CHART TRADING GUIDE 1

Transcription

1 CHART TRADING GUIDE 1

2 How to understand chart trading This guide is designed to teach you the basics of chart trading- the chart patterns that are covered in this booklet can be used for short and medium term positions covering all financial markets across the globe. ADS Securities London hold regular seminars and webinars, to help you become a confident strategic trader. Our MT4 plus trading platform is designed to give you an edge with our additional features including: Client sentiment trading Mini Terminal Trading Alarm Management trading The basics of Chart Trading Technical analysis aims at forecasting the direction of prices through the analysis of past data on charts, it only and exclusively focus on market and price analysis and doesn t take in account anything else such as macro or micro economics factors and fundamentals. Technical analysts usually say everything is in the chart and that s the way they assess financial markets. 2

3 The Different types of charts: Japanese Candlesticks: They are a form of graphical analysis created in Japan 400 years ago, candlesticks provide 4 main information to the trader: opening and closure of the session, high and low. The part between the opening and closure is called Body while the other aspects are called shadows. Candlesticks became very popular in the west in recent decades, they are now one of the most popular way for representing a market. Bar charts: They are a familiar and popular type of chart available in nearly all the platforms including ADS securities London MT4. They give to traders the same information as a candlestick: each bar represents the combination of the opening, the high, the low and the closing price. The difference between the high and the low are also known as the range. The main difference with candlesticks is the graphic representation: 3

4 Trend lines Trend lines are the most common form of technical analysis, they give a good idea of the direction of a market and can be a very powerful tool to include in your decision process to time your entries in the market. A trend line simply connects highs or lows among them, you can valid a trend line with 2 highs or lows but you will need 3 to confirm it. There are two types of trend lines: uptrend (higher highs and higher lows) and downtrend (lower lows and lower highs). It s really important that a trend line fits the highs and lows properly; if it doesn t and you force the trend line to fit in the market then it will not be reliable and probably easily broken. Bearish Trend line Trend line example on USD/CAD 4 hour chart Bullish Trend line Trend line example on GBP/USD 4 hour chart 4

5 Support and resistance Support and resistance is one of the most widely used concept in trading and analysis of markets. A support is an horizontal level that rejected prices in the past. A support is not a precise price level but an area below the market price where buying interest is sufficiently strong to overcome selling pressure and to push price action back up to higher levels. A resistance is the opposite of a support, it s an area above the market price where selling pressure is likely to overcome buying pressure and which could turn back a price uptrend. Support Support example on GBP/USD 4 hour chart Resistance Resistance example on USD/CAD 1 hour chart 5

6 Once a resistance is broken it s very likely that it will act as a support for the prices, if it s a support that is broken, then there is a high probability for it to become a resistance. 6

7 Channels Channels are a popular trading pattern that is composed of 2 parallel trend lines that contains the prices in an uptrend or a downtrend. Each trend line rejects the prices on the upside and the downside. It s a very easy pattern to find on charts and it can be either used to time your entries or size your stop loss and take profit. The most common channelling strategy is to go long when the market tests the downside of an ascending channel with stop losses below the channel (long position in the direction of the trend after a correction) the target is the upside of the channel, and go short when the market tests the upside of a descending channel with stop losses above the channel (short position in a downtrend after a correction). Ascending channel Channel example on GBP/USD Daily chart Descending channel Channel example on USD/JPY Daily chart 7

8 Ranges A range is a pattern formed by both a support and a resistance, the prices are rejected on the downside by the first support and on the upside by the first resistance, each time the prices test one of these areas we have a good probability for a new rejection happening. Ranges are very common in sideways market and can provide good trading opportunities, the idea is to go short on the top of the range with stop loss above it and long on the bottom of the range with stop loss below it. Range strategy allow you to have tight stop losses and so a good risk/ reward on each trade, you can play the range until it breaks. Timing your entry is key when trading a range, you can anticipate the reaction on the support or resistance with a pending order but the best is to wait for a confirmation: a shooting star on the top of a range or a hammer candle on the bottom for example; these setups will increase the probability of a rejection and make the signal stronger. Range example on AUD/USD Daily chart Bearish signal Bullish signal 8

