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While triangle is considered as a continuation pattern, it is highly recommended
one should not jump the gun and wait for the breakout to take place before
entering the market because occasionally the triangle may initially appear as a
continuation pattern but ended up being a reversal pattern just like the chart
shown below.

Other continuation patterns include flags, pennants and rectangles, which can be
commonly found along a trending move. Flags and pennants are basically
considered short-term pattern, as a brief pause or small consolidation before the
previous trend resumes. These patterns are mostly preceded by a sharp rise or
decline and usually happen at the middle of the trend.

No matter how these patterns resemble, they all share a common characteristic,
a near term counter trendline (slope against the trend) appears in the pattern
which serves as the signal line or trigger line. The break of the signal line
confirms the end of the continuation pattern and price should resume.

A reversal pattern is a chart formation that indicates a market top or a market
bottom, the pattern usually goes through a sideways period and upon breakout
of the pattern there will be a change in direction or a turnaround in the current
trend.

Among all the reversal patterns, the Head and Shoulders / Inverse Head and
Shoulders is probably the best known and most reliable one. The following
diagram shows how the Head and Shoulders top pattern is formed (same
principle applies to the Inverse Head and Shoulders pattern).

As you can see three consecutive peaks are formed and are named according to
the appearance (resemble a head and two shoulders). This reversal pattern must
go through several steps before completion, they are:

A break of a major trendline.

Price held above a previous support and rebounded, formed the neckline as a signal line.

Another reaction high was formed but price stayed below previous high (peak).
Break of the neckline confirms the top formation.

Occasionally price test back the neckline (now should act as resistance line),
known as return move and this line should hold, bring the subsequent selloff.

Volume should play an important role in confirming the pattern, highest level of
volume shall appear at the left shoulder, then volume dropped at the peak (Head)
and the right shoulder have lowest volume. However, volume would pick up on
the final decline after the break of the neckline.

However, as it is quite difficult to justify the volume level in forex market, one
can use technical indicators or oscillators to help confirming the pattern. In most
cases, the top should be accompanied by bearish divergences, as illustrate at the
following chart:

It is important to remember that it occurs after a trending move and usually
indicates a major trend reversal upon completion. In a more deal situation, the
left and right shoulders should be symmetrical but it is not a necessary condition.
The identification of neckline support is essential and it is preferably to be a
more horizontal than a steeper slope line.

Other common reversal patterns include Double Top / Bottom, Round Top /
Bottom, Spike Top / Bottom, Falling Wedge and Rising Wedge, most of them
have a common characteristic is that, there should be a signal line (similar to the
neckline in Head and Shoulders) for confirmation of the top or bottom formation
and upon the penetration of this line, which signals the start of a new trend
pointing to the opposite direction.

A very important and useful feature in chart patterns analysis is the measuring
techniques, which could provide price objectives or targets after the break-out of
the signal line.

The measuring technique in a Triangle pattern is that to measure the height of
the triangle at the widest point (far left) of the pattern and project that vertical
distance from the break-out point.

To measure the price objective of a Head and Shoulders Top/Bottom formation,
one should measure the vertical distance from the top/bottom to the neckline
and then project the length downward (top) or upward (bottom) from the breakout
point. As this should mark the major change in market direction, so this
equality or 100% projection of the height from the top to the neckline should be
considered as the minimum upside or downside target.

Measuring technique on Double or Triple Top/Bottom is similar to Head and
Shoulders, also measuring the vertical distance from the top to the neckline, then
project the height from the point where the neckline is broken.
Having said that, any of these price projection targets, for both continuation and
reversal patterns, should serve as a general guide and one should take into
consideration of other factors, such as previous chart support and resistance,
plus the indicators’ readings (whether the market is an overbought / oversold
condition or is there any divergences in price and oscillators).

Even in a trending market, either up or down, price does not move in a straight
line, there will be numbers of short-term countertrend price movement known
as pullbacks and corrections in different magnitude before the prevailing trend
resumes.

Experienced traders know that in order to enhance profitability and make a
trade less risky, the best way is to enter a position at the end of the correction.

Therefore, technique in predicting the retracement level becomes extremely
useful in formulating a trading strategy and technical analysts consider the
Fibonacci percentages are very effective ways to locate the possible retracement
level especially when the actual chart support and resistance levels are too far
away.

Leonardo Fibonacci was an Italian mathematician who first observed certain
ratios of a number series which can describe the natural proportions of things in
the universe. The Fibonacci numbers are the following sequence of numbers: 0, 1,
1, 2, 3, 5, 8, 13, 21, 34, 55, 89, 144, 233, 377, 610, 987 ……

The first two Fibonacci numbers are 0 and 1, then the Fibonacci sequence is
formed by getting the sum of the two previous numbers to obtain the next
number.

