MACD creates higher bottoms. This causes a bullish
divergence between the price action and the Moving Average Convergence
Divergence (MACD) indicator.

This scenario provides a nice opportunity for a long position. As you see, the
EUR/USD price starts increasing right after con rming the bullish
divergence.

Stochastic Oscillator

Another common oscillator used for divergence trading in Forex is the

Stochastic Oscillator.

The Stochastic consists of two lines which interact frequently between each
other. At the top and the bottom of the indicator there are two areas –
overbought and oversold areas. The Stochastic indicator can be used for
overbought and oversold readings. This is its primary purpose. However, the
Stochastic Oscillator is an excellent tool for recognizing divergence trade
setups.

In order to nd a divergence between price action and Stochastic, you

should look for discrepancies between the price direction and Stochastics
tops or bottoms. It acts the same way as with the MACD.

However, the Stochastic Oscillator is likely to give us many more divergence

signals than the MACD. The reason for this is the dynamic character of the
Stochastic. It simply gives more opportunities than the MACD.

However, since the signals can be more frequent, many of them might be
false signals which need to be ltered out.  Have a look at the image below.
Above you see the 240 minute chart of the USD/JPY currency pair. There are
two divergences on the chart, which gives an opportunity for two trades.

We start by analyzing the rst case. We observe higher tops on the chart,
while the Stochastic Oscillator creates lower tops. This con rms a bearish
divergence on the USD /JPY. The price starts decreasing afterwards.

During the decrease, the USD/JPY price closes with lower bottoms. However,
the Stochastic suddenly starts closing with higher bottoms. This is the
second divergence pattern. Soon afterwards, the USD/JPY price starts
increasing.

Relative Strength Index (RSI)

The Relative Strength Index is another good indicator to build a successful

Forex divergence system. The primary function of this indicator is to discover
overbought/oversold price conditions.

The RSI indicator consists of a single line, which moves between an

overbought and oversold zone. In this manner, the RSI has a leading
character. It is an oscillator like the Stochastic. Therefore, it is a good tool for
spotting divergences on your chart.

When you nd a mismatch between price action’s tops or bottoms and RSI’s
tops or bottoms, you have a divergence pattern forming. If you spot the
pattern, it will provide for an early entry signal for your trade.

The image below will show you how to trade divergence with the RSI
indicator.
This is the H4 chart of the GBP/USD. At the bottom of the chart you see the
Relative Strength Index indicator. The chart shows lower bottoms, while the
RSI shows higher bottoms. This means that we have a con rmed bullish
divergence on the chart, which provides an opportunity for a long trade on
the GBP/USD Forex pair.

Momentum Indicator + Bollinger Bands

Let’s discuss another trading setup using Momentum and Bollinger Bands,
which is well suited to trade divergence. We will use the Momentum
Indicator to spot divergence with the price action. However, we will enter
trades, only if the price breaks the Moving Average of the Bollinger Bands
and the bands are expanding at the same time. This way we will get
con rmation for our signals and we will enter trades only during high
volatility. We will exit our trades when the price crosses the Moving Average
of the Bollinger Bands in the opposite direction.

This is how this strategy works:

This is the daily chart of the USD/CAD. At the bottom of the chart you see
the Momentum Indicator. On the price chart you see the Bollinger Bands
overlay in green.

After a period of price increase, the Momentum Indicator starts recording

lower top while price is making higher highs. This is a bearish divergence
between the price action and the Momentum Indicator. Then, we see a large
bearish candle, which breaks the Moving Average line between the bands.
At the same time, the Bollinger Bands start expanding, indicating higher
volatility. Subsequently we see a price drop of about 8% over the next three
weeks. The short trade in this case could have been closed out when price
breaks the Moving Average of the Bollinger Bands in bullish direction.

The proper location of a stop loss order in this trade should be above the last
top of the price action prior the price break at the center Bollinger band line.
As you can see the risk was very nominal in relation to the overall pro t that
could have be realized from this trade.

Money Management when Trading Divergences in Forex

We have discussed the types of divergence patterns and some reliable

indicators to trade divergence with. Now we know how to spot divergence
and how to enter the market on a divergence. However, before you start
trading divergence setups, there are a few more points which we need to
discuss further. These things include an example money management
approach when trading divergence setups. If you do not have a sound
money management plan you are likely to lose money trading divergences
or any other setups for that matter.

Stop Loss when Trading Divergence

Regardless of the trading method you use, you should always use a Stop
Loss order for each of your trades. It is no different when you trade
divergences. And for most traders, it is best to place a hard stop in the
market instead using a mental stop. As far as the divergence setup goes,
one way to place your stop loss would be put it right above the last top on
the chart, which con rms the bearish divergence. If the divergence is bullish,
then we rely on bottoms and the stop should be placed below the last
bottom on the chart.

The image below will give you an idea of where to put your stop loss when
trading divergence.
This is the H1 chart of the USD/CHF Forex pair showing a bullish divergence
between the Stochastic and the price action. This created an opportunity to
enter the market with a long trade at 0.9242 as shown on the image. The
stop loss location would be below the swing low, right below the last bottom
of the divergence pattern.

