That's a
whole lot of chart patterns we just taught you right there. We're pretty tired
so it's time for us to take off and leave it to you from here...
Just
playin'! We ain't leaving you till you're ready!
In this
section, we'll discuss a bit more how to use these chart patterns to your
advantage.
It's not
enough to just know how the tools work, we've got to learn how to use them. And
with all these new weapons in your arsenal, we'd better get those profits fired
up!
Let's summarize the chart patterns we just learned and categorize
them according to the signals they give.
Reversal
Reversal
patterns are those chart formations that signal that the ongoing trend is about
to change course.
If a
reversal chart pattern forms during an uptrend, it hints that the trend will
reverse and that the price will head down soon. Conversely, if a reversal chart
pattern is seen during a downtrend, it suggests that the price will move up
later on.
In this lesson, we covered six chart patterns that give reversal
signals. Can you name all six of them?
1. Double
Top
2. Double
Bottom
3. Head and
Shoulders
4. Inverse
Head and Shoulders
5. Rising
Wedge
6. Falling
Wedge
If you
got all six right, brownie points for you!
To trade
these chart patterns, simply place an order beyond the neckline and in the
direction of the new trend. Then go for a target that's almost the same as the
height of the formation.
For
instance, if you see a double bottom, place a long order at the top of the
formation's neckline and go for a target that's just as high as the distance
from the bottoms to the neckline.
In the
interest of proper risk management, don't forget to place your stops! A
reasonable stop loss can be set around the middle of the chart formation.
For example,
you can measure the distance of the double bottoms from the neckline, divide
that by two, and use that as the size of your stop.
Continuation
Continuation
patterns are those chart formations that signal that the ongoing trend will
resume.
Usually,
these are also known as consolidation patterns because they show how buyers or
sellers take a quick break before moving further in the same direction as the
prior trend.
We've
covered several continuation patterns, namely the wedges, rectangles, and pennants.
Note that wedges can be considered either reversal or continuation patterns
depending on the trend on which they form.
To trade
these patterns, simply place an order above or below the formation (following
the direction of the ongoing trend, of course). Then go for a target that's at
least the size of the chart pattern for wedges and rectangles.
For
pennants, you can aim higher and target the height of the pennant's mast.
For
continuation patterns, stops are usually placed above or below the actual chart
formation.
For
example, when trading a bearish rectangle, place your stop a few pips above the
top or resistance of the rectangle.
Bilateral
Bilateral
chart patterns are a bit more tricky because these signal that the price can
move either way.
Huh, what
kind of a signal is that?!
This is
where triangle formations fall in. Remember when we discussed that the price
could break either to the topside or downside with triangles?
To play these patterns, you should consider both scenarios (upside or downside breakout) and place one order on top of the formation and another at the bottom of the formation.
If one
order gets triggered, you can cancel the other one. Either way, you'd be part
of the action.
Double
the possibilities, double the fun!
The only
problem is that you could catch a false break if you set your entry orders too
close to the top or bottom of the formation.
So be
careful and don't forget to place your stops too!
