Top 3 Reliable Price Action Patterns
The term ‘price action’ refers to the movement of a security’s price and can be found in technical and chart pattern analysis. This has been covered in previous lessons however in what manner do traders find order in seemingly random price movements is still uncertain. How do price action patterns work? How well and successful is the result? Let us find out the top three reliable price action patterns. The later section of this lesson will focus on tips that will help traders to accurately identify price action patterns and candlesticks.
Testing Common Price Action Patterns
The reliability of following mentioned price action patterns was determined after testing over 200,000 patterns. In all instances, price action is included only once i.e. there are complete patterns and features a full break of support/resistance trend-line.
Bull Flag Pattern and Bear Flag Pattern
The bull flag in the side image is a continuation pattern that occurs after a strong trending move. The pattern consists of a strong bullish move quickly and closely followed by a series of lower highs and lower lows that denote the bull flag. Since these patterns don’t escalate much in strong trends, bull flag patterns are usually shown by a small number of price bars (about 20).
The best flag patterns always showcase two features:
- Strong run in price prior to flag setup.
- Tight flag occurring right on upper or lower edge of the run.
An Important Note
There’s a higher percentage chance of a pattern breaking favorably in the direction of a prevailing trend, the higher and narrower (or tighter) the pattern is turning out.
How will traders know they have identified a successful pattern? It’s easy – look for a break in the upper trend-line if pattern is a bull flag. Similarly, look for a break in the lower trend-line if it’s a bear flag pattern. In both instances, the trend-line should cover the exact same distance as the previous trending move but starting from the pattern’s outer edge.
Ascending Channel Pattern and Descending Channel Pattern
This price pattern is quite a common sight in trend moves. Channel price pattern offers good volume and a delayed continuation pattern, both of which are its defining factors. Look at the above example of an ascending pattern and note how similar it’s to the flag. Unlike other bullish or bear flag patterns however, channel patterns are generally wider and consist of more bars which increase success rate and strength.
If you look at both examples, a bullish trend move followed by series of lower lows and lower highs defines the ascending channel pattern. Quite opposite is the descending channel pattern which is defined by a bearish trend move followed by higher lows and higher highs. . These form parallel trend-lines that contain price.
An Important Note
Price has to break through upper trend-line in an ascending manner or break below lower trend-line in a descending channel pattern to be considered a complete pattern. On the other hand, price will have to be equal the movement from outer edge of pattern with trending move that initially started the channel pattern.
Head and Shoulders Pattern and Inverted Head and Shoulders Pattern
Statistically speaking, head and shoulders patterns are the most accurate of all price action patterns. A regular head and shoulders pattern is shown by two swing highs which are the shoulders with a higher high (the head).
The inverted head and shoulders pattern is defined by the opposite i.e. two swing lows with a lower low in between the shoulders. The outer swing highs/lows in inverted patterns don’t have to show same price however the pattern will become stronger the closer to the same area.
An Important Note:
This pattern will be completed when price breaks through neckline of the pattern. In a head and shoulders pattern the neckline is created by two low points. In an inverted head and shoulders pattern, neckline is created by two swing high points.
Additional Tips to Help You Use Price Action the Right Way
As one of the most popular trading concepts, most people still find it difficult when it comes to using price action in trading. Look at the following tips which will hopefully improve your performance and provide new insights when reading trading charts.
Tip #1: All you need to focus on are highs and lows.
Conventional trading methods can be easily combined with analysis of highs and lows, the end result of which is a powerful price action. Here is what you need to know about highs and lows beyond general trading knowledge.
o Long trend waves with only small pullbacks signal a strong trend
o If price is barely making higher highs/lower lows, this indicates fading momentum
o Is there increasing volatility (larger candlewicks) while prices makes new highs/lows?
o Another uptrend that should have your attention is when price fails to make a higher high
Tip #2: candlesticks and price action patterns offer 4 right there clues
The below mentioned clues can help traders avoid some of the most common mistakes they make when looking for just blueprint patterns.
- Length of Wicks
Volatility and uncertainty is on the increase if you spot a lot of wicks on a pattern. Wicks especially get larger during market tops or tight congestions.
- Bullish vs. Bearish Wicks
Are there more or longer wicks on the upside or downside of the trend? Wicks formed and sticking out to the downside signal rejection and failed bearish pattern attempts.
- Position of the Body
Look at the candle’s body. Is it positioned closer to the top or bottom of the candle? Bullish pressure is usually signaled when candle body closes near the top, especially when the pattern features a long bearish wick.
- The Body
The ratio between a candle’s body and wick can tell you a lot about the trend. Candles featuring a large body and small wicks usually indicate strength whereas indecision is signaled by candles with small bodies and large wicks.
And there you have it. Hopefully the above explained tips will teach you how to use price action in a better manner i.e. one that yields positive results and performance. Of course, practice makes perfect before implementing any pattern or trading strategy on your real trades. See how big-shot traders implement their strategies by signing up at AlpsSocial! Here you can design your own forex trade plans and seek inspiration by traders in your own social trading network!