9 Triangles The triangle pattern is formed of two trend lines: a bearish trend line and a bullish trend line forming a triangle. When the trend is clear on a market, this pattern indicates a congestion in the prices. It s a continuation pattern that can be used to time your entries in the direction of the trend. The triangle shows that the buyers are unable to push the price higher while the sellers are struggling to push the price lower, the struggle is resolved by a breakout usually happening a 2/3 of the triangle. The common strategy is to identify the trend first, look for a triangle pattern, wait for the breakout in the direction of the main trend, and jump into the market. The theoretical profit target is equal to the eight of the triangle. To sum up, triangles are very easy to spot, they have a good probability for triggering a decent move and they provide good risk reward to traders! Triangle example on USD/JPY Weekly chart Breakout 9

10 Double bottom The double bottom is a very common bullish reversal pattern potentially showing the end of a bearish trend and the beginning of a new bullish trend or a rebound. This pattern usually has the form of a W and shows that the sellers are losing control to buyers. Double bottoms are easy to spot: the market rejects a support level twice, then break the previous high which is the confirmation for completion of the pattern. Traders can anticipate the breakout and go long directly on the support level or wait for the breakout and the completion of the pattern. Double bottom example on USD/CHF Daily chart 10

11 Double top The double top is the opposite of the double bottom, it s a bearish reversal pattern potentially signalling the end of a bull market and the beginning of a new bearish trend or at least a correction. This pattern usually has the form of an M and is also very easy to spot and to trade. The market rejects a resistance level twice and then breaks the previous low, as for the double bottom traders can either anticipate the correction and go short directly from the resistance level or wait for the confirmation. Double top example on USD/JPY Daily chart 11

12 Shoulder Head Shoulder Head and shoulders is believed to be one of the most reliable reversal pattern. It is composed of 3 different stages: -firstly the price rise to make a peak and then declines forming the first shoulder. -the market then rise again making a new high and declines but doesn t break the previous low: this will be the head of the pattern. -finally the price rise again but stops below the high of the head and declines forming the second shoulder We can then draw a trend line connecting the lows, this is the neckline. Once the price has formed the 3 waves, the breakout of the neckline is the confirmation for the completion of the pattern. The lows can be nearly at the same level forming an horizontal neckline but we can also have the second low higher than the first one, in this case the neckline looks like a bullish trend line, both setups are valid and can be traded. The theoretical target for an SHS is the distance between the peak of the head and the neckline. The stop loss is usually set above the second shoulder. SHS example on AUD/NZD 4 hour chart 12

13 Inverted Should Head Shoulder This pattern is the exact opposite of the SHS, the ISHS is a bullish reversal pattern so you can find these setups in the frame of a downtrend. As the SHS this is a very reliable pattern that gives good probability of triggering a new bullish trend after completion. We find here the same stages as for an SHS: -First the market is in a bearish trend and rebound forming a low and the first shoulder -Then the price makes a new low before rebounding again, this is the head -Finally the market goes down again stops before the previous low formed by the head and rebound, The neckline connects all the highs of the pattern among them, we can have necklines that look like a bearish trend line (lower highs) or like an horizontal resistance level. In both case the completion of the pattern and the signal to go long are given by the breakout of the neckline. The target is equal to the distance between the low of the head and the neckline and the stop loss is usually below the second shoulder. ISHS example on USD/CHF 4 hour chart 13

