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trading patterns

Chart patterns constitute a vital significance in day trading. A variety of chart patterns, including candlestick charts, generate signals which help in cutting through the market price “noise” by clarifying trend and strength. The patterns which result in being fundamental for a profit making day trading technique are considered the best, be it trading stocks, trading cryptocurrencies or dealing in currency pairs.

Due to a vast diversity of factors affecting the market, there are hundreds of trading opportunities available and you have to make a choice every day. Trading patterns allow you to work out several options like setting up stop-loss triggers, short-covering, hedging etc and stimulate emotions like fear of loss or hope of gain.

Candlestick patterns can prove to be helpful as they provide a clear vision of the market by predicting upcoming price movements. Although it is said that technical analysis of the patterns is required to be successful in day trading, it is also critical to note that using the patterns for your profit is not science but more of an art.

This article will not only focus on the theory and powers of chart patterns but will also teach you the methods in which you can gain from the most used trading patterns in breakouts as well as reversals. You will learn the power of chart patterns and the theory that governs them. Ultimately you will have to figure out which day trading patterns suit your trading style and techniques best.

Using Patterns in Day Trading

Trading patterns, if used accurately, can be a very valuable addition to your skillset. There is a saying “History always repeats itself” and this saying applies to financial markets as well. Fortunately, this repetition can prove helpful in identifying potential opportunities and predicting unsuspected ups and downs in the market.

Factors like RSI, Plus Support, Volume, and Resistance Level help in technical analysis when trading, whereas Stock Chart Patterns help identify breakouts and trend reversals. As highlighted in “Stock Patterns for Day Trading”, by Barry Rudd, knowing how to read these patterns helps make smarter trades and thus greater profits.

Definition of Breakout and Reversal

  1. Breakout – When the market price crosses a certain defined level on the charts, be it a fibonacci retracement level, resistance line or a trend line, it is said to breakout .
  2. Reversal – Any change in the direction of a price trend, positive or negative, is known as a reversal. A reversal is also referred to as a correction, a rally or a trend reversal.

In the following parts of this article you will see how breakouts and reversals work in a number of chart patterns.

Candlestick Patterns

Candlestick chart patterns are useful technical tools that help combine data within a given interval of time into a single bar. Being relatively straightforward to interpret, these patterns can help you have a competitive edge over your competitors in the market.


Candlestick Chart patterns were first used by Japanese Rice Traders in the 18th Century and became popular in the West when Steve Nison introduced them through his book “Japanese Candlestick Charting Techniques” in 1991.

Shooting Star Candlestick

Whenever you open a document about candlestick day trading patterns, most of the times, the shooting star candlestick will be the first to come across. The picture below shows a bearish reversal candlestick which is suggesting a peak. It is an exact opposite of a hammer candlestick pattern. It will only emerge after at least three consistent green candles show an upward trend in the demand and price of a particular share. More often than not, traders are not able to keep their cool and jump on the surging prices before realizing they overpaid.

In this candlestick pattern, the size of the upper shadow is generally twice that of the body. This means that where some traders have sold their shares and made profits, some buyers have just started trading. These buyers who pushed the price high are then trapped by the short-sellers which drive the price of the share down to the close of the candlestick. This is the point which induces panic as these late comers promptly sell their shares.

The word “Doji” signifies indecision. Regarded among the most popular candlestick patterns for forex trading, Doji trading is a form of reversal patterns which can be either bearish or bullish depending upon the preceding candlesticks. Doji candlestick patterns usually have the same or nearly same open and closing price with long shadows. These candles may sometimes look like a cross but have relatively small bodies. Also, the preceding candles often indicate as to which way reversal will head.

If you discover that the previous candles are bullish, you can expect that the succeeding candle near the bottom of the body low will generate a short/sell signal upon breaking of the Doji lows. You can then see that the trail stops just above the Doji highs.

Similarly, if the preceding candles are bearish, the Doji will form a bullish reversal and long triggers will form above the candlestick high with trail stops underneath Doji lows.

These candlestick patterns can then be used for intraday trading with stocks, forex, crypto and other assets. However, using these candlestick patterns to make interpretation requires experience. Hence, it is advisable that you practice on a demo account before you actually go on to trade real money.

Hammer Candlestick

Hammer candlesticks are bullish reversal candlesticks that can be used to establish capitulation bottoms. These candlesticks are then followed by a price bump which allows traders to enter a long position.

They form at the end of a downtrend and suggest a near-term price bottom. The tail is generated by a new low in the downtrend pattern which closes back near the open. It must be a minimum of twice the size of the actual body. When a tail gets generated,  the short-sellers start to cover up their positions, and bargainers decide to feast.

To ascertain it is a hammer candlestick, you can check the point where the next candle closes. If the succeeding candle closes above the previous candlestick low you can be sure it is a hammer candlestick. Trading using Japanese Candlestick patterns has become quite popular due to the easy to glean and detailed information they provide. This is another reason why they are ideal for charts for beginners to get familiar with.

Morning Consolidation Pattern

Many successful traders reason this pattern to be a significant contributor in success. Look out for four bars moving in the same direction. After a high/low is reached from number one, the stock will be consolidated in one to four bars. The high/ low will then be exceeded by 10:10a.m.

There are strong reasons that support the patterns’ popularity for an active trader. First, it can be easily identified. Second, it comes to life in a relatively short span of time so you can size things up. Also, the pattern either follows a strong gap or a number of bars will be moving in a single direction, meaning you have a high stock volatility- an essential component in turning intraday profits.