After the con rmed bullish divergence, the USD/CHF price starts increasing

Take Profit when Trading Divergence

You should always have strict take pro t rules when trading divergence. For
all the positives of trading divergences, one of the things that divergence
trading does not offer us, are clear targets. Therefore, an additional tool
should be used in order to select your pro t targets. Typically, If you trade
divergence with RSI or Stochastic, you may need an additional indicator to
close your trades. However, if you use the MACD, then you could fully rely on
this indicator alone. The reason for this is that the MACD is a lagging
indicator and it is a good standalone tool for exits as well as entries. My
preferred method is to use swing analysis and and support resistance levels
for trade management and pro t target setting, however, as I have just
mentioned, the MACD is also a viable option.

A Complete Forex Divergence Strategy Using the MACD

We have all the tools that we need into order put a Forex divergence trading
plan together. Let’s now combine all the rules and see how this would look.
We will use the MACD indicator for spotting divergence and for closing
trades. When we see discrepancies between price action and MACD, we will
enter trades based on a divergence signal. When we see an MACD crossover
in the opposite direction, we will close our trades.
Let’s now see how all this works.

This is the same Daily chart of the EUR/USD we used at the beginning of this
article. However, this time we have included our entire trading strategy here.

We rst start by spotting a bullish divergence between the MACD and the
price action. The chart shows lower bottoms, while the bottoms on the
MACD are increasing. This is our bullish divergence. Suddenly, after creating
its third higher bottom, the MACD lines make a bullish crossover. We could
use this signal to go long on our bullish divergence setup as shown with the
green horizontal arrow. Our stop loss order should be located right below the
last bottom as shown on the image.

The price starts moving upwards. The MACD starts increasing as well. Two
months later, the MACD signals a bearish crossover. We use this as an exit
signal and we close our trade.

So we have discussed various types of Divergences, the indicators that can

be used to trade them and also some trade management techniques that
can be employed within a divergence strategy. This should be a good base
from which you can create and start testing out a divergence method of
your own.

Moving Averages

The moving average is one of the most common indicators in Forex trading.
It is present in almost every chart analysis that you will see online. Some
platforms even come with pre-built templates that include different moving
averages. For this reason, today we will discuss one of the most common
signals given by the different moving average indicators.
The moving average is an indicator that takes price points on the chart on an
equal time distance and averages them. This way, at a speci c moment, the
moving average will show you the price average based on past data on the
chart.

The moving average study is seen as a curved line. It can be applied directly
on the price action chart, no matter what type of chart you are using.
Sometimes the moving average line will be above the price action and other
times it will be below the price action. Here is an example:

The red line on the chart is a moving average line. Notice how the price
constantly uctuates above and below the moving average line. This creates
different signals, which we will discuss later in the article.

The moving average indicator calculation relies on a pre-determined

number of periods on the chart. You can choose how many periods you want
the moving average to take into consideration to give you an average.

For example, if you use a 20-period simple moving average on a H1 chart, the
indicator will take the last 20 hourly price values and will average them. This
way, you will get a moving average point on the chart. The different average
points on the chart create the moving line that you saw above.

If you take a 50-periond simple moving average, it will average the last 50
periods on the chart. If you take a 200-period moving average, it will average
the last 200 periods on your chart and so on.

As a general guideline, the longer the moving average period, the smoother
the moving average line will tend to be. The reason for this is that a single
price uctuation gives a higher deviation on a shorter number of periods,
and is less pronounced as the number of periods increases.
Traders use moving average indicators to get different trading signals on the
chart. They use these signals to set entry and exit points for their trades.
Sometimes, moving averages can simply support the trading strategy with
an extra layer of con rmation. Here are the most common signals that you
will get from a moving average.

Support and Resistance

Every moving average has the power to act as a support or a resistance zone.
Since MAs are a representation of price action, they contain a psychological
factor that can act as a turning point on the chart.

If the price interacts with a moving average from above, the MA can act as a
support. If the price approaches the moving average from below, then we
can have a resistance test.

Here is an example of how a moving average can support and resist the price
action. These bounces from the MA can work as signals for your trades.

Price Breakouts

If the price slices through a moving average and breaks it, then the price is
very likely to continue in the same direction. In some cases, a moving
average breakout will lead to the creation of fresh trends.
Above we see how a relatively slow moving average (50-period) begins as a
support. Suddenly, the price breaks it in the bearish direction. As you can
see, a bearish trend forms as a result. In the meantime, the moving average
turns into a resistance and pushes the price action even lower. An opposite
breakout appears at (5), followed by the end of the trend.

You are free to use more than one moving average on your chart. Actually,
you are not limited to any number of moving averages. However, to get a
moving average crossover, you will need at least two moving averages.

The moving average crossover is a type of signal where a faster moving

average crosses a slower moving average. Since a smaller period moving
average is more volatile, it will act to crossover the bigger period moving
average.

When an MA cross occurs on the chart, this is a signal that the price might
be moving in the direction of the crossover. When the faster moving average
breaks the slower moving average upward, we have a bullish MA crossover. If
the faster moving average breaks the slower moving average downward,
then we have a bearish MA crossover.
Above you see a chart with two simple moving average indicators – 20-
period (blue) and 50-period (red). The smaller one is the more dynamic one
due to the smaller amount of periods taken into consideration. This causes
the blue MA to be more curved, while the 50-period is smoother. At the
beginning of the chart, we see a bullish moving average crossover, which
leads to a solid bullish trend.

At the top of the trend, we see an opposite MA crossover (bearish), followed

by a price hesitation and a second bearish MA cross. A reversal occurs
afterward.

