Technical Analysis 1.4

1.4. Trend Reversal Patterns

Independent of which time unit is applied, price movement charts form different kinds of
periodically repeating equal patterns. Some of those patterns always occur on charts before the
trend reversal when the volume is significantly decreasing or increasing. Such formations known as reversal patterns are considered below.

Head-And-Shoulders. The head-and-shoulders pattern is one of the most reliable and well known chart formations. It consists of three consecutive rallies (See Figure 4.13). The first and third rallies—the shoulders—have about the same height, and the middle one—the head—are the highest. All three rallies are based on the same support line (or on the resistance line in the case of the reversed head-and-shoulders formation), known as the neckline. A real example of the headand- shoulders pattern is shown on the Figure 4.14.
Prior to point A, the neckline was a resistance line. Once the resistance line was broken, it turned into a significant support line. The price bounced off it twice, at point’s  and C.

The neckline was eventually broken in point D, under heavy volume, and the trend reversal was confirmed. As the significant support line was broken, a retrenchment could be expected to retest the neckline (E), now a resistance line again. If the resistance line held, the price was expected to eventually decline to around level F, which was the price target of the head-and-shoulders formation. The target was approximately equal in amplitude to the distance between the top of the head and the neckline. The price target was measured from point D, where the neckline was broken (line DF on Figure 4.13).

Signals generated by the head-and-shoulders pattern. The head-and-shoulders formation provides excellent information:
1. The support line. This is based on point’s  and C.
2. The resistance line. After giving in at point D, the market may retest the neckline at
point E.
3. The price direction. If the neckline holds the buying pressure at point E, then the
formation provides information regarding the price direction: diametrically opposed to
the direction of the head-and-shoulders (bearish).
4. The price target. This is provided by the confirmation of the formation (by breaking
through the neckline under heavy trading volume).
One of the main requirements of the successful development of this formation is that the breakout through the neckline occurs under heavy market volume. A breakout on light volume is a strong warning that it is a false breakout and will trigger a sharp backlash in the currency price. The time frame for this chart formation's evolution is anywhere from several weeks to several months. The intraday chart formations are not reliable.

Inverted Head-And-Shoulders. The inverted head-and-shoulders formation is a mirror image of the previous pattern. (See a diagram on Figure 4.15 and a real example on Figure 4.16).
Therefore, you can apply the same characteristics, potential problems, signals, and trader's point of view from the preceding presentation. The underlying currency broke out of the downtrend ranged by the xx'-yy' channel. The currency retested the previous resistance line (the rally number 3), now turned into a support line. Among the three consecutive rallies, the shoulders (1 and 3) have approximately the same height, and the head is the lowest. Prior to point A, the neckline was a support line. Once this line was broken, it turned into a significant resistance line. The price bounced off the neckline twice, at point’s  and C. The neckline was eventually broken at point D, under heavy volume. As the significant resistance line was broken, a retrenchment could be expected to retest the neckline (E), now a support line again. If it held, the price was expected to eventually rise to around level F, which is the price target of the head-and-shoulders formation.
The price objective is approximately equal in amplitude to the distance between the top of the
head and the neckline, and is measured from the breakout point, D.

Double Top. Another very reliable and common trend reversal chart formation is the double top.
As the name clearly and succinctly describes, this pattern consists of two tops (peaks) of
approximately equal heights (See Figures 4.17 and 4.18). As it is shown on the Figure 4.17, a
parallel line is drawn against a resistance line that connects the two tops. We should think of this
line as identical to the head-and-shoulders' neckline. As a resistance line, it is broken at point A. It turns into a strong support for price level at C, but eventually fails at point E. The support line

turns into a strong resistance line, which holds the market backlash at point F. The price objective is at level G, which is the average height of the double top formation, measured from point E.

