Forex Trading With Price Action - Raoul Hunter1
Forex Trading With Price Action - Raoul Hunter1
Forex Trading With Price Action - Raoul Hunter1
This is dedicated to my long suffering family who have had to put up with me getting up
at all hours of the night to do my trading; something they have done with minimal
complaint.
Copy right © 2013 Raoul Hunter All rights reserved.
Disclaimer
Trading is Speculative and Risky:
Trading in Foreign currency is highly speculative. It is only suitable for those users
financially able to assume losses significantly in excess of margin. It is not an
appropriate investment for retirement funds.
Past Results Performance Disclosure:
Past results are not necessarily indicative of future results and cannot be guaranteed to
perform as such.
General Risk Disclaimer:
All Trading involves risk.
Leveraged trading has large potential rewards but also large potential risk. Be aware
and accept this risk before trading.
Never trade with money you cannot afford to lose.
All statistics are derived from historical performance and are not a guarantee of future
results.
No account may achieve profits or losses similar to those discussed. There is no
guarantee that even with the best advice available you will become a successful trader.
Contents
DISCLAIMER
CONTENTS
CHAPTER 1 - OVERVIEW
PRICE ACTION TRADING
WHAT IS PRICE ACTION
SUMMARY
CHAPTER 2 - PRICE ACTION
HISTORY
TRADING PRICE ACTION
LEARNING PRICE ACTION
VOLUME
CHAPTER 3 - WESTERN CANDLESTICK PATTERNS CANDLESTICK MAKEUP
PINBAR MAKEUP
OUTSIDE BAR MAKEUP
INSIDE BAR MAKEUP
CHAPTER 4 - CANDLESTICK PATTERNS
HISTORY
CANDLESTICKS IN TRADING
CANDLESTICK PATTERNS
WHAT A CANDLESTICK WON’T TELL YOU
MERGING CANDLESTICKS
CHAPTER 5 - TRADING PRICE ACTION
PURE PRICE ACTION
HEAD AND SHOULDERS
DOUBLE TOP
TRIPLE TOP
GARTLEY PATTERN
BUTTERFLY
BAT FORMATION
CUP AND HANDLE
BEARISH DIAMOND
CANDLESTICK PATTERNS
AUTOMATED PATTERN IDENTIFICATION
CHAPTER 6 - TABLE OF CAPTIONS FIGURES
CHARTS
ABOUT THE AUTHOR
Chapter 1 - Overview
There are two basic types of analysis in used in Forex today. The first is Fundamental
Analysis where a trader would use economic figures, financial data and world events
on which to base their trading decisions. This technique focuses on the news and related
international events and their effect on the market.
The second, Technical Analysis, is where traders focus on chart data to assist in their
market analysis. For example, they will utilise indicators of many techniques, Support
and Resistance lines, Moving Averages, etc. to analyse the historical data.
This technique tends to ignore the fundamental factors of a currency pair and primarily
analyses the currency’s price history. It endeavors to predict the future direction from
the historic data.
As you would expect, between Fundamental and Technical Analysis, hundreds, if not
thousands of trading strategies have evolved; some strategies even use a hybrid
combination of Technical and Fundamental data.
Price Action trading is considered part of Technical Analysis but without the use of
additional tools or indicators. What differentiates it from most forms of technical
analysis is that its main focus is the relation of a currency's current price to its past price
as opposed to any values derived from that price history.
Price Action as a Technical Analysis approach to trading is gaining in popularity.
Strategies based on this are becoming increasingly popular in the market today because
they are easy to use and setup, they work as well and produce excellent results.
This popularity is based on three major factor. It is simple, quick to learn and
understand. Anyone can get to grips with Price Action without intensive studying.
The second reason is that generally Price Action requires no indicators! There is no
requirement to understand and interpret the results of various indicators. The side
benefit of this is that you have incredibly clean charts
– they are basically blank without an indicator’s interpretation lines or diagrams. This
naturally makes it a lot quicker to analyse and locate potential orders. To be honest I
think that a successful trader should still use Support and Resistance lines to further
confirm a price movement – but in my defence, this is still not an indicator.
Chart 1 - An Indicator Laden chart
The third reason is that this naturally overcomes a key issue with indicators
– namely that they lag – they tend to only make their prediction or forecast long after the
price has made its move. Using Price Action, you get to make your decision as soon as
the price makes its move.
These Price Action trading strategies form as a result of price movement in markets
tending to be repetitive due to the fact that humans are ultimately behind the price
movement. Also, because human emotions are relatively predictable when it comes to
matters of money; their actions in the market often result in Price Action formations that
repeat periodically. These can be very accurate predictive tools of future price
direction.
Price Action strategies can be traded in any financial market and on any timeframe. It is
advisable though, to focus on trading higher timeframes.
Summary
Price Action is a simple but professional way to approach Forex trading; many traders
believe that it is probably the most consistently profitable method that a trader can use
in the markets today.