There are several moving average types based on the way they actually
average the price action periods. Below are some of the more common ones.

Simple Moving Average (SMA)

The simple moving average (SMA) calculates the mean of the price action
periods taken into consideration. That’s it. With every new candle on the
chart, the moving average calculates a new mean point on the chart.

Exponential Moving Average (EMA)

The exponential moving average (EMA) works in nearly the same way as the
SMA. However, the EMA puts a higher emphasis on more recent periods.
This is where the exponential factor comes from.

Volume Weighted Moving Average (VWMA)

The volume weighted moving average (VWMA) works in a similar way to the
EMA. But the VWMA puts emphasis to price periods, supported by a higher
trading volume.
Displaced Moving Averages

You can shift moving averages forward or backward on the chart, creating
displacement. If you displace a moving average by 10 periods into the future,
the line you have on the chart will simply move 10 periods to the right. If you
displace a moving average in the past, then the line switches to the left.

You can displace any moving average the way you want. Traders perform
moving average displacements to read the price action in a better.

You can combine different moving averages on your chart. It is not necessary
for all your MAs to be of the same type. You can use one SMA with one EMA,
or one EMA with one VWMA, or any other combination.

We will now show you some of the most common crossover setups that
traders use.

2 SMA Crossover Indicator

The rst example includes the use of the most common scenario – dual
simple moving averages.

We see the same 20-period and 50-period simple moving average indicator
above. We have a bullish SMA crossover, followed by a bullish trend. A bearish
SMA cross appears after a horizontal price move and we see a drop afterward.

2 EMA Cross Indicator

Another common scenario is the one that includes two exponential moving
average indicators. Let’s see what will happen if we use two exponential
moving averages with the same periods on the same chart!

The scenario is nearly the same. However, the bullish EMA cross over comes
earlier compared to the SMAs. At the same time, the bearish EMA cross
indicator signal appears later with the EMAs compared to the SMAs.

Other Forex MA Cross Strategy

Now let’s approach another moving average crossover example. This time,
we will use three simple moving average indicators on the same chart.

Here are the three simple moving averages:

Blue: 20-period SMA – fast

Red: 50-period SMA – slow
Green: 100-period SMA – slower
The bigger the MA, the smoother it is. In this manner, the faster SMAs are
breaking the slower ones.

Although we call it an SMA crossover strategy, the general idea is that the
three moving averages line up in a bullish or bearish direction.

In our case, we get a bullish crossover at the moment when the three SMAs
line up from top to bottom: fast, slow, and slower. The bearish crossover
comes when the three SMAs line up from top to bottom: slower, fast, and
slow.

The crossovers here come later than with the dual moving averages. The
reason for this is that we will be waiting for another con rmation from the
third SMA, which takes extra time. On the other hand, these crossovers are
more accurate than the dual moving averages, because they contain an
extra con rmation.

Stop Loss with the MA Crossover Indicator

As with every other Forex trading strategy, we always recommend that you
use a stop loss order when trading MA crossovers.

If you decide to enter the market on an MA cross indicator, you should put
your stop at the other side of the cross.

If the cross is bullish and you open a long trade, the stop loss should go
below the bottom created at the time of the price switch.

If the cross is bearish and you open a short trade, you can place your stop
above the price top at the time of the reversal.

Here is an example of a stop loss order on a moving average crossover trade:

The green circle shows the actual MA crossover. The pink arrow points
toward the swing top before the cross. If you believe that this swing top is
not adequate, you can use the one before. However, that will require your
taking more risk.

Profit Collection for Your MA Forex Crossover Strategy

Notice that we use “pro t collection” and not “take pro t” as a level. The
reason for this is that moving average crossover trading is not providing you
a xed exit point for your trades. You should wait for the opposite crossover
to exit your trades or some other exit mechanism.

This is the same example from above. However, this time we have outlined
the bearish trend that the price action is following.

You can close your trade when the price breaks that trend line or you can
wait for the opposite cross. In this case, the trend breakout is suf cient,
because the trend is very clear on the chart. You can always wait for the
bullish crossover as noted by Close 2, but why would you?
The rst trading strategy we will give as an example involves the moving
average crossover combined with price action techniques. The goal here is
to enter the market on a MA crossover indicator signal and some other price
action signal. Then, you would close your trade on either a strong price action
signal or an opposite MA crossover.

Above you see an H4 chart of the EUR/USD. We have a couple of SMAs on

the chart – the 20-period and the 50-period.

The chart starts with a bullish trend (blue straight line), which gets broken
and shows reversal intentions shortly after.

This reversal intention gradually forms a Head and Shoulders chart pattern,
supported by a bearish SMA crossover. At the time when the price was
creating the second shoulder, we saw a bearish bounce from the blue 20-
period SMA. This looks like a suitable time to sell.

The good thing here is that we have the Head and Shoulders rule to pursue
an eventual target for our trade. We suggest a couple of exits here at close 1
and close 2.

Close 1 – the price completes the Head and Shoulders pattern.

Close 2 – the price action con rms a Double Bottom chart pattern and
breaks the 20-period SMA (blue) in the bullish direction.
One of the best moving average crossover strategies involves the MACD
indicator. MACD works well with MA crossovers, because the MACD involves
moving averages in its calculation. We will open trades based on MA crosses
combined with an extra signal from the MACD. Then, we will close trades on
either an opposite moving average cross or just an opposite MACD signal.