Signals provided by the double top formation. The double top formation provides information
on:

1. The support line, set between points A and E.
2. The resistance line, set between points  and D.
3. The price direction. If the neckline holds the buying pressure at point F, then the
formation provides information regarding the price direction: diametrically opposed to
the direction of the peaks (bearish).
4. The price target, provided by the confirmation of the formation (by breaking through
the neckline under heavy trading volume.) Exactly as in the case of the head-andshoulders
pattern, a vital requirement for the successful completion of the double-top
formation is that the breakout through the neckline occurs under heavy market volume. A
breakout on light volume is a strong case for a false breakout, which would trigger a
sharp backlash in the currency price. The time frame for this chart formation's evolution
is anywhere from several weeks to several months. The intraday chart formations are less
reliable. There is a strong correlation between the length of time to develop the pattern
and the significance of the formation. The target is unlikely to be reached in a very short
time frame. There is no direct suggestion regarding the length of target reaching time; but
foreign exchange common sense links it to the duration of development. It is important to
measure the target from the point where the neckline was broken. Avoid the trap of
measuring the target price from the middle of the formation under the neckline. This may
happen as you measure the average height of the formation.

Double Bottom. The double bottom formation is a mirror image of the previous pattern (see
Figures 4.19 and 4.20). Therefore, one may apply the same characteristics, potential
problems, signals, and trader's point of view from the preceding presentation. As it is shown
on Figure 4.19, the bottoms have about the same amplitude. A parallel line (the neckline) is
drawn against the line connecting the two bottoms (B and D.) As a support line, it is broken
at point A. It turns into a strong resistance for price level at C, but eventually fails at point E.
The resistance line turns into a strong support line, which holds the market backlash at point
F. The price objective is at level G, which is the average height of the bottoms, measured
from point E.

Triple Top. The triple top is a hybrid of the head-and-shoulders and double-top trend reversal
formations (see Figures 4.21 and 4.22). Consequently, they have the same characteristics,
potential problems, signals, and trader's point of view as the double top or double bottom,
respectively. As shown in Figure 4.21, in a typical triple-top formation, the tops have about the
same height. A parallel line (the neckline) is drawn against the line connecting the three tops (B,
D, and F). As a resistance line, the neckline is broken at point A. It turns into a strong support for price levels at Ñ and E, but eventually fails at point G. The support line turns into a strong
resistance line, which holds the market backlash at point H. The price objective is at level I,
which is the average height of the three tops formation, as measured from point D. As a double
top, the formation fails at point E. The price moves up steeply toward point F. The resistance line is holding once more and the price drops sharply again toward point G. At this level, the market pressure is able to penetrate the support line. After a possible retest of the neckline, the prices drop further, to eventually reach the price objective.

Triple Bottom. Triple Bottom is a hybrid of the double top and inverted head-and-shoulders
Patterns (see Figures 4.23 and 4.24). As shown in Figure 4.23, in a triple-bottom formation, the
bottoms have about the same amplitude. A parallel line (the neckline) is drawn against the line
connecting the three bottoms (B, D, and F). As a support line, the neckline is broken at point A. It turns into a strong resistance for price levels at Ñ and E, but eventually fails at point G. The
resistance line turns into a strong support line, which holds the market backlash at point H. The
price objective is at level I, which is the average length of the triple-bottom formation, as
measured from point D.

The head-and-shoulders, the double top and bottom and the triple top and bottom, due to their
significance in trend reversals, are generally known as major reversal patterns.

Rounded Top, Rounded Bottom, Saucer, Inverted Saucer. Rounded Top (see Figure 4.25),
Rounded Bottom (see Figure 4.26), Saucer (see Figure 4.27) and Inverted Saucer (see Figure
4.28) patterns form as a result of a slow and gradual change in the direction of the market. These patterns reflect the indecision of the market at the end of a trend. The trading activity is slow. It is impossible to know when the formation is indeed completed, and not for a lack of trying. Though is known that the longer it takes to complete patterns, the higher is the likelihood of a sharp price move in the new direction.

Technical Analysis 1.3

1.3. Lines of trends, support and resistance

The trendline is a main initial element for the price chart analysis. While the market moves in
any direction not along a straight line but along a zigzag, the mutual placement of upper and
bottom points of those zigzags permits you to plot a line connecting the significant highs (peaks)
or the significant lows (troughs) of an appropriate zigzag using technical tools of the computer
program (See Figures 4.1 – 4.3). To draw a trendline only two points are necessary and the third one is the contact point confirmation. On a bullish trend chart it should be drawn using troughs, on a bearish trend chart – using peaks. The trendline and a line which is about parallel to it and drawn on the opposite side (through peaks on a dullish trend and through troughs on a bearish) form the trade channel. Both lines are then channel’s borders. Examples of trade channels are shown on Figures 4.9, 4.10.