There is a strong belief that most Technical Analysis strategies in use are tailored to the
market conditions at the time - whether intentionally or not. However, when the market
conditions change these systems tend to lose their effectiveness. The markets are
dynamic in nature meaning they are constantly changing and require dynamic strategies
to be completely successful.
Conversely, Price Action will adapt with any changing market condition; the price will
always reflect the status of the market.
There is an adage amongst traders who firmly believe in Price Action trading; “The
Price is the one thing that never lies”.
Chapter 2 - Price Action
History
Martin Pring is credited with being the first trader to notice the PinBar pattern on charts.
Interestingly, the term ‘pin bar’ is short for Martin’s original term for the bar formation –
which he called the Pinocchio bar. This was based on the fact that Pinocchio, a wooden
doll brought to life by his creator, would have his nose grow larger every time he told a
lie. This analogy tied in perfectly with Martin’s observations because a pin bar is
broken down into two moves. The first move is when price moves from the first
position to the second. This often attracts eager breakout traders who enter the market
based on this initial price momentum – thereby causing a strong price action, either up
or down.
The second part of the move happens when this original movement does not replicate
the market’s true intentions and is basically telling a lie. The price then springs back
from the second position to its original position – leaving a long candle wick in its trail.
This imitates the story of Pinocchio’s nose; the bar grows a big nose as the ‘lie’ is
ultimately revealed by the price on the chart.
When Martin Pring identified the PinBar most traders were using bar charts – today the
more popular graphical representation is the Candlestick chart. Traders find this more
popular because it is easier to read and tends to reveal better market information. The
use of candlestick charts makes the PinBar pattern much more noticeable.
The best way to trade the Price Action is to behave like a specialist surgeon and not a
general butcher. You will need to wait for the best price action indication rather than
trade anything that you think could be a possible opportunity. You need to consider it as
a game of patience; a game where you wait for the perfect condition to reveal itself and
then trade only that action. By doing this, you will definitely find a positive correlation
between your account value and amount of patience exercised. Just as it requires effort
to be successful in anything, you have to take time to learn how to recognise and use this
strategy effectively.
Start with the higher timeframes. Higher timeframes naturally smooth out the price
action of the lower timeframes. This has the dual effect of limiting your trading exposure
while increasing your success ratio.
Practice, practice, practice. You need to be able to instantly recognise a pattern and the
action it has on the market. To do this successfully you need to practice. Avoid a lot of
trial and error by having a skilled trader mentor you on this concept.
Understanding, and hopefully mastering Price Action trading will certainly make you a
better and more successful Forex Trader. This holds true even if you only add this
technique to improve or confirm the indications of an existing strategy. It doesn’t matter
what trading strategy or system you are currently using, nor end up using, the ability to
recognize high-probability price action patterns and setups will make that strategy much
more effective.
Remember that irrespective of your trading strategy you will always have to deal with
price movement as you trade the market, either consciously or sub-consciously. It makes
sense that if you really want to become a profitable trader you simply have to
understand price dynamics and how it ebbs and flows and interacts with various levels
in the market.
Volume
I don’t think that many traders believe that Volume plays a part in Price Action trading
but I assure you that it does.
Volume is simply the number of contracts traded over a period of time. As even the most
reliable of patterns or formations will fail sometimes, you should consider volume as
another tool in determining what is happening within the market and more specifically
within the pattern.
The general belief is that volume should increase in the direction of the price. If the
trend is moving up, the volume should be heavier on the up periods and lighter on the
down periods. Conversely, if the trend is down, volume should be heavier on the down
periods and lower on the up periods. This has to be true because in an uptrend there
should be more buyers than sellers while in a downtrend there should be more sellers
than buyers.
When volume starts to diminish it could be a warning that the trend may be losing
momentum and that a consolidation or a reversal could be coming up. If the trend was
up and you start to see more volume on dips rather than on rallies; it is possibly a
warning that the buyers are weakening and that the sellers are becoming more
aggressive. The reverse would be true in a downtrend. Another point to consider is that
when volume moves in the opposite direction of the price, it is divergence – an
extremely powerful signal in Forex Trading.
One of the reasons why volume tends to reduce during periods of indecision is for that
very reason. During periods of consolidation or sideways movement, traders will often
tend to avoid the market, waiting to re-enter once a definite breakout appears.
While it is typical for volume to diminish during times of consolidation, it is a clue to
possible future direction by measuring the level of conviction of the buyers and the
sellers. During sideways movement, seeing if there is heavier volume on the up periods
or on the down periods could be useful in getting positioned or confirming the formation
of a pattern. The idea is that if there is more volume on the up periods than the down
periods, the buyers are probably more aggressive and the market will more than likely
breakout upwards. The reverse is true if the volume is heavier on the down periods; the
market is much more likely to breakout to the downside.
Chapter 3 - Western Candlestick Patterns
These are candlestick patterns that have originated from the Western world – as
opposed to the Far East, Japan, who are credited with original candlestick discovery.