This time, we have a MACD at the bottom of the H1 EUR/USD chart and 20-
period and 50-period SMAs.

The rst bearish signal we get at the green circle on the MACD indicator,
when its two lines cross.

Shortly after, we get a bearish SMA crossover, which con rms the MACD
signal. This is a good moment to sell, placing a stop loss order above the last
top on the chart.

The EUR/USD starts trending in a bearish direction. Our closing signal comes
when the MACD lines interact with each other in the opposite direction.
 Moving averages are among the most common Forex trading
indicators.
MAs are curved lines and can appear above or below the price action.
A moving average uses a certain xed period as a user input.
Signals of the MA indicator:
Support and Resistance
Price Breakouts
Moving Average Crossover
Bullish MA Cross – a faster MA breaks a slower MA in bullish
direction
Bearish MA Cross – a faster MA breaks a slower MA in bearish
direction
Different Moving Average Indicators:
Simple Moving Average (SMA) – simply averages the periods
Exponential Moving Average (EMA) – puts weight on more recent
periods
Volume Weighted Moving Average (VWMA) – puts weight on
periods with higher trading volume
Displaced Moving Averages – shifts the MA a certain number of
periods
MA crossovers can appear in any MA setup
2 SMA Crossover Strategy
2 Forex EMA Crossover Strategy
3 EMA Crossover Strategy
SMA + VWMA Crossover Strategy
Other MA Strategies
Your stop loss order should be placed at the other side of the cross.
Close your trades based on opposite signals
Two of the best MA crossover strategies
MA Crossover + Price Action: Open your trades on MA crosses and
price action signals. Put your stop at the opposite side of the
moving average crossover. Close your trades based on opposite
MA crossover.
MA Crossover + MACD: Open your trades on MA crossovers,
con rmed by a signal from a MACD indicator. Put your stop at the
opposite side of the MA cross. Close your trades on either an
opposite MA cross, or an opposite MACD signal.

Elliott Wave Impulse Pattern

Prices within all major nancial markets tend to move in a fairly predictable
manner. This is all described within the context of the Elliott wave principle.
Essentially, the market is composed of what are known as impulsive price
moves, and corrective price moves.
Knowing which stage the market is currently in will allow a trader to isolate
the highest probability trade setups, and make better trade management
decisions.

Motive waves refer to price moves that occur in the direction of the larger
trend. There are two types of motive waves within the Elliott wave theory.
The rst is called the impulse pattern, and the second is called the diagonal
pattern.

The diagonal pattern comprises of what are known as leading and ending
diagonals. The more prevalent structure seen within the nancial markets is
the impulse pattern. It occurs much more frequently than either of the
other two types of motive waves described.

The impulse structure can be seen as consisting of a total of ve price

moves, or waves as they are typically referred within the context of the Elliott
wave theory.

Again, the impulse structure moves in the direction of the larger trend, and
is easily recognizable once you know what to look for.

Below you can see the impulse structure.

The image above shows an illustration of a bullish impulse sequence. This
entire structure often starts near a major swing low, and that point is referred
to as the start of Elliott impulse wave 1. As price moves higher in wave 1, it is
often associated with a bear market rally. That is to say that the market has
been in a relatively long downtrend prior to the upward price thrust in wave
one. As such, most traders and investors believe this to be a minor
retracement within the context of the downtrend.

When wave one ends, it will lead to a price move lower in wave two that will
retrace a portion of the wave one move. However, wave two will not fall
below the start of wave one. This is an extremely important rule within Elliott
wave and one that can never be violated.

Wave two will often be a deep retracement to wave one. Typically we will see
a 61 to 78% b retracement within the wave two correction. After wave two
complete, prices will begin to move higher once again. When the price
breaches the top of wave one, more and more traders will begin to position
to the long side, and start exiting much of their prior short positions. This will
help propel price higher within wave three, and the momentum seen in this
wave will be stronger than any other wave within the entire impulse
sequence. We will often see parabolic style moves in wave three or price
gaps in the direction of the wave three price move.

Elliott impulse wave 3 often ends at a 1.618 Fibonacci projection of wave 1.

That is to say that the length of wave three is often 1.618 times the length of
wave one. Once wave three ends, it will be followed by wave four which has
characteristics of sideways price movement. The correction within wave four
will be relatively shallow but the duration of the correction can be quite
extended. Wave four is often associated with pro t-taking, as those who
made money in wave one and three, are now booking their pro ts.

The nal wave within the impulse structure is wave ve. Elliott impulse wave
5 will be less dynamic than wave three, and often we will see momentum
divergences occur between wave three and ve. This is because the wave
ve price move higher will be much more sluggish then the wave three
move earlier. Wave ve has a strong relationship to wave one. More
speci cally, the termination of wave ve will often be correlated to the
length of wave one. That is to say that wave ve will terminate at a level at
which it is equal in length to wave one.
Elliott Wave Corrective Patterns

The complete Elliott wave cycle consists of ve waves of the impulse

sequence, and three waves of the corrective sequence. As such, one
completed Elliott wave cycle is often referred to as a completed 5-3 cycle.
We’ve looked at what the Elliott impulse pattern appears as, now let’s
discuss the corrective forms within the Elliott wave theory.

