Charting your way to trading profits

REVERSAL
DOUBLE TOP

DOUBLE top and double bottom chart patterns are straightforward to spot and can be seen across a range of different time frames, both in long and short-term charts.

“Double tops are important to look out for, as are double bottoms,” says Ian O’Sullivan, head of sales for SpreadCo. “They confirm a resistance point that has been retested a second time and failed.”

This pattern should be seen as a set up for a possible trend reversal, and so traders should wait for the price to break below the neckline before entering the trade.

However, according to O’Sullivan, you need to look out for additional clues to base a trading decision on – did volume drop on the second run up? Was it a slightly lower high? Are the relative strength indicators (RSI), stochastic and moving average convergence-divergence (MACD) indicators turning lower, indicating weakness? Only then should you consider making the trade and selling short or closing a long.

CONTINUATION
HEAD AND SHOULDERS

“Head and shoulders patterns are one of those that a lot of people like to follow and trade,” says Ian O’Sullivan. He adds that the skeptics out there would say that it is just another self-fulfilling prophecy as traders jump on to a trade and help it get to target levels – but it is definitely a pattern you should be looking out for and watching as they form on a regular basis.

A head and shoulders formation can be a clear warning that momentum is fading from the market. The top of the head of the movement is formed with volumes dropping. The right shoulder is formed as the move runs out of momentum. “Another thing to watch out for though is when a head and shoulders pattern fails,” says O’Sullivan. “This can often result in a sharp move the other way as traders scramble to close out and traders taking the other side squeeze hard.” O’Sullivan adds: “So look out for Head and Shoulders patterns, but trade with caution.”

REVERSAL
INVERSE HEAD AND SHOULDERS

The inverted head and shoulders formation is the same as the head and shoulders, just turned on its head. It can be considered a buy signal when the price breaks above the neckline. This formation is typically seen after a long downtrend. In the case of an inverted head and shoulders formation, volume generally plays a larger role than in a regular head and shoulders, requiring an increase in volume for a breakout from the neckline. The inverted left shoulder is formed by an increase in volume, the inverted head of the chart is accompanied by lighter volume, and then a big jump in volume on the rally from the inverted head. An inverted head and shoulders is confirmed with the upside penetration of the neckline.

“Only last week we spotted an inverted head and shoulders developing in the Dax on the five minute chart,” says Ian O’Sullivan. “The target once it broke the neckline was 6,710 and it duly got there. Buying as it broke about the neckline around 6,685 would have yielded a 25pt profit in less than an hour.”

REVERSAL
TRIANGLE

Triangle patterns consist of two trend lines converging into a triangle, and the price moving between these lines. Triangle chart formations tend to be a sign that traders need to sit on their hands and wait to see where the breakout will head.

There are three kinds of triangle formations. Symmetrical triangles are seen as a suggestion that the trend is in a period of consolidation before continuing with the trend. The price will usually rebound between the descending resistance line and the ascending support line before breaking out in the direction of the original trend.

An ascending triangle suggests that the price will head higher upon completion. The key aspect is the ascending support line – indicating selling in the market, after which buyers will move in and raise the price above the breakout level and into an upward trend. By contrast, a descending triangle suggests that the price will turn to a bearish move on completion of the pattern, however traders should be wary of the price breaking the lower support line of the triangle pattern.