You will find that there is a degree of similarity between these and the Japanese
patterns, probably due to the fact that the Japanese Candlestick patterns were
discovered many years before these, and as such are extremely comprehensive in their
coverage. From this it is reasonable to assume that there should be some degree of
overlap.
Candlestick Makeup
Before discussing Candlestick patterns we should look at the make-up of Candlesticks
themselves.
Figure 1 -
Candlestick Makeup
The wicks or shadows also give market related information. Candlesticks with a long
upper wick and short lower wick indicate that the buyers were more dominant during
that period and pushed the prices higher. However, the sellers later forced prices back
down from these highs creating a long upper wick.
Conversely, Candlesticks with a long lower wick and a short upper wick indicate that
the sellers initially dominated during the period and forced the prices lower. Later,
towards the end of the session, the buyers rallied, bidding the prices back up creating a
long lower wick.
It is this type of information that you are able to gather from Candlesticks making them
the charting choice amongst traders.
PinBar Makeup
The diagram shows the basic makeup of a PinBar. They should always have a long wick
on one side and either no wick or a very short wick on the opposite side. The bodies
should also be rather short – the Open and Close points close together.
Figure 2 - Basic PinBar Makeup
They are labelled Bullish and Bearish respectively as usually an empty body refers to a
Bullish candle while a filled body refers to a Bearish one. These patterns generally
indicate price reversals and consequently the Bullish PinBar actually indicates a
Bearish price reversal and vice versa. The first pattern in the diagram is a Bearish
Reversal and the second a Bullish Reversal. From this you will realise that patterns are
generally named for their action rather than their makeup.
The diagram below shows the full PinBar makeup. Here you can see what some traders
refer to as the eyes of the pattern – the eyes of Pinocchio. The pattern shows a Bearish
Reversal where the Left Eye is the Bullish trend that has been running; the Nose is the
actual PinBar where the reversal takes place and the Right Eye is the start of the Bearish
trend. This is then the start of a Bearish reversal – the running Bullish trend is now
reversing to the start of a new Bearish trend.
The lie that Pinocchio told is that some traders believed that the initial Bullish run on
the nose candle would endure but it reversed leaving a long nose – Pinocchio’s lying
nose. Hence, the price lied about its intended direction.
The ideal makeup of this pattern has the following characteristics;
The wick must be at least three times the length of the candle body
Ideally the wick should also be of similar size as the previous candle. The bigger the
wick the better – in fact, the smaller the body and the longer the wick the better
The closing price must be located within the length of the preceding candle – there
should be no gaps between Closing Opening and prices
Body must be on the very end of one side of the wick; there should not be a wick on the
opposite end of the body. If there is it should be very short
From the chart above you can see the PinBar indicating the Bearish reversal. This
PinBar example meets all the requirements for a classic reversal signal.
The best point of entry would be to wait for the open of the next candle before placing
your order. As further confirmation try and see if there is a Support or Resistance line -
in this example a Resistance line - close to the PinBar. This approach will further re-
enforce the reversal pattern.
An Outside bar is larger than the bar preceding it and totally overlaps it in Japanese
Candlestick terms, it is known as an Engulfing bar. Its high is higher than the previous
high and its low is lower than the previous low.
An outside bar's interpretation is based on the concept that market participants were
undecided or inactive on the previous bar. Subsequently, during the development of the
Outside bar they demonstrated new enthusiasm, and as shown in these two examples,
created a new Bearish run.
Also importantly, you need to consider the full pattern in which the Outside bar occurs;
in both cases the Outside bar was a strong Bearish bar indicating strong continued
downtrends.
Chart 4 - Outside Bar
An Outside bar is therefore a continuation pattern – where trading will continue in the
direction of the Outside candle. In the above chart, traders would be looking to go short
upon the close of the Outside Vertical Bar; this is in anticipation of reaping the renewed
momentum.
Naturally, the Bullish Outside bar is the reverse of the Bearish Outside bar described
above.
the high to low range of the previous bar. In this pattern the high is lower than the
previous bar's high, and the low is higher than the previous bar's low. Where it actually
sits inside the previous bar is irrelevant. It can be towards the top or bottom of the
previous bar; its actual position makes no difference to its interpretation.
Figure 5 - Inside Bar Makeup
It is also acceptable to have the two lows at the same level; the Inside bar
must just not exceed the boundaries of the previous candle. However, if both the highs
and the lows are the same, it becomes more difficult to recognise it as an Inside Bar.
The Japanese also have a similar pattern called a Harami – which means pregnant in
Japanese. This because it looks like a pregnant mother when viewed from the side; the
first bar being the mother with the Inside Bar giving the appearance of being the baby.
A slight negative about this pattern is that it generally reflects a period of indecision or
consolidation as Inside Bars generally appear when the market consolidates after
making a large directional move. Perhaps more importantly, they can also appear at
turning points in the market – often at a key decision level such as at major Support or
Resistance level.