There are many more corrective wave patterns than motive wave patterns.
The three primary types of corrections include the zigzag correction, at
correction, and the triangle correction. Additionally, these three corrective
patterns can combine to form more complex corrective structures.

If you have spent some time scanning the various price charts, you will have
noticed that there are periods within the price action that appear as
trending legs where a good amount of directional price movement occurs.
These directional price moves are typically impulsive in nature, and as such
can be classi ed as impulse price structures. Now, after an impulse phase
ends, it will be followed by a corrective phase.

Corrective phases appear as pauses within the directional price move. More
speci cally, corrective structures will retrace a portion of the prior impulse
move. And these corrections can appear to be prolonged sideways forms, or
can be seen as a sharper retracement against the prior impulse leg.

Below you can see a price chart that shows what an impulse move versus a
corrective move appears like.
Notice the up trending market condition on the chart above. The blue arrow
represents impulsive price action, which corresponds to one way directional
price movement, in this case to the upside. Notice that following these
impulsive price legs there are countertrend price moves that act to correct a
portion of the gains made within the impulsive price legs. These
countertrend price moves are what are referred to as corrective patterns
within the context of Elliott wave. The price action within the orange circled
areas represents these corrective price moves. As soon as the correction
ends, price continues to move higher as it enters into the next leg within
the impulse phase.

Zigzag Elliott Wave Pattern

Let’s now start detailing the Elliott wave correction rules. The rst type of
corrective structure that we will be looking at is called the zigzag pattern.
This zigzag corrective pattern is one of the more prevalent formations seen
within the markets. It is considered a simple ABC correction. It appears as a
lightning bolt formation with three distinct price legs labelled as A,B,and C. 

Below you can see an example of the Zigzag corrective pattern.

This zigzag pattern represents a bearish correction. As you can see here, the
zigzag formation consists of three legs labeled as A, B, and C. Notice from the
swing low near the far left of this price chart, that there was a strong
impulsive price move to the upside. Following that, we can see a three wave
correction against that impulse structure. This entire three wave sequence
to the downside constitutes the zigzag pattern.
Notice how wave A of the zigzag pattern moves lower against the prior leg,
followed by wave B of the zigzag pattern which moves counter to wave A.
Finally wave C moves in the same direction as wave A. Wave C will move
quite a distance below the swing low seen at Wave A.

The zigzag pattern will often be a sharp retracement against the trend as
can be seen in this example. Additionally, wave A and C within the zigzag are
often of equal length. Following the termination of wave C within a bearish
zigzag correction, prices will begin to move higher as the new impulse phase
begins. Keep in mind that what we are describing here is a zigzag pattern as
a bearish correction. Zigzag patterns will also appear as bullish corrections in
the context of a larger downtrend.

Another important feature of the zigzag correction is that it is a 5-3-5

formation. That is to say that wave A within the zigzag will subdivide into ve
smaller waves, wave B within the zigzag will subdivide into three smaller
waves, and wave C within the zigzag will subdivide into ve smaller waves. As
such, if you were to zoom in on this zigzag pattern by going to a smaller
timeframe chart, you would be able to recognize this 5-3-5 internal structure.

Elliott Wave Flat Correction

Along with the zigzag, the Elliott wave at correction occurs quite frequently
in the market. The at corrective structure can be classi ed as either a
regular at, an expanded at, or a running at.

Each of these at formations has the same implication. That is to say that a
at formation that appears as a bearish corrective will lead to a price move
higher after the completion of the pattern. Similarly, a at formation that
appears as a bullish corrective will lead to a price move lower after the
completion of the pattern.

The regular at can be seen as a three wave affair labeled ABC, similarly to
the zigzag pattern illustrated earlier. However, within the regular at pattern
the B wave will terminate near the start of wave A, and wave C will extend
just beyond the end of wave A.

The subdivision within all at patterns is a 3-3-5. That is to say that wave A will
subdivide into three smaller waves, wave B will subdivide into three smaller
waves, and wave C will subdivide into ve smaller waves. Note that this is
different from the zigzag structure which subdivides as a 5-3-5 structure.

Let’s look at an example of the regular at corrective pattern.

The above price chart illustrates an example of a regular at that corrects to
the upside. Notice how the price action on this chart starts with a strong
bearish impulse move. Following that we can see the ABC corrective
structure that retraces the price move of this bearish impulse move. The rst
wave within this at pattern is wave A, and moves higher to correct a portion
of the prior impulse. Then wave B retraces wave A and terminates near the
start of wave A. Within a regular at correction wave B will terminate near at
least the 90% retracement of wave A.

You can see on this chart that in fact wave B was a very deep retracement of
wave A, and one that can be seen to exceed this 90% threshold. Following
the end of wave B, prices will move higher once again in the direction of
wave A. We can see that wave C terminates just beyond the swing high of
wave A. This entire sequence of events forms the regular at correction
pattern. Again keep in mind that we are looking at a regular at correction
that is correcting a bearish trend. However, the regular at correction will
also appear in the context of a bullish trend as well.

As we mentioned earlier there are a total of three variations of the at

correction pattern. The one that we’ve just looked at is referred to as the
regular at. The other two variations of the at include the expanded at and
the running at. Within the expanded at wave B will extend beyond the
start of wave A, and will move slightly beyond the end of wave A.  Within the
running at variety, wave B will also extend beyond the start of wave A, but
will fail to move beyond the end of wave A.
Elliott Wave Triangle

Elliott wave triangle formations are important corrective structures that are
often seen within the larger wave 4 of the impulse sequence. Triangles are
described within many traditional technical analysis textbooks, however, the
Elliott wave theory provides the most granular description of the different
triangle structures, and their inner subdivisions.