14 Fibonacci Fibonacci was a famous mathematician considered one of the most talented of the middle age. He create the famous Fibonacci sequence: His research in mathematics have been applied to many fields including financial markets to create different tools. Double top example on USD/JPY Daily chart The market never goes from point A to point B in a straight line, the trends are formed of waves: it means a move up or down and then a correction or rebound, then a new impulsion and a new wave. The Fibonacci retracement gives us the potential retracement area before the market gives a new impulsion and allow the trend to keep on. There are 3 important levels: 38.2%, 50% and 61.8%, statistically most of the moves retraces 50% to 61.8% which makes the area between these 2 levels very interesting for traders. The Fibonacci retracement is a very reliable tool but it needs to be drawn properly in order to give the right information. The first thing is to identify a swing, it needs to be a clear bullish or bearish move. Then draw the retracement in the direction of the trend: if it s a bullish move draw it from bottom to top and if it s a bearish move from top to bottom, you need to take the low and the high of the swing as reference to draw the retracement. The Fibonacci retracement is a tool that will help you time your entries and jump in a trend, therefore if the initial move is a bullish move, you should be looking to go long from one of the retracement levels if the initial move is bearish then you should look for a short position. Good setups can be found If a Fibonacci level matches with a support or resistance level then the probability of a rejection happening will be higher. Fibonacci retracement example on AUD/USD daily chart 14

15 Fibonacci retracement example on GBP/USD daily chart Candlestick patterns 15

16 Hammer: It s a bullish candlestick that signal a reversal in a downtrend, the body of the candle is small with long tail, to be valid the size of the shadow has to be at least twice the size of the body, the body can either be white (hanging man pattern) or black. Bullish engulfing: A bullish pattern composed of a black candle and then a white candle that engulfs the black one, on the stock market typically the white candle would open lower than the low of the black candle (bearish gap) and close higher than the high of the black candle; on the Forex market this setup can be a little bit different: most of the time the white candle opens at the same level as the closure of the black candle and close above the high. This pattern in a downtrend signals a reversal. Bullish harami: The bullish harami is the exact opposite of the bullish engulfing pattern, it s still a bullish reversal setup but there is first a black candle followed by a white candle completely held in the body of the black candle. The opening of the white candle should be higher than the low of the black candle (bullish gap) and the closure lower than the high of the black candle. Bullish three soldiers: This bullish reversal pattern is composed of three long bodied white candles each one making a new high respect to the closure of the previous candle. This setup represent a potential shift in the momentum and a probable reversal in a downtrend or after a period of consolidation. Shooting Star: It s a bearish candlestick that signal a reversal in an uptrend, the body of the candle is small with long tail, to be valid the size of the shadow has to be at least twice the size of the body, the body can either be white or black. Bearish engulfing: A bullish pattern composed of a white candle and then a black candle that engulfs the white one. On the stock market typically the black candle would open lower than the low of the white candle (bearish gap) and close higher than the high of the black candle; on the Forex market most of the time the black candle opens at the same level as the closure of the white candle and close above the high. This pattern in an uptrend signals a reversal. Bearish harami: The bearish harami is the exact opposite of the bearish engulfing pattern, it s still a bearish reversal setup but there is first a white candle followed by a black candle completely held in the body of the white candle. The opening of the black candle should be lower than the high of the white candle (bearish gap) and the closure higher than the the low of the white candle. Bearish three soldiers: This bearish reversal pattern is composed of three long bodied black candles each one making a new low respect to the closure of the previous candle. This setup represents a potential shift in the momentum and a probable reversal in an uptrend or after a period of consolidation. 16

