Pattern Recognition

1. Pattern Recognition

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3. Technical Analyst set up trading decisions based on continual exposure to repeated patterns. You will eventually be able to visualise and see these patterns as they are developing. However, before this you must firstly understand the concepts behind these patterns and what type of patterns to look for. Over time you will be able to identify these more freely in hindsight, the true strength of a great trader is to be able to see these evolving in real time. Pattern Recognition

4. Identifying recognisable patterns (trends) within the price movements helps in a couple of ways: They can give more clues as to how the market may move in the future They can be used generate price objectives for potential future moves Pattern Recognition Continuation Patterns Reversal Patterns

5. Continuation Patterns Pattern Recognition • Triangles • Pennants • Flags 3

6. Triangles Pattern Recognition • As the name suggests, triangle formations involve the price action trading in a narrowing range to form the shape of a triangle. • 3 types of triangle: Symmetrical: Ascending Descending Symmetrical

7. Triangle Rules It is a continuation pattern so it is likely to break out of the pattern in the direction of the prevailing trend (down in this example) You only establish your position after the break out at point X on the diagram (you would short your position here) Your target and minimum price objective (MPO) is the height of the pattern (measured at point Y), projected from the breakout, X The price must break out between ½ and ¾ way through the pattern. Pattern Recognition Y X MPO Your stop should be placed inside the triangle, tracking the triangle support line. Especially as price often retraces back to support line before continuing the breakout.

8. Pennants Pattern Recognition Pennants are formed over a shorter time scale than triangles - up to a few hours. As far as the shape of the pattern is concerned, pennants are identical to symmetrical triangles. Pennants, unlike triangles, rarely reverse price action. However, you do not trade them until they have broken.

9. Pennant Rules There should be an area of price congestion followed by a sharp move in one direction The price then forms a sideways pattern like a continuation triangle The price will then break out and move sharply again in the original direction This pattern is difficult to trade because the moves are explosive and it is difficult to establish the position following the break out of the pattern. The advantage of a pennant is that the target is the height of the “flag pole” rather then the height of the consolidation, giving a larger comparable profit potential. Pattern Recognition Previous area of congestion

10. Flags Pattern Recognition Flags are continuation patterns which can occur between the short and medium term - they do not usually form over much more than a week. Flags consist of a channel of price action moving against the direction of the prevailing trend, followed by a break in the direction of the trend.

11. Flag Rules Pattern Recognition x The target is the height of ‘x’ projected from the break-out point at ‘y’. This is generally a very short term pattern and would be traded in a similar fashion to a triangle. y x

12. Reversal Patterns Pattern Recognition • Double Tops / Bottoms • Triple Tops / Bottoms • Wedges • Head & Shoulders

13. Double Tops & Bottoms Pattern Recognition b a c Easy to detect Only trade on a double top when price the action breaks below the reaction low The minimum price objective for this pattern is derived by projecting the height of a-b from the breakout at c The double bottom is the exact opposite but is a bullish reversal pattern MPO

14. Triple Tops & Bottoms Pattern Recognition Stronger than Double Tops and Bottoms but less common as a third test of the high or low is required Always wait for the breakout before trading The Japanese call this a three mountain top A triple top is bearish and a triple bottom is a bullish reversal pattern. Target

15. Rising Falling Wedge A rising wedge is a top reversal pattern (bearish) where the trend becomes less steep and the range of the market becomes narrower Following the break out from the support line the wedge may trade back up to this line so it is important to put your stop inside the wedge The target is calculated by projecting the height of the pattern at its widest point from the breakout point The falling wedge is a bullish reversal pattern. Pattern Recognition Minimum PriceObjective

16. Head and Shoulders Pattern Recognition H S The Head and Shoulders pattern was first discovered in the 17th Century by Sokyu Honma and was called the Three Buddha pattern. As its name implies, the ‘Head and Shoulders’ formation consists of two ‘shoulders’ with a higher ‘head’ in the middle. Classically the Head and Shoulders pattern is a long term reversal pattern, however it does also work over a shorter time frame. S

17. Pattern Recognition Highs start to top out Broken Trend Line Lower High Return Move Broken Trend Line Minimum PriceObjective Prior Trend Required Possible Oscillator Divergence may occur

18. Head and Shoulders Top H S S Prior Trend in Place Divergence in Oscillator

19. Summary Continuation Patterns Reversal Patterns Pattern Recognition • Double Tops / Bottoms • Triple Tops / Bottoms • Wedges • Head & Shoulders • Triangles • Pennants • Flags

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