Within the context of Elliott wave, we can label three primary types of
triangle structures. This includes the contracting triangle, the barrier triangle,
and the expanding triangle. The contracting triangle is similar to the
symmetrical triangle in traditional technical analysis. Within the contracting
triangle we can draw two trendlines that connect the peaks and troughs of
the triangle formation, and this appears as a contraction in price as it
progresses within this type of triangle formation.

A barrier triangle is similar to an ascending triangle, or descending triangle in

the traditional technical analysis terminology. However within Elliott wave,
the ascending barrier triangle should only occur within the context of an
uptrend, and the descending barrier triangle should only occur in the
context of a downtrend.

Finally, we have the expanding triangle variety. Expanding triangles are often
called broadening triangles within traditional technical analysis. And so,
expanding triangles are the inverse of contracting triangles. That is to say
that the price action within an expanding triangle, expands rather than
contracts as the price progresses through its structure.

Below you can see an example of one of the more common triangle
formations, the contracting triangle.
Notice here that this triangle formation is labeled as ABCDE. All triangles will
be labeled in this fashion. That is to say that a triangle formation must have
ve legs within it to be classi ed as a valid triangle structure. Triangles are
often referred to as 3-3-3-3-3 formations as well, because each of the legs
within the triangle formation subdivide as three waves, and these waves are
often seen as zigzag patterns.

Referring to the price chart, you can see that there was a strong bullish
impulse prior to the triangle formation. Once the peak was put in, the price
began to pull back in wave A of the triangle, and then progressed to form
wave B, wave C, wave D and the nal wave E of the triangle. Often wave E will
end near the apex point, which is at the terminal point of the converging
trendlines that contain the price action.

The proper way to draw the trendlines within Elliott wave triangle formations
is by connecting the ends of wave B and D and then similarly at the other
end, you would connect the ends of wave A and wave C. Within the
contracting triangle, as can be seen here, these lines will then converge
towards an apex. On the other hand, within the expanding triangle, these
lines will diverge.

Triangles offer an excellent opportunity to trade in the direction of the larger

impulse. At the termination of point E, we can expect one more price move
higher in the case of a bullish impulse, or one more price move lower in the
case of a bearish impulse. The termination point for this nal leg can often be
measured by taking the widest part of the triangle formation and then
projecting that from the breakout point, which is a breach beyond the BD
trendline.

Elliott Wave Complex Corrections

We have now discussed the three primary Elliott wave correction types. This
includes the zigzag correction, at correction, and triangle correction. Now, in
some cases we will nd that these three corrective forms can combine to
form what are known as complex corrections. More speci cally, these
complex corrections can form what are called double three combinations or
triple three combinations.

Double three combinations are combinations wherein two corrective

structures combine to form a larger complex correction. Triple three
combinations are combinations wherein the structure contains a total of
three corrections.
Although complex corrections are advanced patterns that can be quite
challenging to label correctly, the whole process can be simpli ed by
understanding that these larger complex corrections are merely some
combination of the three primary corrective forms described earlier.

Let’s look at an illustration that shows a Double corrective combination.

The illustration above depicts a Double three corrective combination that is

comprised of a regular at correction, and a triangle correction. If you look
closely you can see the ABC legs that compose the rst correction, which is a
regular at. Notice how wave B retraces at least 90% of wave A and then
wave C extends just beyond the end of wave A.

Within a Double three combination the rst structure is labeled as W.

The second structure within this combination is a triangle. Can you see the
ve legs that comprise this triangle formation? The second correction within
a double three is labeled as Y. And the wave that connects these two
structures is referred to as the X leg. You can see the connecting X leg
shown within the two vertical lines.

And so, this entire double three structure that is comprised of a regular at,
and a triangle is labeled as WXY. Keep in mind that this is just one example
of a double three combination. There are many different ways in which a
double threes or triple threes can combine to form a larger structure. Within
the context of a triple three combination, the labeling convention would be 
WXYXZ, where W,Y,Z are the three corrective structures, linked by the two X
waves.
Summary

The Elliott wave principle is an advanced form of technical analysis. Although

it takes a bit of practice to get acquainted with this analysis method, it is one
of the best forms of market forecasting available to any serious trader.

Although a complete understanding of the Elliott wave theory is beyond the

scope of this lesson, you should now at least have a good understanding of
the nature of impulsive moves and corrective moves. Once you begin to
appreciate that the markets are fractal, meaning that price movements
generally occur in a repetitive manner at all degrees of trend, you will be
better equipped to read the price action and predict with a good level of
accuracy, where prices are likely headed next.

Harmonic Patterns in Forex

I bet you have traded some chart patterns during your trading career.
Double Tops, Double Bottoms, Head and Shoulders – we all know these.
Therefore, today we are going to take our knowledge of chart patterns to the
next level. I will introduce you to Harmonic Patterns, which are a little more
advanced as far as trading patterns go. Although they are harder to spot, it is
certainly worth watching out for them, since these patterns can lead to
highly pro table trading opportunities when analyzed properly. So in this
article, I will be teaching you how to implement harmonic pattern trading.

