Strategies - Trend Reversal Patterns

The sideways price action of a reversal pattern signifies that upon breaking out of the pattern there will be a turnaround in the current trend.

We will be investigating the Head and Shoulders and Inverse Head and Shoulders on this page. Double Tops and Bottoms and Triple Tops and Bottoms will be discussed on the next page.

Other reversal patterns such as Rounded Tops and Bottoms, V-Formations, and Diamond Formations are not as common and harder to see. Rounded Tops and Bottoms will be discussed briefly on the next page while you can check our glossary for some information on V-Formations and Diamond Formations.

Head and Shoulders
The Head and Shoulders pattern is one of the most classic patterns in a technical analyst’s toolkit.

This three-peak formation is named for its resemblance to a head and two shoulders. The center peak (head) protrudes above the remaining two peaks (shoulders), which are set at or close to identical levels. The common line of support for all three peaks, which does not have to be a horizontal line, is known as the Neckline. The final downward penetration of the neckline confirms the start of a new downward trend.

There is a chance that even after there is a break of the neckline that the trend may not reverse. A good validation of a reversal would be if the break is significant or if the neckline is tested and it turns from support to resistance. Also, a trader should look and see if momentum was higher during the formation of the left shoulder compared to the right shoulder as this would indicate that buying pressure is decreasing and a true reversal pattern is taking place. During a true head and shoulders reversal, the downward move can be expected to be equal to the distance from neckline to head.

Inverse Head and Shoulders

The inverse Head and Shoulder pattern follows the same model.

In the 4-hour chart below you can see that at first price is heading downwards. After the pattern forms, price reverses and there is a substantial move in an upward direction. Soon though price retracts and tests the neckline.

The neckline holds as support, and the uptrend continues, completing the reversal. You can also see, from the momentum indicator, that selling pressure eases by the time the right shoulder is forming.

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In finance, Fibonacci retracement is a method of technical analysis for determining support and resistance levels. They are named after their use of the Fibonacci sequence. Fibonacci retracement is based on the idea that markets will retrace a predictable portion of a move, after which they will continue to move in the original direction.

The appearance of retracement can be ascribed to ordinary price volatility as described by Burton Malkiel, a Princeton economist in his book A Random Walk Down Wall Street, who found no reliable predictions in technical analysis methods taken as a whole. Malkiel argues that asset prices typically exhibit signs of random walk and that one cannot consistently outperform market averages. Fibonacci retracement is created by taking two extreme points on a chart and dividing the vertical distance by the key Fibonacci ratios. 0.0% is considered to be the start of the retracement, while 100.0% is a complete reversal to the original part of the move. Once these levels are identified, horizontal lines are drawn and used to identify possible support and resistance levels.

Fibonacci ratios
Fibonacci ratios are mathematical relationships, expressed as ratios, derived from the Fibonacci sequence. The key Fibonacci ratios are 0%, 23.6%, 38.2%, 61.8%, and 100%.
F_{100\%} = \left(\frac{1 + \sqrt{5}}{2}\right)^{0}  = 1 \,
The key Fibonacci ratio of 0.618 is derived by dividing any number in the sequence by the number that immediately follows it. For example: 8/13 is approximately 0.6154, and 55/89 is approximately 0.6180.
F_{61.8\%} = \left({\frac{1 + \sqrt{5}}{2}}\right)^{-1}  \approx 0.618034 \,
The 0.382 ratio is found by dividing any number in the sequence by the number that is found two places to the right. For example: 34/89 is approximately 0.3820.
F_{38.2\%} = \left({\frac{1 + \sqrt{5}}{2}}\right)^{-2}  \approx 0.381966 \,
The 0.236 ratio is found by dividing any number in the sequence by the number that is three places to the right. For example: 55/233 is approximately 0.2361.
F_{23.6\%} = \left({\frac{1 + \sqrt{5}}{2}}\right)^{-3}  \approx 0.236068 \,
The 0 ratio is :
F_{0\%} = \left({\frac{1 + \sqrt{5}}{2}}\right)^{-\infty}  = 0 \,