The number sequence generates some mathematical relationship and the most
well known and widely used is the ratio of any number to its next higher number
which approaches a constant value of 0.618 (e.g. 13/21 is 0.619, 55/89 is 0.6179,
377/610 is 0.61803 and the higher pair of number you get, you will have a result
closer to 0.618). Another percentage is the ratios of alternate numbers which
approaches a constant value of 0.382 (e.g. 13/34 is 0.3823, 55/144 is 0.3819,
377/987 is 0.382, again the higher pair of number you use, you will get a result
closer to 0.382). In addition, 0.382 is also the inverse of 0.618 (1-0.618=0.382).
Finally is the ratio of 0.5, which only occurs between the relation of the 2
numbers 1 and 2, nevertheless, this ratio is also considered as one of the very
important Fibonacci ratio especially in technical analysis.

These Fibonacci percentages / ratios, 0.382, 0.5 and 0.618 can be very useful
especially for swing traders in order to identify the pivot points on the chart. In
an uptrend, whenever a pullback takes place, which should be treated as golden
opportunity to enter long position and these percentages can be applied to
predict the retracement level (i.e. where you can set your entry point) or identify
Fibonacci support level which should contain the correction (i.e. where you can
put your stop-loss). The following diagram explains the retracement patterns of
3 major Fibonacci percentages and same principle also applies to downtrend.

In a rising market, after meeting certain resistance level, point (A), when
correction unfolds, it is quite common for price to find support at these three
Fibonacci retracement levels. In a fast market, pullback tends to be shallow and
normally only reaches 38.2% of the nearest upmove before turning north again.
Some people consider this as the first line of defense, once this level is
penetrated, this implies a deeper correction of the underlying trend has
commenced.

Another well known percentage is the 50 percent retracement, no matter is a
primary, secondary or intermediate trend, correction against a major uptrend
often retraces approximately 50% of the prior uptrend as it is quite common for
half of the participants to take profit after certain temporary top is formed.

Last but surely not least, is the famous 61.8% Fibonacci percentage, in a weak
trend, it is not uncommon to see this percentage of correction, this point is also
considered as the maximum retracement level which is allowed if the prior trend
is going to resume. Once this level is broken, a break of 61.8% retracement, it
usually warns of a reversal rather than a retracement is taking place.

Whilst there are no fixed rules in applying Fibonacci retracement, we do have
some useful guidelines which should help enhancing the accuracy in predicting
the pullback or correction levels.

Before you could start calculating Fibonacci retracements, you must first identify
the market high and low prices. Generally many people consider using the longer
term historical high and low may help identifying significant support and
resistance levels. However, for short term trading, using the major high and low
might not have too much help as even you take the smallest percentage (e.g.
23.6% or 38.2%) could still be too far to reach, so it is not practical to use it as an
entry point.

In an uptrend, when ever pullback takes place, there is only one temporary top
(high) but there are numbers of reaction low, therefore, picking the appropriate
intermediate low would greatly improve the chance to predict the pivot point. It
is more like an art than science in choosing this so-called appropriate
intermediate low, we believe the Elliott Wave Theory can do the job pretty well
(we will discuss this in details in our next E-book).

Guideline 2: Plotting the Fibonacci retracement levels

After selecting the relative high and low points, this is the time to draw the
Fibonacci percentage retracement levels on the chart. In a rising market, the
measurement should be started from the low point (i.e. 0%) to the high point (i.e.
100%), then draw 38.2%, 50% and 61.8% and 38.2% retracement should be the
first line of correction target, and vice versa for a falling market.

The above chart is the correct way of drawing Fibonacci retracement levels (from
point A to point B) on the chart, however, we have come across some people who
draw these retracement lines as the follow chart which we do not recommend.

This is not the proper way as it will make the chart messy, therefore, try to keep
those lines in untouched area, usually in the far right of the chart.

Guideline 3: Take reference of Historical Behavior

In addition to normal Fibonacci percentage expectation, e.g. 38.2% for fast
market, one should also observe what had happened before and take it into
consideration. If all along the uptrend, most previous pullback took place
reached 50% before finding renewed buying interest, then one shall reasonably
adjust the pivot point prediction accordingly.

Guideline 4: Always have a Plan B

Once a temporary top is formed, we normally expect 38.2% retracement before
upmove resumes, however, one should also set a percentage (e.g. 50%) which
would abort this scenario and suggest either a deeper correction is going to take
place or a reversal is in progress, then at which point would signal price is
heading another direction.

