Price PatternsTechnical Analysis
Human trading psychology typically repeats itself across investment assets. As a result, price patterns typically also repeat as traders absorb economic, sentiment and fundamental news in the same way across thousands of assets. Patterns are the result of these psychological patterns repeating.
Patterns come in two general types. There are reversal patterns, which change the direction of a trend. The alternate is continuation patterns, which continue the direction of the trend after a short pause or consolidation.
All assets in those two types have two potential directions. The first is bullish, which means that price will exit the pattern by increasing. The second is bearish, which means that price will exit the pattern by decreasing.
Learning price patterns, which are combinations of bars or candlesticks, can greatly assist you in identifying likely future price action. Patterns combine random price action into a fairly reliable prediction, allowing you to anticipate potential trends. A forecast of future price action is hidden in the price action pattern. If you can identify most of the pattern, you can watch the pattern until completion. All patterns essentially break down into two categories: Reversal, and Continuation.
Both pattern’s names give highly obvious hints at their purpose. A continuation pattern resumes a trend after pausing for a set of price movements. A reversal pattern turns an existing trend in the opposite direction. Being able to accurately identify a pattern in formation and enter a trade trending in the same direction as fundamentals can greatly assist trading or investing.
It is highly important both types of patterns are confirmed with volume. When a pattern completes, a sharp increase in volume is usually noticeable. This confirms that other people following the pattern have seen the same thing and are now trading the completed price action. These traders and anyone late to the trade help move price action.
Simply knowing the pattern created is not enough. You must also know how to trade the pattern created.
Very important note: Price pattern reliability decreases with chart time frames. Patterns on time frames below the daily chart are more likely to fail or be used as bait by high level market participants to trap retail traders. This increases possibility of failure the lower duration time frames. Higher time frames are driven by economics and longer term market factors, and are more consistent in their results.
Reversal Price Patterns
Reversal price patterns occur before the major trend reverses. An existing trend will begin to weaken, losing momentum. The reversal pattern will consist of multiple attempts to continue in the prior trend direction. After making consistent effort, traders resign from pushing the trend in the existing direction. Price begins a new trend in the opposite direction.
Continuation Price Patterns
Continuation price patterns indicate a trend will “continue”. The trend takes a pause for a price formation before resuming the previous trend. This usually consists of sideways price action before the resumption, appearing like a small consolidation before again moving in the prior trend’s direction. These trends are substantially shorter than reversal patterns.
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