17 Moving averages: A moving average is a widely used indicator in technical analysis, it basically helps traders to smooth out the price action of the market over a period of time. Moving averages are based on past price and are very useful for trend following strategies, but it gives high number of false signals when the market is in range. There are two main types of moving averages: Simple Moving averages and Exponential moving averages. The difference is in the calculation method, the exponential moving average will give more weight to the most recent prices resulting in an indicator that reacts quicker to the changes of the market, this helps traders get entry signals earlier but also raise the amount of false signals you can get. The basic and simplest way is to use moving averages to determine the trend, let s say we look at an 8 days moving average on the chart: -if prices are above it means that prices are in a general uptrend -if prices tend to stay below the moving average the market is in a general downtrend. Moving averages can act as dynamic resistance or support in a trend, each time the price will test the moving average there is a good probability for a rejection happening (see picture below). You can then think about different ways to include moving averages to your trading but here are some examples: -time your entries (support / resistance or breakout of the MA) -trail your stop losses to lock profits as the trend accelerate -size your stop losses (above or below the MA) Crossover strategy: This strategy is based on 2 different moving averages, a fast moving average (usually an exponential one) for example the 8 period EMA along with a 20 period SMA. When the market is in a trend, each crossover between these 2 moving averages will represent a potential shift in the trend and so a good entry point. The idea is to ride the trend until an opposite crossover happens and so close the positions. As mentioned before this is exclusively a trend following strategy that will work very well when the market has a clear direction but if the market is in range this strategy will give many false signals. 17

18 Bollinger bands The Bollinger Bands is a famous indicator in technical analysis, it acts as an envelop for the prices. This indicator is composed of a lower band, a middle band and an upper band. The main purpose of the Bollinger Bands is to measure the volatility of a market, if the bands are tight it means that the market is not really volatile and pretty quiet; if the bands are wide it means that there is some volatility and the market makes some noise! The Bollinger bands bounce: Apart from measuring the volatility the Bollinger bands can be used as a complete trading system, one of the strategies is called Bollinger bounce. This strategy use the upper band and lower band as support or resistance for entry points and the idea is to target the middle band, you play a bounce of the price on the upper and lower bands: -if the market tests the upper band you go short and target the middle band. -if the market tests the lower band you go long and also target the middle band. The Bollinger Bounce gives very good results when the market is trading range. 18

19 The Bollinger bands squeeze: When the bands squeeze each other it signals that potentially a trend is about to start, the idea in this strategy is to wait for a breakout of the lower or upper band, get the position before the move start and then just ride the trend. 19

20 Ichimoku: Ichimoku is a full trading system that is becoming more and more famous among retail and professional traders. There is only 1 indicator that gives all the infos to trade: from entry point to exit and placement of stop losses. Ichimoku is well known for the clouds of the indicator, and most of the successful traders who use ichimoku have the impression to understand what s going on a market and the direction of the market just looking at the clouds. Ichimoku trading system is composed of 5 different parts: Tenkan-Sen / trigger line (in red) It s the fastest moving average of the system, it is basically used as a trigger line when it crosses the Kijun-Sen on the upside or downside. Kijun-Sen / base line (in blue) It s the slowest moving average of ichimoku, this is the base line of the system. Senkou Span A / main extension A (in pink) Average of Tenkan-Sen and Kijun-Sen, Senkou Span A is drawn 26 period before the last full trading period Senkou Span B / main extension B (in green) The sum of the high and the low of the 52 past period then divided by two. Here again drawn 26 days before the last full trading period, very similar to a 50% retracement line on the last 2 months. The area between Senkou Span A and Senkou Span B is called the Kumo, this cloud is always coloured and in advance of 26 periods respect to the current price. The colour of the cloud will depend on the position: is the Senkou Span A above or below Senkou Span B? When the cloud is pink it means that the Senkou Span B is above, which means that the price is below the 52 period moving average. It s a bearish signal and the trader generally look for short positions below the cloud when relevant signals appear. When the cloud is green it means that the Senkou Span A is above, so the price is above the 52 period moving average. That s a bullish signal and the traders are generally looking for long positions above the Kumo when signals appear. Chikou Span (purple line) It represent the current closing price, delayed by 26 periods. If this line is above the price 26 period ago then we are in a clear uptrend 20

21 ADS Securities holds regular seminars and webinars. We also have a dedicated education area which showcases our MT4 trading platform please visit If you are feeling confident in your knowledge try our trading quiz: 21