Inside Bars are considered to act as both continuation and reversal signals. When using
this pattern as a signal to enter the market, and because of this indecision, rather wait for
the price which would be the third bar of the pattern to move past level of the first bar -
the one prior to the Inside Bar
- the mother.
Chart 5 - Inside Bar
From the example chart above, you can see the Inside Bar appearing after
a period of consolidation. Place your order through a Pending order or manually, after
the candle after the Inside Bar breaks the level of the mother candle. This is indicated
by the Entry label on the example chart. By waiting for the candle after the Inside Bar
(the baby) to break the level of the mother, you remove all the indecision of whether the
pattern is signaling a continuation or a reversal.
Generally, you would place your Stop Losses just above or below the mother bar; the
bar before the Inside Bar. You would have to adjust your Stop Losses if the mother bar
is exceptionally long - you would need to do this so as to bring your risk/reward ratio
back to an acceptable value.
Chapter 4 - Candlestick Patterns
History
Candlesticks in Trading
Candlestick Patterns
Please note that all the Candlesticks represented here use the default MT4 colour set;
this is where a white candle indicates a downward moving or Bearish candle. A black
candle is the opposite; this shows a Bullish or upward moving candle. It is however
possible to change these colours to anything that you like so it is important to realise that
whenever you look at Candlestick Patterns it is most important that you understand what
represents Bullish candles and what indicates Bearish ones. I have also used as many of
the more Western names as I could; hopefully making them easier to memorise.
Remember that when reading other Candlestick literature, both the name and the colours
of the pattern could be different; there is unfortunately no fixed standard addressing
either of these issues.
Spinning Tops
Doji
The word Doji refers to both the singular and plural forms of this pattern.
The body of a Doji must be as small as possible; ideally, but not necessarily, the open
and close should be equal.
Doji reflects an indecision between buyers and sellers. Prices move above and below
the opening level during the session but close at or near the opening level. Neither the
bulls nor the bears were able to gain control during
Figure 8 - Doji
the session and a turning point could be developing.
Steven Nison states that Doji formed among other Candlesticks with small real bodies
should not be considered too important. However, Doji that form among Candlesticks
with long real bodies are deemed significant.
Doji Combinations
Hammer
A Hammer is Bullish Reversal Candlestick pattern made up of just one candle. With a
little imagination the candle looks like a hammer as it has a long lower wick and a short
body at the top of the Candlestick and with little or no upper wick. Do not get this
confused with the Doji.
In order for a candle to be a valid hammer, the lower wick must be at least twice as
long as the length of the body.
When you see the Hammer form in a downtrend
Figure 10 - Hammer
it is a sign of a potential reversal. The long lower wick represents a period where the
sellers were initially in control but the buyers were able to reverse that control and
drive prices back up to close near the high for the period, thus the short body at the top
of the candle.
Hanging Man
The Hanging Man candlestick pattern is a Bearish sign. This pattern occurs mainly at the
top of uptrends and is a warning of a potential downward reversal. It is important to
emphasize that the Hanging Man pattern is a warning of potential price change and is not
in itself a signal to go short.
The Hanging Man formation, just like the Hammer, is created when the open, high, and
close are roughly around the same price. Also,
Figure 11 - Hanging Man
there is a long lower shadow which should be at least twice the length of its body.
After a long uptrend the formation of a Hanging Man is Bearish because prices hesitated
by dropping significantly during the period of the candle.
Star Patterns
These are patterns where there is a Doji above or below a longer bodied candle; these
are three candle patterns. The Evening Star is a pattern where a Bullish long bodied
candle is followed by a Doji and then another long bodied Bearish candle. The third
candle must close at least halfway down the first candle body. This indicates a Bearish
reversal.
The Morning Star is the opposite – it comprises a Bearish long bodied candle followed
by a Doji, and then a Bullish candle that closes at least half
There is another commonly recognised Star pattern – the Shooting Star. This is a two
candle pattern which generally appears in an uptrend. It opens higher, trades even higher
and then closes near its open. One of its traits is that the second candle should have a
long wick and short body and is Bearish. Lower trading in the next candle reinforces a
pullback.
Figure 13 - Shooting Star
Harami
This is a two Candlestick pattern. Harami means pregnant in Japanese and, to a degree,
this pattern reflects a woman’s pregnant body as the second candle is embedded in the
body of the first; a pregnant mother viewed from the side.
The first Candlestick usually has a large real body, either bullish or bearish, and the
second candle’s body is smaller than the first. The shadows - both high and low - of the
second Candlestick do not have to be contained within the first, though it is preferable.
The second candle may also be a Doji.
Figure 14 - Harami
A pattern criterion is that the second candle must be completely engulfed by the body of
the first candle. The second candle direction can be opposite to the first but is not
mandatory. Haramis indicate a possible reversal to the opposite direction of the first
candle.
Engulfing
This is a reversal pattern that can be either bullish or bearish depending upon whether it
is after an uptrend or downtrend. The pattern comprises the second last candle having a
small body, followed by the last candle whose body completely engulfs the previous
candle’s body. If the pattern follows a downtrend it indicates a potential bullish reversal
– after an uptrend it indicates a bearish reversal.
