Technical analysis is the process of analysing securities to determine profitable trading strategies.
The goal of a technical analyst is to identify price trends and patterns through scientific tools. Technical analysts use a vast array of charts and mathematical principles when conducting their studies.
It’s no surprise that many successful professionals in this field have backgrounds in mathematics, engineering, physics, computer programming or finance.
While we can say much about market theory and various methods for profiting from the markets, we’d like to take a moment to discuss some standard technical terms and what they mean when explicitly used about topping formation patterns in London traders’ circles.
- A formation is a specific pattern created by placing price movement on a chart. A formation may present several bars in either an uptrend or downtrend, with exceptional price resistance and support characteristics.
- Resistance is the term used to describe the price level at which most holders of a particular security will sell their shares when presented with an offer (or ask). It’s also known as “selling pressure”.
- Support is the term used to describe the price point that most traders (market makers included) who hold this same security will buy when presented with an offer (or bid). In other words, it’s where demand meets supply. It’s also known as “buying pressure”.
Knowing the basics, let’s look at some common topping patterns using the GBP/USD as an example.
This pattern usually appears during bearish markets where the price consolidates, moving down infrequently with lower highs and higher lows.
However, when they do occur, those lows form an ascending trend line, creating a descent triangle as seen in prices breaking out downwards once support is broken.
The descending triangle is formed when the price action of a financial instrument forms lower highs and lower lows.
Typically, these formations form over time – from weeks to months – but can also be completed within hours when traders sense that the top is in and begin to dump stock rapidly.
In the following example, we have a bullish ascending triangle.
The key differences between the two are (a) the direction of the price action; and (b) support met with demand coming from underneath (i.e., there’s buying pressure at support).
It signals a reversal in trend and eventually increases market price and new highs around wave e of iii.
Here is another example with yet another typical topping pattern:
The double top or head-and-shoulders formation
This pattern usually appears during bullish markets where prices consolidate, moving up infrequently with higher highs and lower lows; however, when they do occur, those highs form a descending trend line which creates a double top pattern.
Double Top pattern breaks downward once resistance at one is broken, where the market moved lower after testing support at two and B, respectively.
After hitting a low price of 1.4000, there’s a rally – or bounce – back up to meet with resistance, where more selling pressure meets demand from traders looking to buy.
The second peak is reached, signalling the end of this particular formation as prices plummet on wave e of iii.
Although most people listen to technical analysis, few conduct it.
Many believe that sometimes the patterns and techniques used by traders are very complicated and thus difficult to understand.
However, this is not the case as most formations can be spotted as a novice or an experienced trader.
Rectangle Formation or Wedge Formations
They are also easy to spot using technical analysis during trading sessions. They often occur in various markets, including forex, commodities, and indices shares, without one necessarily being an expert in technical analysis.
This formation appears when the price moves sideways in a well-defined range with higher lows and lower highs between two trend lines, which illustrates what happens when support at one is broken.
Hence one can sell once the price falls to touch the descending trend line.
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