Harmonic chart patterns are considered harmonic because these structures

have an integral relationship with the Fibonacci number series. Identi ed
harmonic patterns conform to crucial Fibonacci levels. As you may already
know, Fibonacci numbers can be seen all around us in the natural world, and
these harmonic ratios are also present within the nancial markets.

Harmonic trading in the currency market includes the identi cation and the
analysis of a handful of chart gures. In most of the cases these patterns
consist of four price moves, all of them conforming to speci c Fibonacci
levels. Therefore, a harmonic chart pattern should always be analyzed using
Fibonacci Retracement and Extensions tools.

For the more inclined, there are also several harmonic indicators and
software programs that will automatically detect various harmonic trading
patterns. The most widely traded harmonic patterns include the Gartley
pattern, Bat Pattern, Butter y Pattern, Cypher pattern, and the Crab pattern.
Gartley Harmonic Chart Pattern

The Gartley pattern was introduced by H.M Gartley in his book, Pro ts in the
Stock Market, The Gartley pattern is sometimes referred to as Gartley 222,
and because 222 is the exact page in the book where the Gartley pattern is
revealed.

So the Gartley pattern is the oldest recognized harmonic pattern and all the
other harmonic patterns are a modi cation of the Gartley pattern.  Let’s now
take a look at the legs within the Gartley formation:

XA: This could be any move on the chart and there are no speci c
requirements for this move in order to be part of a harmonic pattern.

AB: This move is opposite to the XA move and it should be about 61.8% of the
XA move.

BC: This price move should be opposite to the AB move and it should be
38.2% or 88.6% of the AB move.

CD: The last price move is opposite to BC and it should be 127.2% (extension)
of BC move if BC is 38.2% of AB. If BC is 88.6% of AB, then CD should be 161.8%
(extension) of BC.

AD: The overall price move between A and D should be 78.6% of XA

The image below illustrates a Bullish and Bearish Gartley pattern:

The black lines on the image above show the four price moves of the chart
patterns. The blue lines and the percentage values show the retracement
relation between each of these levels. The green arrows show the potential
price move of the pattern.

Bat Harmonic Chart Pattern

The Bat harmonic pattern is a modi cation of the Gartley pattern, and was
discovered by Scott Carney. The lines are a bit more symmetric and the
pattern’s most important ratio is the 88.6% Fibonacci retracement:

XA: This could be any move on the chart and there are no speci c
requirements for this move in order to be part of a harmonic pattern.

AB: This move is opposite to the XA move and it should be about 38.2% or
50.0% of XA.

BC: This move should be opposite to the AB move and it should be 38.2% or
88.6% of the AB move.

CD: The last price move is opposite to BC and it should be 161.8% (extension)
of BC move if BC is 38.2% of AB. If BC is 88.6% of AB, then CD should be 261.8%
(extension) of BC.

AD: The overall price move between A and D should be 88.6%% of XA

This is how the bullish and the bearish Bat harmonic chart patterns appear:
As you see, the Bat harmonic pattern is similar to the Gartley pattern,
however, the retracement levels are different. Both are considered internal
patterns because the ending D leg is contained within the initial XA move.

Butterfly Harmonic Chart Pattern

This is another modi cation of the Gartley harmonic pattern, which consists
of the same four price moves.

The retracement levels, though, are different, and this is considered and
extension pattern as the ending D leg extends outside the initial XA leg

XA: This could be any move on the chart and there are no speci c
requirements for this move in order to be part of a harmonic pattern.

AB: This move is opposite to the XA move and it should be about 78.6% of XA.

BC: This move should be opposite to the AB move and it should be 38.2% or
88.6% of the AB move.

CD: The last price move is opposite to BC and it should be 161.80%

(extension) of BC move if BC is 38.2% of AB. If BC is 88.6% of AB, then CD
should be 261.80% (extension) of BC.

AD: The overall price move between A and D should be 127% or 161.80% of XA

This is how the bullish and the bearish Butter y harmonic chart patterns
look:
Notice that the Butter y harmonic chart pattern indicates that the AD move
should go beyond the initial price move (XA). In this manner, the Butter y
harmonic pattern is considered an external formation.

Crab Harmonic Chart Pattern

The Crab harmonic pattern has some similarities with the Butter y chart
pattern. The Crab pattern actually looks like a stretched Butter y sideways.

The Crab also suggests that the last price move goes beyond the initial
move, where a Fibonacci extension should be used. The Fibonacci levels
used to identify the pattern are described below:

XA: This could be any move on the chart and there are no speci c
requirements for this move in order to be part of a harmonic pattern.

AB: This move is opposite to the XA move and it should be about 38.2% or
61.8% of XA.

BC: This move should be opposite to the AB move and it should be 38.2% or
88.6% of the AB move.

CD: The last price move is opposite to BC and it should be 224% (extension)
of BC move if BC is 38.2% of AB. If BC is 88.6% of AB, then CD should 361.80%
(extension) of BC.

AD: The overall price move between A and D should be 161.80% of XA

This is how the Crab harmonic chart pattern looks like:

Cypher Harmonic Chart Pattern

The Cypher chart pattern is similar to the other chart patterns we already
discussed, however, it has one speci c difference. The BC move of the
Cypher chart pattern goes beyond the XA move. This means that we use an
extension level on AB in order to measure the BC output. Below you will nd
the list of the Cypher pattern retracement levels:

XA: This could be any move on the chart and there are no speci c
requirements for this move in order to be part of a harmonic pattern.