Figure 15 - Bullish Engulfing
Tweezers
This pattern comprises of two candles; a Bullish candle in the first period and a Bearish
candle in the second. In the Bearish pattern, the longish Bullish candles closes on the
high and has a relatively short Low wick.
The next candle is a Bearish candle must open at the same high/close of the first candle.
There must be no upper wick and the close must be reasonably close to the low.
This pattern comprises of five candles – a long Bearish body followed by three small
bodies – in this example, Bullish
- and a long Bearish body on the outside. The three small Bullish candles
Figure 17 - Bearish 3-Method
must be contained within the range of first Bearish long body. This is considered as a
Bearish continuation pattern with the price continuing in a Bearish direction.
There is a similar pattern, Bullish 3-Methods which is the exact opposite of this pattern
– this pattern would suggest that the price would continue in a Bullish direction.
3 White Soldiers
Consists of three long Bearish Candlesticks with consecutively lower closes. In this
pattern the closing prices need to be near to or very close to their lows. The closing
wicks need to be short, if they exist at all.
When it appears at the top of a trend it is considered as a Bearish reversal signal.
There is the opposite pattern to this; 3 Black Crows which would comprise of 3 Bullish
candles, which when at the bottom of a Bearish trend signals a potential reversal.
This is a three candle Bearish pattern that happens only in an uptrend. The first candle
has a long Bullish body followed by a gap to the next open; this candle has a small
Bearish body and remains gapped above the first candle. The third candle is also a
Bearish candle whose body is larger than the candle before it and must engulf it.
The close of the last candle must be above the close of the first long Bullish candle.
Figure 19 - Upside Gap Two Crows
Piercing Line
This pattern starts with a long Bullish candle followed by another Bullish candle and
most importantly, one that has opened with a gap above the first one.
The third candle is a Bearish candle which must open within the body of the second
candle. It must partially close the gap between the first two candles but most
importantly, must not completely close the gap.
This is a Bullish continuation pattern indicating that the Bullish trend will continue.
Stick Sandwich
For example, with a long Bullish candlestick the assumption is that prices advanced for
most of the session. Based on the high and low sequence, the session could have been a
lot more volatile. The example above depicts two possible high and low sequences that
could form the same resultant Candlestick.
The first sequence shows two small moves and one larger move: a small reversal off
the open to form the low followed by a sharp retracement to form the high and finally, a
small decline to form the close. The second sequence shows three rather sharp moves: a
sharp advance off the open to form the high, a sharp decline to form the low and finally,
another sharp advance to form the close.
The first sequence portrays strong, sustained buying pressure and would be considered
more Bullish. The second sequence reflects more volatility with some increased selling
pressure. These are only two examples and there is a multitude of potential
combinations that could result in the creation of the same basic Candlestick.
Candlesticks still offer valuable information on the relative positions of the open, high,
low and close. Just remember that the trading activity that finally formed a particular
Candlestick can vary dramatically.
Merging Candlesticks
There is an interesting phenomenon with Candlestick patterns; those patterns that are
made up of one or more Candlesticks can usually be merged together to form a single
Candlestick. This resultant Candlestick should always capture the principals of the
original pattern.
Generally, you can achieve this by using the following components – those in a two
Candlestick pattern:
The open of first Candlestick
The close of the second Candlestick
The high and low of the pattern
In this example, use the close of the first Candlestick to create the open of the resulting
candle. Use the open of second Candlestick to create the new open.
Finally, use the high and low of the pattern to create the new high and low of the single
candle. From the two candles, which represent a Bullish Engulfing Pattern you can
merge them into a single Hammer pattern. The long lower shadow of the Hammer
signals a potential Bullish reversal and just as with the Hammer, the Bullish Engulfing
Pattern requires Bullish confirmation.
Chapter 5 - Trading Price Action
The following strategies utilise Price Action. Although they do not use any indicators
they often use some form of Support and Resistance lines.
Pure Price Action
Without considering Candlestick patterns, the principle behind using Price Action to
gauge future market direction is relatively simple. One strategy will do this is;
Wait for at least three candles all in the same direction – more than 3 is even better
A candle in the opposite direction negates the count – you would need to start the count
again
In an Uptrend, wait for a candle to close below the Low of the previous candle, then
enter with a Sell
In a Downtrend, wait for a candle to close above the high of the previous candle, then
enter with a Buy
In the example, you can see the first Sell opportunity which is highlighted by the first
circle. There were four distinct Bullish candles and then the momentum stopped –
coincidentally on a Doji pattern, which helps to confirm the reversal. The next candle
closed below the low of the Doji, which is the trigger to place the Sell order. The result
was a sustained and profitable Bearish run.
The next circle shows a profitable Buy opportunity. Notice the swing high between the
first and second circles – this did not meet the criteria for a sell opportunity as there
were not three consecutive Bullish candles. There were two Long candles, a Short and
another two Long candles. The next swing high also did not meet all the criteria.