Other ratios

The 0.764 ratio is the result of subtracting 0.236 from the number 1.
F_{76.4\%} = 1- \left({\frac{1 + \sqrt{5}}{2}}\right)^{-3}  \approx 0.763932 \,
The 0.786 ratio is :
F_{78.6\%} = \left({\frac{1 + \sqrt{5}}{2}}\right)^{-\frac{1}{2}}  \approx 0.786151 \,
The 0.500 ratio is derived from dividing the number 1 (second number in the sequence) by the number 2 (third number in the sequence).
F_{50\%} = \frac{1}{2}  = 0.500000 \,



You may have heard to the old business clich√© “buy low and sell high”. New forex traders usually ask the question how low is low and how high is high. One way we can quantify these levels is using areas where price has stopped and changed direction. The area where price stops after moving up and then turns around is called resistance. Resistance acts as a “ceiling” capping the further advance of price.


Resistance is not just some random area where price turns around. There are potential sellers, traders who have sold a Forex currency pair once before and remember the collective power they had to push price lower. There are also buyers who went long at support and were disappointed that price did not go higher and will close their buy positions with sell orders at or just before price gets to the resistance ceiling.

Another group that make up resistance are the ones that bought at or near resistance and are trapped when price fell at resistance. These traders are begging for price to come up one more time to get them out at breakeven. All of these groups work together to send prices lower and make up the “supply” in the supply and demand equation. More supply than demand, price falls, more demand than supply price rises; Resistance=Supply

5 Most Consistent Candlestick Patterns

Some say the  power of candlesticks partially stems from a self-fulfilling prophecy.  The tremendous volume of traders who utilize candlestick charts translate into predictable market movements based upon certain formations. The truth is however thats a bunch of BS – the reason they work is because they pinpoint the underlying emotions of the market as a whole.

Top 5 candlestick pattern

The following top 5 five candlestick formations are the most popular among technical analysts, and, therefore, have the highest probability of producing the most reliable and consistent results.

5 Most Consistent Candlestick Patterns
When is comes to the 5 Most Consistent Candlestick Patterns these take the cake…

Doji Formations
Doji formations, such as dragonfly and tombstone, are widely regarded as strong indicators of a probable reverse. They both consist of a single horizontal line indicating that both the closing and opening prices were identical. As a result, there is no body, and the wick is either rising for a gravestone Doji or falling for a dragonfly Doji. The gravestone pattern implies depleted bullish sentiment and, consequently, a downward movement will subsequently appear.  A dragonfly pattern is naturally an opposite bullish type of signal.

Piercing and Cloud Cover Formations
Both of these formations are basically mirror images of each other and represent reversal signal patterns. The piercing pattern consists of a long black candlestick followed by a long white one that closes over halfway up the first candlestick.  The implication is that market participants, who sold on the first day in anticipation of a continuing downward movement, had to cover their shorts, and, as a result, prices rose and will likely continue in that direction.  The cloud cover pattern, on the other hand, is a bearish indicator for similar reasons and is formed by a long white candlestick followed by a long black one that closes over halfway below the first candlestick.

Engulfing Formations
This pattern  and the doji candlestick are likely top on the list of the Top 5 Most Consistent Candlestick Patterns. The bullish engulfing formation consists of a short blackbody candlestick followed by a taller white bodied candlestick that begins below and ends above the previous day’s trading range.This means prices on the second day opened lower than the first and closed higher.  This is a highly bullish formation and indicates a long position should be considered.
A bearish engulfing pattern would be the opposite with a short white bodied candlestick followed by a longer black bodied candlestick.  Here the signal is bearish and consideration should be made for selling short.

Hammer and Shooting Star Formations
These patterns are basically short candles with one long wick.  For the hammer, the wick points downwards, whereas for the shooting star, it points upwards.  The hammer is considered bullish in that price action clearly was able to reverse all selling sentiment, while the shooting star would be viewed as bearish for a similar reasoning logic.

Harami Formations
A bullish Harami consists of a long black candlestick with a close near the low, followed on the next day by a short white candlestick.  This indicator is interpreted as signaling that selling pressure dominated the market on the first day, but was halted on the second, suggesting that upward movement in prices will continue.  A bearish Harami has the exact opposite structure and interpretation.
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