Lines of support and resistance. The upper and the bottom borders of trade channels are called
accordingly support and resistance lines. The peaks represent the price levels at which the selling pressure exceeds the buying pressure. They are known as resistance levels. The troughs, on the other hand, represent the levels at which the selling pressure succumbs to the buying pressure. They are called support levels. In an uptrend, the consecutive support and resistance levels must exceed each other respectively. The reverse is true in a downtrend. Although minor exceptions are acceptable, these failures should be considered as warning signals for trend changing.

The significance of trends is a function of time and volume. The longer the prices bounce off the
support and resistance levels, the more significant the trend becomes. Trading volume is also very important, especially at the critical support and resistance levels. When the currency bounces off these levels under heavy volume, the significance of the trend increases. The importance of support and resistance levels goes beyond their original functions. If these levels are convincingly penetrated, they tend to turn into just the opposite. A firm support level, once it is penetrated on heavy volume, will likely turn into a strong resistance level (see Figure 4.11). Conversely, a strong resistance turns into a firm support after being penetrated (see Figure 4.12). In general, to evaluate the reliability (that is the possibility of a break) of the trade channel borders taking a decision to close or to save an existing position one should govern himself with following rules :

1. A channel is the more reliable the longer it exists. Hence, the "solidity" of very old
channels (e.g. existing more than 1 year) decreased sharply.
2. A channel is the more reliable the more is his width ("It takes time to break channel").
3. The resistance may be broken if it is bounced on the background of a growing volume
("It takes volume to break resistance").
4. A steep channel is less reliable in compare to a gentle one.
5. The support may be broken independent on the volume ("under own weight").

Technical Analysis#1.2

1.2. Charts for the technical analysis

Kinds of prices and time units. Charts for technical analysis are being constructed in coordinates, "price (the vertical axis) – time (the horizontal axis)". The following kinds of currency prices
represented on charts are being distinguished on Forex:

• open – a price at the beginning of a trade period (year, month, day, week, hour,
minute or a certain amount of one from these units);
• close - a price at the end of a trade period;
• high – the highest from prices observed during a trade period;
• low – the lowest from prices observed during a trade period.

Providing the technical analysis one uses charts for different time units – from 1 year or moreuntil 1 minute. For instance, the computer program Trading Intl. uses allows you to analyze pricemovement charts for 1 day, 4 hours, 30 minutes, 15 minutes, 5 minutes and 1 minute. The longerthe time unit applied to plotting the chart, the longer the time span used to analyze pricemovements and to determine the major trend by means of the chart. For short trading, charts forsmaller time units are more suitable.

Line chart. The line chart is plotted connecting single prices for a selected time period. The most popular line chart is the daily chart. Although any point in the day can be plotted, most traders focus on the closing price, which they perceive as the most important (see Figure 4.6). But an immediate problem with the daily line chart is the fact that it is impossible to see the price activity for the balance of the period as well as gaps (See chapter 4.6) – breakups in prices at joints of trade periods. Nevertheless, line charts are easier to visualize. Also, technical analysis goes well beyond chart formation; in order to execute certain models and techniques, line charts are better suited than any of the other charts.

Bar chart. The bar chart consists from separate histograms (See figure 4.7). To plot a histogram in coordinates price – time the points responding to high, low, open and close prices for a time period analyzed should be marked on the one vertical bar. The opening price usually is marked with a little horizontal line to the left of the bar; and the closing price is marked with a little horizontal line to the right of the bar. Bar charts have the obvious advantage of displaying the currency range for the period selected. An advantage of this chart is that, unlike line charts, the bar chart is able to plot price gaps. Hence, it is impossible to see on a bar chart absolutely all price movements during the period.

Candlestick chart. The candlestick chart is closely related to the bar chart. It also consists of four major prices: high, low, open, and close (See Figure 4.8). In addition to the common readings, the candlestick chart has a set of particular interpretations. The latter is possible thanks to the convenient visual observation of that chart.