The next two circles show where the candles met the requirements for placing an order
– and as shown in this example, both were successful. The trigger highlighted by the
third circle was also confirmed by a Doji pattern.
Chart 6 - Price Action strategy
Take Profit Points
Using this strategy your take Profit position – your exit strategy – is also rather simple.
Conservatively, you can wait for three consecutive candles in your direction and then
close the order
A mandatory close would be a trigger in the opposite direction – where there is a
reversal and the next candle closes either above the previous high or below the
previous low
This is a chart formation rather than a Candlestick pattern. The formation can range over
many candles with the total number varying from formation to formation.
The Head and Shoulders formation consists of a Left Shoulder, a Head and a Right
Shoulder. You would then add a line below the two Shoulders as the Neckline.
Figure 25 -
Head and Shoulders Top
down generally with lower volume. The prices then rally upward to form the Head, but
now with greater volume. There is then a second retracement back down with less
volume.
The Right Shoulder is formed when prices rally but remain below the Head. They
should then retrace and fall down to at least below the peak of the Left Shoulder.
A neckline is drawn across the bottoms of
Figure 26 -
Head and Shoulders Bottom
the left shoulder, the head and the right shoulder. When the price breaks through this
neckline and keeps on falling after forming the right shoulder, it is confirmation of the
completion of the Head and Shoulders Top formation.
The Neckline is important as it forms a Support or Resistance line for the two
Shoulders. The formation is incomplete until the neckline has formed.
You get both a Top Head and Shoulders and a Bottom Head and Shoulders pattern – the
Bottom is the reverse of the Top formation – as shown in the two diagrams above.
Chart 7 - Head and Shoulders
Trading the Head and Shoulders Formation
Double Top
This is another formation rather than a pattern. You can even think of it as a Head and
Shoulders but without the Head – only the two Shoulders.
It appears as two consecutive peaks of approximately the same price – they can form a
Resistance line but this is not mandatory. The two peaks are separated by a trough
between them. The price level of this trough is
Figure 27 -
Double Top
the Neck Line of the formation. The formation is completed and confirmed when the
price falls below the neck line indicating that further price decline is highly probable.
The double top pattern shows that demand is outpacing supply – the buyers are
dominating - up to the first top. This will cause the price to rise. The supply-demand
balance then reverses; supply outpaces demand
– the sellers now dominate - causing the price to fall. After a price valley, the buyers
again begin to dominate again and the prices rise.
This formation is generally regarded as a Bearish signal if prices drop below the neck
line after the second Top. The formation is often found at the end of a Bullish trend.
Figure 28 -
Double Bottom
As a word of caution, the valley between the two Tops should be reasonably well
formed. If they are too close – if the valley is too small it could be that it is simply a
minor reversal in the basic upward trend and not the actual valley. In this case, the
Double Tops formation would not be created.
As expected, there is the opposite formation; Double Bottoms, which is the reverse of
the Double Tops.
Chart 8 - Double Top
Trading the Double Top Formation
Trading this formation is similar to trading the Head and Shoulders formation.
You would wait for confirmation of a break down through the neckline after the second
Top was formed. This would be your signal for a Sell entry - when the formation is a
Double Top. Alternatively, you would enter a Buy for a Double Bottom.
Just as with the Head and Shoulder formation, your exit points, - your Take Profits – are
vaguely defined. You would have to wait for a reversal Candlestick pattern to appear or
exit just above a Support or Resistance line.
You would place your Stop Loss just above the high of the second Top for a Double Top
formation. They would be just below the second Bottom for a Double Bottom formation.
Triple Top
As expected, this formation is almost identical to the Double Top formation with the
exception that it has an additional high and low in its makeup, making three high Tops.
Figure 29 - Triple Top
The fundamentals that drive the Triple Top formation are the same as those for the
Double Top except that there is one more renewed attempt by the Buyers to enter the
market. If this action did not take place and the Sellers rallied, you would have had a
perfect Double Top with the price continuing down. It is this last attempt by the Buyers
that creates the third Top.
The formation is only complete when the price drops below the Neck Line
– which is also the entry for a Sell opportunity.
Figure 30 - Triple Bottom
Just as with its counterpart there is also a Triple Bottom which is the reverse of the
Triple Top.
Trading this formation is identical to trading the Double Top or Bottom formation.
You would wait for confirmation of a breakdown through the neckline after the third Top
was formed. This would be your signal for a Sell entry
- if the formation was a Triple Top. Alternatively, you would enter a Buy for a Triple
Bottom.
Just as with the majority of these formations, your exit points, - your Take Profits – are
less well defined. You would have to wait for a reversal Candlestick pattern to appear,
or exit just above a Support or Resistance line.
You would place your Stop Loss just above the high of the third Top for the Triple Top
formation. They would be just below the third Bottom for a Triple Bottom formation.