AB: This move is opposite to the XA move and it should be 38.2% or 61.8% of
XA.

BC: This move should be opposite to the AB move and it should be

anywhere between 113.0% and 141.4% of the AB move.

CD: The last price move is opposite to BC and it should be 78.6% of the
general XC move.

See below the structure of the Bullish and Bearish Cypher formation

Again, the important consideration of this pattern is that the BC move goes
beyond XA and it is an extension of AB. Therefore, we measure CD with a
retracement of XC and not on BC. This is so because the general move is XC,
which is bigger than the partial BC.

Let’s now identify a couple harmonic trading examples on a chart.

Harmonic Chart Formations Analyzed

The image below will give you an example of an actual harmonic pattern on
a candlestick chart:

This is the H4 chart of the USD/CAD currency pair for May, 2015. The
formation we are looking at is a Butter y pattern.

We start with a bullish XA move. Then comes a contrary AB move which is

78.6% of the XA move. The next BC move is opposite to AB and it takes 88.6%
of AB. CD reaches 161.8% extension of BC and also 127% extension of XA.

These retracement levels con rm the presence of a bullish Butter y chart

pattern. As you see, the USD/CAD price records a signi cant increase after
the con rmation of the pattern.

Let’s look at another one now:

This is the H4 chart of the EUR/USD for Nov – Dec, 2012 showing a bullish
Cypher harmonic pattern.
We start with the AB move, which takes about 38.2% of the XA move. Then
comes the BC move which approximately reaches the 141.4 extension of the
AB move. The last move we identify is the CD move, which is about 78.6% of
the big XC move. This is how we identify the bullish Cypher pattern. As you
see, after creating point D, the EUR/USD price starts a solid price increase.

Trading Strategy Using Harmonic Chart Patterns

When trading with harmonics it is important to recognize the entry point at

Point D, but equally important is to have a sound exit strategy. Let’s take a
look at how we can trade harmonic patterns that incorporates simple risk
management rules.

Stop Loss Order when Trading Harmonic Patterns

There are several different methods for managing a trade once you have
identi ed a harmonic setup. A simple but effective method to implement
would be wait for price con rmation at the D point and place a stop loss just
beyond that immediate swing point. Have a look at the image below:

This is the same rst example with the bullish Butter y chart pattern. This
time we have indicated the potential place where a Stop Loss order should
be placed when trading the pattern. Notice that the Stop is relatively tight in
comparison to the following price increase. This provides for a very attractive
return to risk ratio when trading the pattern. And this is why harmonic
setups are such great chart patterns to trade. There is very little left to
judgement because the Fibonacci relationships within harmonic patterns
gives us an exact location of the potential turning point. If the price goes
beyond that point, the pattern fails and we simply do not enter the market.

Take Profit Zones when Trading Harmonic Patterns

Since we already know when to enter the market and where to place our
stop loss, it is time to discuss how long we should stay in the trade. I will now
introduce you the potential target levels of a harmonic chart pattern.

As you may have already guessed, the targets of a harmonic pattern should
be related to the levels of the pattern itself. Let’s now include these target
levels on our bullish Butter y example:

Again, this is the same bullish Butter y example on the USD/CAD. This time,
in addition to the Stop Loss level, we have added four potential targets in
front of the price move.

The rst target is related to point B on the chart. It is the level, which
indicates the price drop during the AB decrease. The second target marks
the C point on the chart and the price top after the BC increase. The third
target is the high which appears as a result of the XA increase. As you see,
these are the three targets which are related with the levels of the Butter y
pattern. However, we have a fourth target as well which price should
approach in cases where we complete the previous targets. The fourth
target is indicated by the 161.8% extension level of the CD price move.

Notice that the price increase continues beyond the fourth target in this
example. Therefore, one could also employ a trailing stop to stay with his
long position until the price show signs of weakening. Keep in mind, there is
no one standard way of managing your pro t targets when trading
harmonic patterns, but it is important to maintain consistency in whichever
exit methodology that you utilize.
Some traders like to use additional trading tools to con rm harmonic signals.
Some of the more popular trading indicators to get exit signals when trading
harmonics are Moving Averages, MACD, or Stochastics. In additional, one
should always keep an eye out on higher time frame Support and
Resistance levels in conjunction with harmonic setups. Also, higher
Fibonacci extension levels could be used in order to determine further price
targets when trading harmonic chart patterns.

Adjusting the Stop Loss Order when Trading Harmonic

Patterns

An important consideration when trading harmonic patterns is the use of a

trailing stop to take advantage of larger price moves and protect ones capital
as prices begin to move in our intended direction. It is a good idea to modify
your Stop Loss based on the price action in order to lock in pro ts. The image
below will show you an example of how to adjust your Stop Loss order
according to the price move:

We use the same USD/CAD chart with the bullish Butter y pattern.

Every time the price completes a target, we adjust the Stop Loss order to be
located below the lowest bottom at the time of the target break. On our
image above we see that this guarantees us a stay in the market even after
the fourth target is completed.

The basic harmonic patterns consist of four price moves which are contrary
to each other. The four legs are named XA, AB, BC, and CD.

The difference between the harmonic patterns is the Fibonacci levels they
retrace or extend to.