Late Consolidation Pattern

It becomes difficult to turn a profit as the day progresses so it won’t be surprising to know that perfecting this trading pattern is difficult. In late consolidation patterns, the stock keeps rising in the direction of the breakout.

It is important to look out for traders that enter after 1300 hrs and introduce a break in the already lengthy trend line. Check the trend line that started the same day and the day before as well. Finally, don’t forget to keep an eye on four consolidation bars preceding the breakout.

There are some advantages to using this pattern to make trading interpretations. The stock runs for the entire afternoon. Therefore, you can the time to sit back and watch how the market unfolds.

 

Stock Patterns

Stock market witnesses the most cutthroat competition amongst all the markets. This is just another reason for applying chart patterns if you want to succeed in day trading. By studying several intraday stock price trends, you will be better at anticipating how the stock price might behave in the future.

Using Price Action

A number of strategies which use price action trading patterns are suspected to be of no use to gain profits. This myth is clearly not true as price action patterns are easy to imply and very efficient. These qualities make them imperative for beginners as well as professional traders.

In layman terms, price action can be explained as the response of the price of a share towards certain levels of resistance or support. If applied correctly, price action patterns will help you in identifying price swings as well as trendlines.

The below mentioned strategies can be adopted while using price patterns. This is irrespective of the type of day trading you are engaged in.

Zone Strategy

There are various strategies which can be employed while day trading, one of which is the zone strategy. You can read articles explaining how to apply it. This strategy is free from complex indicators and measures. This system creates charts which are easily understandable and applicable. It has three zones which are explained below:

·      Dead Zone

The dead zone reveals that the price action is stationary which means there is no clear cut upward or downward trend. If you want huge gains, it is absolutely essential to avoid this zone completely. You will not be able to make a lot of pips here.

·      The Red Zone

The red zone is the place where things start to heat up. After entering this zone, the end goal is visible and huge profits come within you reach. For example, if the price of the share crosses into the red zone and continues to go up, you might want to purchase more shares. It is possible that you witness higher highs and it might become an upward trend. On the other hand if the price hits the red zone and keeps going down, you will want to sell your shares. You would witness lower lows and an indication that it is going to become a downward trend.

·      The End Zone

The end zone is the place where things really turn around. While employing this strategy, your main goal should be to get in the end zone from the red zone. After getting in this one, draw rectangles on the chart like portrayed in the image above and only trade in those rectangles. If you draw these rectangles more than 10-20 pips wide, there will be plenty of room for the price action’s general retracement before going up or down.

Outside Bar at Resistance or Support

In the given image, you shall witness a bullish outside bar if today’s share price low is lower than it was yesterday but then the share price recovers and closes higher than yesterday’s high. If the movement of the price had been the complete opposite from this, it would be a perfect bearish example.

However, just identifying an outside bar and placing a trade based on that is not enough. You have to cautious about a major break in trend after finding an outside day.

Spring at Support

The definition of spring is that when the share price reaches a new low, but then promptly bounces back into the trading zone and immediately starts a new trend. You can see an example in the image below. One common mistake traders make is waiting for the last swing low to be reached. It is crucial to not stress about a few pennies as trading setups do not always meet your exact expectations.

Little to No Price Retracement

Simply put, less retracement means a robust and continuous primary trend. Forget about brainstorming on the numerous Fibonacci retracement levels, important is to focus on keeping the retracement levels below 38.2%. This means that even if today’s asset takes the previous swing, you’ll have a greater chance that the breakout will continue to move in direction of the primary trend.

Trading with price patterns at hand allows you to work with any of the strategies. Find the one that works best with your trading style. The best trading chart patterns are simple and provide a clear picture using minimal indicators thus reducing the possibilities of mistakes.

Consider Time Frames

When trading with short price patterns it is important to consider the time frame in calculations. A number of time frames co-exist simultaneously in the market. This means that you’ll find a number of conflicting trends in the asset that you are trading. You stock can be in a primary downtrend while also being present in the short-term uptrend.

A majority of traders commit the mistake of focusing on a specific time frame and ignore the underlying primary trends. Longer the time frames, the reliable will be the signals. Therefore, beware of getting distracted by false moves and noise and prefer trading off 15 minute charts but also don’t forget to utilize the 60 minute and the 5 minute charts that define the primary trend and the short-term trends.

The final word

The 1932 work of Richard Schabacker in “Technical Analysis and Stock Market Profits” has contributed a lot to our understanding of chart patterns. As Schabacker asserts, “A general stock chart is a combination of countless different patterns and its accurate analysis depends upon constant study, experience, and knowledge of all the fine points, whether technical or fundamental”, remember, there is an abundance of patterns out there and to reap benefits out of them you need to be accurate on your analysis.

Dayanira Munoz

With experience in the finance industry exceeding 7 years, Dayanira’s impressive CV includes key positions at leading companies such as Merrill Lynch, Credit Suisse, and Morgan Stanley. She has held a wide range of key roles across research, sales, and trading, and has worked with both retail and institutional clients. Over her blossoming career, Dayanira has gained extensive exposure to equities, the Forex, and fixed income markets, putting her in a unique position. This varied and specialized experience allows her to provide expert insights, suggestions, and risk-management strategies for colleagues and clients. Previously, Dayanira graduated in Applied Finance at the University of Barcelona and is currently studying for her Master’s degree.

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