Gartley Pattern
This is an interesting pattern that was first introduced in 1935 by trader H.M. Gartley in
his book, Profits in the Stock Market. There are some very definitive rules regarding
this formation but it will suffice to say that you would look for a lopsided “M” or a
lopsided Double Top.
I find this to be a rather accurate formation - it doesn’t appear too often, but when it
does, I follow its prediction. Also, to be completely truthful, I have an indicator which
easily identifies this pattern and draws the pattern on the chart and I use this indicator on
all my charts. If you are interested, it is freely downloadable off the internet.
A few points to consider;
For this pattern to be valid, each of the points - X, A, B, C and D - should represent a
significant high or significant low on a price chart. These points define four consecutive
price swings or trends which make up each of the four pattern lines.
Some rules to try and consider;
The following points comprise the make-up of all of H.M. Gartley’s patterns.
Point X is the start of the trend – either up or down Point A is the end of the initial
trend
Point B is the first pullback of the trend
Point C is the reversal after the pullback; generally, not breaking
point A
Point D is the last of the markets reversal momentum
Trading the Gartley pattern Trading this formation is similar to trading the other
formations.
You would wait for confirmation of a breakout through the CD Resistance line once the
full pattern was formed. This would be your signal for a Buy entry if the pattern was a
Bullish Gartley. The reverse of this holds for a Bearish Gartley.
Just as with the other formations, your exit points, - your Take Profit and Stop Losses –
are less well defined. You would have to wait for a reversal Candlestick pattern to
appear or exit just above a Support or Resistance line.
You would place your Stop Loss below the low of the CD leg of the formation.
Butterfly
There is quite an assortment of harmonic patterns, although there are four that seem most
popular. These are the Gartley, Butterfly, Bat and Crab patterns.
This is another pattern from H. M. Gartley and was originally published by him in his
book Profits in the Stock Market. What is interesting though, is that the Fibonacci levels
were only later added by Scott Carney in his book The Harmonic Trader.
Figure 32 - Bullish
Butterfly
This formation is very similar to the Gartley except for one major difference. In the
Gartley, point D is above point X; in this pattern it is important that point D is well
below point X.
There is another technical difference; a Butterfly pattern completes at the convergence
of two separate Fibonacci extension levels, whereas the Gartley completes at the
convergence of a Fibonacci retracement and extension.
Lastly, the pattern is basically formed by connecting two triangles at point B.
Aside from those three points there is a lot of similarity between the two formations.
Chart 11 - Bullish Butterfly
Some points to consider about the Butterfly;
Just as with other formations, you have the reciprocal Butterfly as well; the Bearish
Butterfly which is simply the opposite of the above. The triangles
– the wings – would be pointing down.
Trading this formation is almost identical to how you would trade the Gartley formation.
Wait for confirmation of a breakout through the CD Resistance line once the full pattern
was formed. This would signal a Buy entry if the pattern was a Bullish Butterfly. The
reverse of this hold for a Bearish Butterfly Just as with the other formations your exit
points - your Take Profit and Stop Losses – are not well defined. To exit, you would
have to wait for a reversal Candlestick pattern to appear or alternatively, exit just inside
a Support or Resistance line.
You would place your Stop Loss below the low of the CD leg of the formation.
Bat formation
This is another formation identified by H.M. Gartley which is similar to the others but
with some technical variations.
The Bat pattern is close to the Butterfly in appearance but not in its technical makeup.
Point B has a smaller retracement of XA of 0.382 or 0.50 – but less than 0.618. The
extension of the BC wave into D is at minimum 1.618 and potentially 2.618. Therefore,
D will be a 0.886 retracement of the original XA wave.
Also, you will find that point D is higher than point X; whereas with the Butterfly it is
lower.
Figure 33 - Bullish
Bat
When the selling has stopped and the buyers enter the market, you would place a long
position and take advantage of the Bullish reversal on the breakout of the CD Resistance
line – this for a Bullish Bat. The opposite is true for a Bearish Bat.
The makeup is similar to the Butterfly in that the formation comprises of two triangles –
pointing up for a Bullish formation and pointing down for a Bearish one.
Chart 12 - Bullish Bat
You would wait for confirmation of a breakout through the CD Resistance line once the
full pattern was formed. This would be your signal for a Buy entry if the pattern was a
Bullish Bat - the opposite is true for a Bearish Bat.
Just as with most of these formations, your exit points - your Take Profit and Stop
Losses – are less well defined. You would have to wait for a reversal Candlestick
pattern to appear or exit just inside a Support or Resistance line.
You would place your Stop Loss below the low of the CD leg of the formation.
This is another formation pattern and not a Candlestick pattern. As you would expect, it
is made up of many candles over a long period. In reality, it is often much more erratic
than the diagram below. Although the
formation can range of many candles, its basic form should remain
the same.
The example chart above highlights many of the Cup and Handle requirements. Most
notable is the consolidation phase at the bottom of the cup. Also, in this example, the
handle is neatly bounded by a channel.
