Top and Bottom Patterns

Understanding Key Reversal Patterns

When you are trading Forex or binary options, you could conclude that price is moving in a sequence of waves and that each one exhibits a trough or bottom and a crest or top. You will also find that tops and bottoms are classified as key reversal formations indicating that a major change to a long term trend is imminent. A very popular trading strategy is to try to detect a top or bottom and subsequently trade to the next opposite one, i.e. enter at a top and exit at a bottom or execute a position at a bottom and close it at a top.

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Your aim if you utilize this approach will be to identify tops and bottoms as accurately as you can by using the following types of techniques. You can choose to use scientific tools, such as the W D Gunn, Elliot Wave or the Fibonacci retracements. These concepts are essentially based on the theory that price action constantly repeats itself. However, structuring your strategy on such models, just on their own, is not a wise practice and could produce indifferent results.

One of the primary explanations for this is that the financial markets are not predictive in nature and the optimum you should attempt to achieve is to ascertain the probabilities of its next move. This means that, should you merely try and predict the market’s next move, you are, in fact, stacking the odds against yourself and, as such, will almost certainly lose. In addition, a currency market, such as the Forex, advances in a way that prices cannot be predicted. As a consequence, scientific theories should be utilized with caution and, then, in conjunction with other proven trading resources.

Other investors structure their methodologies on the favorite trading maxim which states: “purchase low and sell high” but this concept is not so easy to implement as it sounds. In order to detect a bottom, you must search for a support level that price has rebounded against numerous times. Once achieved, you can then set an entry condition to buy. The flaw with this type of action is that you will be only guessing or even gambling that the support will hold next time. As you will not be placing the odds in your favor by performing such actions, the chances are that you could experience many failures by doing so.

Instead and in order to increase your chances of success, you should first confirm that the support holds. You need evidence verifying that this level is not breached and that price has generated enough momentum to propel itself into your preferred direction before you enter a new trade.

If you start to understand that trading the financial markets is about odds and not certainties, you can then begin to position your trades to achieve more wins than losses and as such will begin to enjoy more success. You will find that a number of methods have been designed to help you achieve these objectives.

One technique requires you to examine monthly and weekly charts searching for tops and bottoms. In particular, you must attempt to locate those against which the price has bounced a number of times. Once achieved, you must then link the troughs and peaks to generate support and resistance lines for those assets of interest. These lines offer good chances of entering new trades on rebounds especially if you can also identify evidence of momentum buildup in the reverse direction as well.

Another method you can use is to spot great levels for reversals is to locate psychological levels of currency pairs, such as 1.4000 for the EUR/USD. These numbers not only appear to have some type of effect on the psychology of investors but also provide outstanding prospects for new entry points. However, when attempting this procedure, you should always analyze historical data in order to confirm that these levels held a number of times previously. Once again, you must detect indications of price reversal which you can do by identifying entry points about 20 points back in the direction that you anticipate price to advance.

When seeking for levels, as just defined, always remember that although the price may break through them this time, that this action could be a fakeout and not a real breakout. To counter this issue, you are advised to safeguard your trades from fakeouts and create a potentially larger reward if a real breakout does materialize.

Identifying Top and Bottom Reversal Patterns

Here are a number of the most famous top and bottom reversal patterns which should help you detect them and as a result improve your trading results.

6.3.1 – Head and Shoulders Pattern

This renowned structure possesses three tops or peaks. The central peak or head is marginally higher than the two lower, although not balanced shoulders. The line joining the troughs of the two shoulders is termed the neckline which is rarely perfectly straight or horizontal. This formation is a powerful reversal indicator which is not formed until the neckline is pierced. A sound strategy that you can utilize in order to verify the strength of the reversal is to pause until two consecutive closes below the neckline have been registered on trading charts displaying the longer time-frames.

head and shoulders pattern

Some investors utilize the distance between the head top and neckline to determine price-targets for their positions. They accomplish this objective by determining the distance from the head to the neckline and the deploying the equivalent distance beneath their opening value.

6.3.2 – Double Top and Bottom Formations

Double tops, also termed “M” patterns, are created by an initially steep climb in price. The structure then proceeds to produce two peaks, separated by a dip, before finishing with a substantial price drop.

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Double bottoms are also known as “W” patterns and start with a serious plunge in price, followed by two troughs divided by a peak before completing with a significant climb in price. The key features of top and bottom formations are the following:

1. They are major reversal formations that normally identify the pending closure of the prevalent trend.

2. Tops are usually more precisely defined although shorter than bottoms.

3. They provide strong indications of a pending change in price direction.

6.3.3 – Triple Top and Bottom Structures

The former is created when price bounces against a level at least three times indicating a major resistance. Similarly, the latter is generated whenever price rebounds against a support three times and is indicative of serious purchasing interest.

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6.3.4 – V-Pattern

This formation is produced when price reverses very rapidly from one direction to another without prior warning.

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You will find that reversals offer some of the best prospects for executing new trades with outstanding profit potential as they normally indicate serious price changes. However, you will discover that true bottoms and tops can be quite difficult to detect.

As such, you are advised to pause until price verifies a reversal by fully creating one of the above proven and dependable structures. In conclusion, devising trading strategies enabling you to proficiently identify bottoms and tops can be a very lucrative activity and well worth your time achieving.

Adam

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Adam is an experienced financial trader who writes about Forex trading, binary options, technical analysis and more.

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