Market Structure and Chart Patterns
“Market Structure is KEY, once you are able to read what price is doing, the game is your playground.”
Market structure is the “wave form” movement of the market which creates Higher Highs & Higher low points in an uptrend and Lower low & lower highs as it moves in a downtrend.
if the market is not trending, we say it’s in a consolidation or it’s ranging.
The Downtrend
The example above is market structure during the continuation of a downtrend. In a down trend, more sell orders are coming into the market which pushes price lower forming Lower lows(LL). When these sell orders start getting filled, more people start taking their profits and closing their sell orders causing price to retrace.
Since we in a down trend, price retraces to retest the broken support which is now a potential resistance forming a Lower high(LH). This gives sellers higher price to place more sell orders (at resistance) that push the price further down forming new lower lows (LL).
The Uptrend
In this example, we will look at when price reverses from a major support and the trend changes to bullish.
Price breaks through resistance and forms a high which signifies a possible trend change, in this case more buy orders. we then see a retest of the broken resistance which is now a possible support creating a Higher low (HL). More Buy orders (at support) are placed and price pushes further up creating new Higher highs (HH).
When these buy orders start getting filled and traders start taking their profits, price retraces and creates HLs. The High but low points are good enough price areas for buyers to place more buy orders that continue to push price further up.
Chart Patterns
There are two types of chart patterns:-
- Reversal chart patterns
- Continuation chart patterns
Reversal chart patterns
- Head and Shoulders
It is formed by a peak (shoulder), followed by a higher peak (head), and then another lower peak (shoulder).
A “neckline” is drawn by connecting the lowest points acting as a support zone.
When the neckline (support) is broken, a new low is created signifying a change in trend.
Price might then retest neckline which has now turned to resistance forming a LH. More sellers place their orders at this point and push price further down.
When trading the head and shoulder pattern, the best entry is right after the neckline retest.
2. Inverse Head and Shoulder
It is basically a head and shoulder formation, except this time it’s upside down.
A valley is formed (shoulder), followed by an even lower valley (head), and then another higher valley (shoulder). These formations occur after extended downward movements.
When the neckline (resistance) is broken, a new high is created signifying a change in trend.
The new high formed signifies that bulls are gaining control. The neckline is retested, gives a good price for buyers to continue placing buy orders thus pushing price further up.
3. Double Top
A double Top is a reversal pattern that forms after an extended move up. They are peaks that form when price hits a resistance zone that can’t be broken.
After hitting resistance, price bounces off slightly then returns to test the level again. If the price bounces off that level again, we have a Double Top. The second test of that zone failed to break up, a strong sign that buying pressure is just about finished. When the neckline breaks, it confirms a bearish trend therefore taking sells would be wise.
4. Double Bottom
The double bottom is also a trend reversal formation, but this time we are looking to go long instead of short.
These formations occur after extended downtrends when two valleys or “bottoms” have been formed.
From the chart you can see that after the previous downtrend, the price formed two valleys because it wasn’t able to go below a certain level. The second bottom wasn’t able to significantly break the first bottom.
This is a sign that the selling pressure is about finished, and that a reversal is about to occur.
5. Triple Top
Similar to the double top, the triple top is a reversal chart pattern that form when price retests a resistance zone three times and fails to break.
This signifies a weakness in buying pressure and a possible reversal, whereby sellers will continue pushing price lower.
The best confirmation for sells in a triple top is a close below the neckline. A retest of the same would prompt more sellers to place sell orders thus pushing price lower.
6. Triple Bottom
This is simply the inverse of the triple top.
It forms after an extended down trend and signifies a possible bullish reversal.
The best confirmation for buys in a triple bottom is a close above the neckline. A retest of the same would prompt more buyers to place buy orders thus pushing price higher.
Continuation Chart Patterns
- Bullish Rectangle
When price is in a continuous bullish trend, it might consolidate(move sideways) for a while before resuming the bullish trend. This stalling in price usually means that some traders are taking their profits off the previous push up, and a break upward(above consolidation) means more buy orders have been placed thus pushing price further up.
A buy entry would be ideal if candles close above the consolidation as this gives confirmation of a bullish continuation.
2. Bearish Rectangle
Just like in the bullish continuation, in a bearish continuation pattern, price also consolidates before breaking the range to continue the bearish trend.
It is key to note that during a consolidation, price moves sideways and does not form higher highs or lower lows. In other words, price is ranging. Therefore, when price forms confirmation candles that close above/below the consolidation, it’s an opportunity for traders to place their orders.
3. Bullish Pennant
Pennants are also continuation patterns that could be used to identify possible entries in the market.
After a big upward or downward move, buyers or sellers usually pause to catch their breath before taking the pair further in the same direction. Because of this, the price usually consolidates and forms a tiny symmetrical triangle, which is called a pennant.
While the price is still consolidating, more buyers usually decide to jump in on the strong move, forcing the price to bust out of the pennant formation continuing the bullish trend.
4. Bearish Pennant
A bearish pennant is formed during a steep, almost vertical, downtrend.
After that sharp drop in price, some sellers close their positions while other sellers decide to join the trend, making the price consolidate for a bit.
As soon as enough sellers jump in, the price breaks below the bottom of the pennant and continues to move down.