Once the retracement is over and price is starting to resume previous direction,
this is the time to apply projection technique in order to predict the next upside
or downside target. Fibonacci projection (extension) takes into account three
points, in an uptrend, they are the starting low point (A), the swing high (B),
then the reaction low (C), measures the vertical distance from (A) to (B) and get
the Fibonacci percentage (e.g. 50% or 61.8%), then project it from point (C).

The following chart displays an actual example in NZD/USD daily chart of the
application of Fibonacci retracement and projection.

On the left hand side of the chart, after forming a temporary high (H1), kiwi
retreated almost 50% (of L to H1) and renewed buying interest emerged at L1,
then started to move higher from there, then one can use these 3 points L, H1
and L1 to projection upside target and the currency pair rose to as high as H2,
slightly exceeded 100% of L-H1 measuring from L1. This kind of process
continues and after forming another temporary top at H2, one can calculate the
Fibonacci retracement level by using L1 and H2 and get the three percentage
(38.2%, 50% and 61.8%) levels ready. Price reached 38.2% retracement level and
headed north again from there, as the retracement was shallow (only 38.2%),
initial upside target should be 61.8% of L1 to H2 measuring from L2 and when
this level is exceeded, get 100% projection level ready for the next upside
objective.

In general, the simplest way in picking which ratio to use is if previous move has
retraced between 0.236-0.382, then apply 50% projection, and if correction was
near 50%, use 61.8%. When retracements exceeded 61.8%, use 100%, 123.6% or
161.8%.

Candlestick chart was developed in 1700s in Japan by a man named Munehisa
Homma, originally designed to trade rice futures in the 17th century, he invented
a method to analyze the price with an overview of the open, high, low and close
prices of each trading day over a certain period of time.

A line, known as shadow, was drawn to show the day’s price range and a broader
part of the candlestick represents the area between the session’s opening price
and the closing price, known as real body. If the opening price is lower than the
closing price (i.e. a rising day), then the body is white; if the opening price is
higher than the closing price (i.e. a falling day), then the body is black.

As the style of charting is relatively easier to read and understand, it became very
popular and analysts relate the chart patterns to various bullish or bearish signals, which were considered quite reliable in predicting future market
directions.

The colour (white or black) and the length of the real body exhibit the market
forces, whether bulls / demand or bears / supply are winning. Generally

speaking, the longer body indicates the more intense in buying or selling
pressure (e.g. long white candlesticks reveal strong buying interest, i.e. buyers
are very aggressive) whilst shorter real body normally suggests indecisive market
situation and further sideways consolidation would take place. According to
different combinations of candlesticks, various bullish and bearish patterns were
found and we are going to discuss some of those major patterns here.

This is a single candlestick reversal pattern made up of a small real body, ideally
to be white but could be black, with a long lower shadow but a very short or even
non-existent upper shadow. This candlestick should be formed after a decline,
the bottom of the shadow marks a new low and then followed by white
candlesticks. Therefore this is grouped under bullish reversal patterns.

Doji

Another single candlestick reversal pattern which could be either bullish or
bearish, depending on the combinations of the preceding and the subsequent
candlesticks formations. A doji star is formed when the opening price and the
closing price are virtually the same level (the word doji is actually a Japanese
words ‘同市’ which means same price level) which made no real body, the length
of the upper and lower shadows can vary and the appearance of the candlestick
resembles a plus sign, a cross or an inverted cross. One doji star alone is only a
neutral pattern as it indicates a sense of indecision between the bulls and bears,
whether it is going to be a bullish or bearish sign mainly depends on the prior
and future price developments.

Whenever you see a ‘doji’ candlestick after certain trending moves, you can
consider it as a warning sign or a red flag for a possible reversal and one should
wait to see if there is candlestick pointing to the other direction after the doji.

In the above example, once the white candlestick is formed after the doji, this
should be treated as a confirmation and one can buy the underlying security in
anticipation of a low formation.

Morning star

This is basically a three steps bullish reversal pattern at the bottom of a
downtrend consisting of three candlesticks, starting with a long real body black
candlestick after an extended downtrend, a small body candlestick (could be
white or black but a white body tend to have stronger indication) that gapped
down on the open and closed below the low price of the previous candlestick
(which make that candlestick appears isolated from prior bar), finally a long real
body white candle which gapped up on the open and closed near the bar high or
at least well above the mid-point of the previous black candle.

If the star itself is a hammer or doji, this normally suggests a stronger reversal signal and the subsequent impact is more likely to be bigger.

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