You would wait for confirmation of a breakout through the Resistance line at the top of
the Handle. This would be your signal for a Buy entry. Just as with the other formations,
your exit points - the Take Profits – are not well defined. You would have to wait for a
reversal Candlestick pattern to appear or exit just inside another Support or Resistance
line.
You would place your Stop Loss just below the Support line of the Handle at the point
of the breakout
Bearish Diamond
This is probably one of the more difficult patterns to recognise – or at least I think so.
To try and help you to identify it I would suggest that you look for a lopsided or off-
centre Head and Shoulders pattern. One of the shoulders should be a lot lower, or
higher, than the other. The Head must still be the prominent swing high.
Figure 35 -
Bearish Diamond
Once you have identified these points you need to draw a diamond - a square on its side
– covering these three points. Also, you will notice there is no neckline in this pattern –
the diamond takes its place.
To draw the Diamond, which acts as the Support and Resistance lines, you should start
from the left Shoulder to the Head and then from the Head to the right shoulder. These
two Resistance lines will form the top of the formation and importantly, the price should
not break above the upper Resistance line formed by the right Shoulder. If the price was
to break the Resistance line the pattern would fail and you would need to redraw it – the
price would effectively have created a new right Shoulder. You would finally draw the
two Support lines creating a Diamond which Support the lower troughs of the Shoulder.
These two lines should now connect the bottom half to the top and complete the pattern.
Chart 14 - Bearish Diamond
The example chart shows most of the Bearish Diamond features. The offcenter Head and
Shoulders is easily visible with the left Shoulder being lower than the right.
In this example, the Head is only just the highest swing high, but it is higher than both the
Shoulders.
Perhaps the only component that may add some confusion is that there is almost a
second right Shoulder. When the Support and Resistance lines of the Diamond are added
all the components fall into place and it is more recognisable.
The breakout below the right Shoulder Support line is clearly visible and resulted in an
extremely profitable Bearish price action.
Trading this formation is similar to trading any of the previous formations; you would be
looking for a break of the lower Right Shoulder Support line. You will then want to
place your entry shortly below this level to capture the subsequent decline in the price.
As with most formations your exit points, both Stop Losses and Take Profits, are less
well-defined.
Candlestick Patterns
This strategy shows you how you can utilise Candlestick patterns in conjunction with
Support and Resistance lines.
From the example chart, you can see the first Bearish Outside bar which indicates a
reversal of the trend. At this point you would not know that this swing high was to
become a line of Resistance.
On confirmation of the new downtrend, you would then draw the Resistance line along
the swing high. This would then become a future Resistance line for all other high
points.
At the swing low after this, you can see an outside bar indicating a new Bullish
reversal. This reversal is not highlighted on the example chart.
This Bullish trend continued back to the Resistance line and at that level there is a
Bearish Inside bar pattern indicating a reversal and the start of another new Bearish
trend.
This downward trend then reversed at a Bullish Inside bar pattern where it reversed all
the way back to the Resistance line.
At the third hit on the Resistance line another Bearish Inside bar appeared indicating a
third Short opportunity.
Your exit points would either be just inside a Support or Resistance line or at an
opposite signal from another Candlestick pattern.
I am aware that it goes against the principle of not using indicators when trading on
price action however I think that this is justifiable as we are not using an indicator to
predict market direction but rather only to highlight a pattern or formation.
You can find indicators to identify Gartley’s formations and others to highlight
Candlestick patterns.
Chart 16 - A
highlighted Gartley formation
Of course the negative of using this type of indicator is that they tend to clutter your
screen – you would need to make the decision whether to manually identify the patterns
or to use some assistance.
On the positive side – the identification of the patterns is extremely accurate and
produces excellent trading results. Also, when using an indicator, you are less likely to
miss any formations irrespective of how hidden they are in the chart.
However, ultimately the choice is yours whether to use this type of indicator or not.
Chapter 6 - Table of Captions
Figures
Charts
Chart 1 - An Indicator Laden chart Chart 2 - A Typical Price Action chart Chart 3 -
Bearish Reversal PinBar
Chart 4 - Outside Bar
Chart 5 - Inside Bar
Chart 6 - Price Action strategy
Chart 7 - Head and Shoulders
Chart 8 - Double Top
Chart 9 - Triple Top
Chart 10 - Bullish Gartley
Chart 11 - Bullish Butterfly
Chart 12 - Bullish Bat
Chart 13 - Cup and Handle
Chart 14 - Bearish Diamond
Chart 15 - Candlestick Patterns
Chart 16 - A highlighted Gartley formation
About the Author
Raoul Hunter has been an IT professional for over 40 years. He started trading Forex
over 10 years ago initially with moderate success. Having persevered with his trading
he has achieved a high degree of success in the last few years.
His technical IT background has been extremely valuable in his Forex endeavours
as he has developed a number of Indicators, Scripts and Expert Advisors for the MT4
platform.
Although this book explains some of the basics around Support and Resistance lines its
primary focus is using these levels in day-today trading strategies. The strategies
discussed here are tried and tested and produce some good results.
He has also published;