The opening and closing prices form the body (jittai) of the candlestick. To indicate that the
opening was lower than the closing, the body of the bar is left blank. Current standard electronic
displays allow you to keep it blank or select a color of your choice. If the currency closes below
its opening, the body is filled. In its original form, the body was colored black, but the electronic
displays allow you to keep it filled or to select a color of your choice. The intraday (or weekly)
direction on a candlestick chart can be traced by means of two "shadows": the upper shadow
(uwakage) and the lower shadow (shitakage). Just as with a bar chart, the candlestick chart is
unable to trace every price movement during a period's activity.

Technical analysis#1.1

The destination and fundamentals of technical analysis

Technical analysis is used for the prediction of market movements (that is alterations in
currencies prices, volumes and open interests) outgoing from the information obtained for the
past. The main instruments of technical analysis are different kinds of charts, which represent
currencies price change during a certain time preceding exchange deals, as well as technical
indicators. The latter are obtained as a result of the mathematical processing of averaging and
other characteristics of price movements. The instruments of technical analysis are universal and applicable to any Forex sector, any currency and any time span.

Technical analysis is easy to compute what is important while the technical services are becoming increasingly sophisticated and reasonably priced. They are available to all Forex participants independent of their trade plans, strategies applied and the time of position continuance.

Dow Theory

The fundamental principles of technical analysis are based on the Dow Theory with the following main thesis:

1. The price is a comprehensive reflection of all the market forces. At any given time, all
market information and forces are reflected in the currency prices ("The market knows
everything").

2. Price movements are trend followers ("Trend is your friend"); trends are classified as
up trends (bullish), downtrends (bearish) and flat (sideways). Examples of mentioned
trends are given on Figures 4.1 – 4.3.

3. Price movements are historically repetitive ("The history repeats") which results in the
same patterns periodically emerging on the charts.

4. The market has three trends: the longest (about 1 year) major, or primary, less
enduring (1 month and more) intermediate, or secondary, and rather short (several days
or weeks) minor. The primary trend has three phases: accumulation, run-up/run-down,
and distribution. In this way, in the accumulation phase of a bullish market the shrewdest
traders enter new positions. In the run-up/run-down phase, the majority of the market
finally "sees" the move and jumps on the bandwagon. Finally, in the distribution phase,
the keenest traders take their profits and close their positions while the general trading
interest slows down in an overshooting market. The secondary trend is a correction to the
primary trend and may retrace one-third, one-half or two-thirds from the primary trend.
In frame of a major trend may be any amount of secondary or minor trends. The structure
of a bullish trend is shown on Figure 4.5.

5. Trends exist until they are broken (See Figures 4.2, 4.3) and their reversals are
confirmed. Figure 4.4 shows examples of reversals in a bearish currency market. The
buying signals occur at points A and В when the currency exceeds the previous highs.
All training material found in this manual and provided by Trading Intl. L.L.C. are held proprietary to Trading Intl.

6. Volume must confirm the trend. Volume consists of the total amount of currency traded
within a period of time, usually one day. Large trading volume suggests that there is
interest and liquidity in a certain market and low volume warns the trader to close
positions. Open interest is the total exposure, or outstanding position, in a certain
instrument. Volume and open interest figures are available from different sources,
although one day late such as the newswires (Bridge Information Systems, Reuters,
Bloomberg), newspapers (the Wall Street Journal, the Journal of Commerce), weekly
printed charts ( Commodity Perspective, Commodity Trend Service).

Percentage measures of price reversals. The price of a foreign currency even on the strongest
trends is never moving constantly up or down. Traders watch possible reversals (a change in the
movement direction) at certain points of charts. There are three following typical points of a
possible reversal that can be marked on a chart in percents against the preceded movements
(percentage retrenchments):

1. Along Charles Dow a reversal up traditionally is occurring after the price has passed
down 1/3 (33%), ½ (50%) or 2/3 (66%) of the latest rise up. The reversal after 66% is
considered as a trend correction.
2. Using Fibonacci constants (See Chapter 5) one may wait for a reversal up at the
downtrend points at 0.382 (38%), 0.5 (50%) and 0.618 (62%) of the latest rise up.
3. Along Gann one has to wait for a reversal up after each 1/8 of the latest rise up on the
path down.