OKE FOREX: usd/jpy

Hi, I am happy to continue writing on my series of chart patterns. Last time we analyzed bullish and bearish pennants that are continuation patterns and today I want to expand on one specific reversal pattern. I covered head and shoulders pattern a few years ago and today I want to discuss its� twin: inverted head and shoulders pattern. It is often formed after a security has been in a prolonged downtrend. The pattern indicates that the downtrend is most probably over and we are going to see higher prices soon. It is a very powerful pattern as prices often start trending for a prolonged period of time when the pattern is eventually broken upwards.

The pattern consists of three lows: left shoulder, head and right shoulder. The structure is joined by a neckline that constitutes resistance.

How is inverted head and shoulders pattern formed?

Firstly, there has to be a downtrend in order for the pattern to be formed. After a prolonged collapse prices start to go (sort of) parabolic and at some point suddenly shoot up. At this point (usually) the left shoulder and the point for a neckline are formed. Then the previous downtrend resumes and prices go below previous low (the left shoulder). Then the security rises again, but fails to go beyond previous resistance. It falls back again, but this time lower low is not achieved. At this point the right shoulder is usually formed. All the other attempts to go lower fail and the security starts going upwards bit by bit till it reaches the highs of previous rally after the left shoulder was formed. It my bounce off the level or break it (the neckline). When a break upwards occurs new uptrend usually starts. If the break does not occur and prices go below the right shoulder the pattern is distorted and you may justly call it a failure.

False breakouts

False breakouts are a repetitive thing in financial markets and prices often come back to the range. However, you should have specific entry rules and you either you risk and jump on the trade or you stand aside and continue waiting when the breakout occurs. In the latter situation you will be sure that it was the true head and shoulders pattern after the move up have gone so far that it is no longer useful for you to join it. So, you go long after the neckline (resistance) is broken.

Various time frames

If you read classical technical analysis you will be told that these type of patterns last from six months to a few years. However, you can find both �head and shoulders� and �inverted head and shoulders� patterns on various time frames. These patterns might be formed on hourly charts and the patterns can stretch a few days� or a few weeks. And you can successfully trade both long and short term patterns. At least my experience confirms the fact.

How to trade the pattern

The best way to trade the pattern is to buy the break of the necklace. The chart above shows you how you could enter the market with long orders. The necklace (or resistance) was at 80.67 point. That�s the place to enter your first package of orders (if you are a serious trend trader). The ideal place for a stop loss order was below the low of the breakout day. In our case it was 80.12 level. So, you could place your stop at 80.07 (five pips below the lowest point of the day). How could you have exited the market? There are plenty of ways to do that. Much depends on the size of your position, number of orders and the state of the market. I like moving my stop as the market makes new highs by placing the stops below clusters of daily candles. These spots are marked with blue rectangles on the chart above. Finally, market stops going upwards and starts going sideways. This is one of the signs that the tendency is about to end. Eventually, your stop loss is hit and you are out of the market with nice profits. What a nice way to trade the pattern!

Ok, I will finish now. Be sure to read related articles to learn more on technical analysis. I promise to expand on this in my future posts.

I hope you benefited from the post. If you liked the post I would also be happy if you gave a plus on Google+, tweeted, liked it on Facebook and other social platforms. Have a nice day.

Vytas.

Analyzing chart patterns: pennants

Analyzing technical patterns: flags

Wedge technical pattern

How to do technical chart analysis

Six key elements of technical analysis

Triangle patterns

Head and shoulders pattern

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Disclaimer

Trading financial markets carries a high level of risk, and may not be suitable for all investors. All information on the blog http://trend0.blogspot.com/ is of educational nature and cannot be considered as advice, recommendation or signals to trade in any financial markets.

I want to start a series of articles on various technical chart patterns. I do believe that if you learn them and start applying in your trading you will significantly increase your chances of making stable money in financial markets. I have recently finished one series on different market conditions: calm trend, calm range, volatile trend and volatile range and I would suggest that you read those very carefully at least once. You should find a lot of useful practical tips in each article. Now, this article will cover a pretty power technical pattern: wedge. I like trading this one as we usually have a very powerful breakout out of the pattern and prices move very strongly and fast when a wedge is broken. So, let us analyze what this pattern is and how you can successfully trade it.

