The psychology behind chart patterns!
For all situations involving chart patterns, there are a few general rules you should be aware of. And the reason for this is that you have to think creatively and carefully about the patterns because they don't arise constantly as the books claim.
- At any given price level in the market, there will always be people thinking that the price is good to sell or buy. You can see this in red and green arrows. This is the ¨fight¨ between bulls and bears, before deciding the winner.
- A false break is always possible on a break. The common term for this is "second life haunting." The head-and-shoulders profile is a classic case in point.
- Accumulation zones of order volumes are being formed by candlestick patterns at support and resistance levels. As a result, there will be plenty of funds available for institutional traders to make new transactions. The chart has been updated to include a Volume Profile to emphasize this.
- Institutional traders will notice the same patterns as individual traders. The price is typically pushed back after the break by institutions looking to increase their holdings. In all of these cases, the prices are retesting their initial support.
- Each individual trader has varied creativity, this means that the patterns will not always be spotted on the chart, in the same way by all traders, and they will not be developed perfectly in all conditions. Leave the search for the ideal pattern alone.
These are just a few examples of chart patterns
Chart 1 - Descending triangle - continuation pattern
Price is consolidating at a rounded price, chart example is 0,7. There are buyers hopping for the price to go up from there ( green arrows) and they are ¨protecting¨the support level .
Meanwhile, institutional sellers are actively driving the price below 0,700 at any available chance. This will prevent the TP of buyers from being hit and lead to a buildup of purchase trades in the support zone.
As the volume of the sell orders increases and hits the SL of the buyers, the price drops precipitously. As a result of the inevitable retest, institutional traders will have yet another opportunity to increase their holdings.
Chart 2- Flag - continuation pattern
Similar to how it has moved up and down between support and resistance levels around the psychological level of 1700, the price will be affected by the same bull and bear conflict as well as uncertainty.
There will be a buildup of volume on both sides of the flag, but a break to the downside would indicate that sellers have the upper hand and the price will continue to decline. There will be a second opportunity to get in when price returns to the support zone.
Invalidate the pattern if the price starts making new highs. Because false breaks from flag patterns are so common, trading on the other side of the pattern is not advised.
Chart 3- Head and Shoulders - Reversal pattern
The market is testing a key psychological level of support at $145.00.
The battle between bulls and bears will resume right here. In the same way that the triangle's neckline experiences this phenomenon, so will this shape. Numerous purchasing volumes will accumulate near the neckline because buyers are constantly being halted from adding to their position by sellers who want to have TP hit.
Importantly, some traders are getting in short with a stop loss at the first shoulder, only to go SL hunting and have their stop loss levels hit. The pattern's Head will be constructed from this.
For buyers, the final shoulder represents yet another aborted attempt at reaching TP.
The most effective reentry hinges on adjusting the neckline, or support line.
Chart 4 -Ascending triangle - continuation pattern
Same as chart 1.
Chart 5 - Side channel - double bias pattern
High volumes are being generated at the channel's support and resistance levels as the price approach a support level and the psychological 105 level.
This is a struggle between buyers and sellers. Profitable participants will be large financial institutions that require large amounts of liquid assets to execute the desired trade direction.
The price will typically continue to move in the broken channel's direction, though fake breaks are common.
Chart 6 - double bottom - reversal pattern
An initial formation that looks like a double bottom or top is often followed by the development of a triangle, flag, or pennant.
In this case, the price is about to break through a significant psychological level of 80, and there will be traders looking to buy at that price in the hopes of getting a good deal.
By reaching the SL of buying orders at 80, price will build the double bottom pattern and create liquidity for institutional traders. The retest provides a third opportunity for institutional traders to buy at the lowest price and increase their holdings.
NOTE: The formation of these patterns serves the interests of institutional traders. Don't just trade the idea of patterns if you're going to trade patterns. Do your best to think beyond the box by always questioning HOW and WHERE the institutions will gain the most from any given scenario.
In addition, false breakouts should be taken into account at all times because they provide institutions with a chance to gain access to additional liquidity and increase their position size.
I am appreciative of the fact that you have taken the time to read this. If you have any questions, please ask them in the comments section below. I'll get back to you with the answer to your question.
