Five Trading Charts to Take You a Level Higher

Starting to use candlestick charts in your online trading is an exciting step because they tell a vivid visual story of recent market behaviour.

The value of turning lots of different data points into a digestible image with actionable conclusions should not be underestimated, as any experienced trader will tell you. Employing chart patterns to generate buy and sell signals is the next exciting step to take.

An important caveat to mention is the true nature of these signals, which is statistical probability based on historical market behaviour.

This means that the basis to rely upon them is not some scientific study of the markets that revealed the rules governing their movements.

Aeroplane manufacturers are fortunate enough to have just such ironclad rules – laws of nature – to work with, and they employ them with a high statistical degree of success in predicting the courses of planes through the atmosphere.

Not so in the world of technical analysis and chart patterns.

How, then, do chart patterns work? Let’s say you’re interested in finding out what mood your spouse is in this evening. Being far away from her, you can’t examine her facial expressions for answers on this.

Yet, if you see a message telling you she received a traffic fine this morning, you can already start to guess.

When the news comes in that she also got a flat tire on the freeway, and that her computer was stolen, your earlier conclusions begin to grow sturdier.

When you finally open the door to greet her, you may find you were totally wrong. In fact, her spirits are very high in spite of all the above because her boss gave her a promotion in the afternoon.

However, as we know, in most cases you probably would have been right. The reason is that most of the time, when subjected to these stimuli in the course of a single day, her mood would turn sour.

A similar sort of probability underlies the power of the standard chart patterns, though the level of that probability would differ depending on the pattern in question.

In this article, we’ll go through five chart patterns that beginners can use to elevate the quality of their engagement with the financial markets.

Ascending Triangle

This image shows you the general structure of price action when justifying the buy signal sent by an Ascending Triangle pattern. In reality, the two peaks formed at the upper limit of the triangle don’t have to be of identical heights but only similar ones.

The grey lines are there, not to ensure geometrical perfection, but to indicate the general trend guiding prices. What is that trend?

From the perspective of buyers, we see evidence of their strong conviction that this asset is undervalued since they are successively getting the better of the sellers, time after time.

This is clear from the two rising lows exhibited by prices, which prove the bulls are holding the bears back from sending prices lower.

On the other hand, the bulls are having trouble breaking through the upper resistance level because the bears take a stubborn stand at that point.

The result is that prices are getting squeezed into a tighter and tighter corner that eventually disappears into the apex of the triangle. Prices have to go somewhere, but where will that be? Statistics answer that the direction will likely be upwards.

In other words, history suggests that buyers take the lead in this scenario and shatter the upper resistance level, freeing prices to seek out a new ceiling.

When that happens, the grey, horizontal line will cease to enforce resistance and start to signify support.

It will become the new floor for prices, which have been liberated from their triangular prison. The time to open your buy deal is when prices break out above the upper trendline on higher trading volume.

Bullish Engulfing Pattern

When prices for your asset have been in a downturn and then produce a formation like the one above, you may have a Bullish Engulfing Pattern on your hands, which is reason to be happy. This is a powerful bullish reversal pattern that signifies prices might be about to embark on a long upwards trek.

It’s especially powerful when the body of candle number one is small, and candle number two is quite a lot bigger.

The short stature of candle one shows that the bears, who have been controlling price action up until now, are losing their self-belief. Candle number two – a surprisingly tall bullish candle – gives us an indication that there’s pent-up bullish energy waiting to be released.

Your Bullish Engulfing pattern gains credence when it comes after a particularly long downturn, or a very quick one. In these cases, the market could be overextended, which implies prices will snap back bullishly with more of a bite.

To gain confidence in your pattern, check whether candle two has a very small wick on top and, perhaps most importantly of all, that there’s high trading volume on the second candle. Open your buy deal when a third candle takes prices higher than the top of candle two.

Hanging Man

In this scenario, the bulls have clearly been holding the reins, but things are starting to turn around.

If your Hanging Man has a small head, with a long shadow underneath (at least twice the height of the candle), there’s reason to sit up and take notice because you may be sitting on a powerful reversal signal.

This means that prices are positioning for a sustained drop, albeit in the short term rather than the long.

What this formation means on a practical level is that, in the Hanging Man’s trading session, the bears made a surprise ambush on the bulls, successfully driving prices all the way to the bottom of that long shadow.

The bulls were down but not out, fighting back to bring prices close to where they opened for the day. Still, they’ve been spooked, and they doubt their ability to defend against another attack tomorrow.

Technical analysts’ research shows that, on a significant proportion of occasions like this, the bears are going to wrest control of the market and pull prices down over the coming sessions. Wait for confirmation from a red candle on the following day, and then open a sell deal near the end of that session.

Head and Shoulders

Here’s another reliable bearish reversal pattern that appears at the cusp of an uptrend. After making the peak at the left shoulder, prices decline to the level of the neckline, after which they shoot up to form a higher peak (the head).

Following this, they decline to the neckline again but soon go for another bull run to create the right shoulder.

Finally, they drop below the neckline. Your Head and Shoulders pattern need not be true to life in any way. The shoulders need not be of equal heights and the neckline, which connects the low points of the shoulders, doesn’t have to be exactly horizontal.

The time to open your short trade is when prices break below the neckline. In this case, the ensuing downtrend could continue into the long term, so prepare for the era of the bears.

Dragonfly Doji

Here we see that prices for a session opened, peaked, and closed at about the same point, which is quite a rare occurrence. The lower shadow, which constitutes our dragonfly’s body, drops much lower than this point, though, showing that the bears were putting all their energy into dragging prices lower.

Unfortunately for them, their best efforts proved in vain because the bulls drove prices all the way back up to where they started.

In the context of a downturn in prices, as depicted above, a Dragonfly Doji signals a bullish reversal of the prevailing trend.

The same pattern, when found at the top of a bull run, indicates the opposite: that prices will turn around and fall in sessions to come. When using this chart pattern, it’s crucial to wait for a confirming candle to form afterwards, increasing the likelihood that a reversal is indeed in the works.

Your pattern becomes more actionable when the candles to come show vigorous energy in the direction of the reversal, and if they are accompanied by high trading volume.

Wrapping Things Up

When employing these candlestick patterns, remember to take the larger price picture into account, rather than following the oracles blindly. Approach the markets like a detective: What sort of trading sentiment could explain this particular set of data?

If no answer is forthcoming, take a look at other indicators for a clue. For instance, a Dragonfly Doji is more trustworthy as a buy signal when appearing at the bottom of a short-term correction in a large uptrend. In this case, you’ll have the opportunity to trade in the direction of the major trend, rather than the minor one, which is often preferable.

It's important to ensure your trading platform allows you to make candlestick charts and plot technical indicators on top of them. When you trade with IFOREX Europe, you’ll enjoy the latest in charting technology and a sleek, intuitive platform that was built in-house in consultation with professional traders.

Visit the iFOREX Europe website to find out more.

iFOREX Europe is the trading name of iCFD Limited, licensed and regulated by the Cyprus Securities and Exchange Commission (CySEC) under license # 143/11. The materials contained on this document have been created in cooperation with iFOREX Europe and should not in any way be construed, either explicitly or implicitly, directly or indirectly, as investment advice, recommendation or suggestion of an investment strategy with respect to a financial instrument, in any manner whatsoever. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 73.2% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Please note: Calculations of past performance movements may represent the futures and not the underlying asset.