What is a wedge? It is a technical pattern with a narrowing range within two converging trendlines (that slant in upward or downward direction (depending on the type of a pattern: upward or downward)) and that usually indicates an end of a trend that can be traced in the pattern itself. It means that if you have a falling wedge (prices are going down) the breakout will most probably be upwards. Price moves between the two trendlines and the narrowing range builds pressure for an upcoming breakout. If you have a rising wedge (prices are going down) the breakout will most probably be upwards. Well, maybe the explanation was kind of difficult, but when you see the examples you will clearly understand what the pattern is like.

Falling wedge

Falling wedge is recognized as a bullish technical chart pattern. You can clearly see converging trendlines in the pattern that has a downward direction. The range is narrowing towards the end of the pattern and most often than not prices break upwards starting a new trend or continuing a previous one.

The example above in usd/jpy pair clearly shows us a nice falling wedge pattern. As the price was moving down and the range of the wedge narrowing increasing pressure and finally causing the pattern to be broken upwards with an explosive move. The pair moved around 600 pips when the upper trendline of the wedge was broken. That is precisely what you are looking for. You expect the upper trendline to be broken in a wedge. If it is not, the pattern is finally distorted and loses its� validity.

How to trade a falling wedge?

You need to place a buy stop order above the closest point where the price hit the upper trendline and then retraced. If it failed to reach the lowest low (of the pattern) you place the stop loss a few pips below the retracement (from the upper trendline). In the example above you can see that the point for entry in usd/jpy was 93.68 level (a few pips above that) since that was the place where the price hit upper trendline and retraced. The price however failed to reach previous low and started rising again. The lowest point of retracement marked a level where we need to place our stop loss order. In our case that would be 92.71 level (a few pips below that). Open your chart to find out yourself entry and stop levels for the trade. You either exit your trades by moving stop loss as the price moves in the direction of the trend till the stop is hit or you exit your trade at a predefined level. In the latter case you still need to move your stop in order to protect your profits.

Rising wedge

Falling wedge is recognized as a bearish technical chart pattern. You can clearly see converging trendlines in the pattern that has an upward direction. The range is narrowing towards the end of the pattern and most often than not prices break downwards starting a new trend or continuing a previous one.

The example above in eur/usd pair shows an excellent rising wedge pattern. As the price was moving up and the range of the wedge narrowing increasing pressure and finally causing the pattern to be broken downwards with an explosive move. The pair moved around 900 pips (with minor retracements) when the lower trendline of the wedge was broken. That is precisely what you are looking for. You expect the lower trendline to be broken in a wedge. If it is not, the pattern is finally distorted and loses its� validity.

How to trade a rising wedge?

You need to place a sell stop order below the closest point where the price hit the lower trendline and then retraced. If it failed to reach the highest high (of the pattern) you place the stop loss a few pips above the retracement (from the lower trendline). In the example above you can see that the point for entry in eur/usd was 1.3203 level (a few pips below that) since that was the place where the price hit lower trendline and retraced. The price however failed to reach previous high and started falling again. The highest point of retracement marked a level where we need to place our stop loss order. In our case that would be 1.3243 level (a few pips above that). Again, you either exit your trades by moving stop loss as the price moves in the direction of the trend till the stop is hit or you exit your trade at a predefined level. In the latter case you still need to move your stop in order to protect your profits. As you may see your stop loss was only 45 pips and the potential profit very big (900 pips). So, when you see a wedge forming next time get ready to take a trade.

Time frames

Some say that the pattern has to be three or six months in length and I could not agree less. You will notice those patterns on various time frames. If it is a continuation pattern and a wedge is formed in a counter trend move you would usually see it on hourly chart and that may last a few days. And then you have a nice breakout in the direction of the prevailing trend. On a longer term chart (lasting months and weeks) the pattern will probably signal a reversal and a change of trend.