Hi everybody and welcome to our third episode of #DueDEXConnect event, the place where traders exchange opinions! Today we are joined by ThreeSteps, for a talk about chart patterns, a massive topic for anyone interested in technical analysis.
Hi ThreeSteps, thank you so much for joining us. Super excited to have you here!
ThreeSteps: I would like to thank DueDEX in advance for letting me host this second AMA session. It’s a great way to be in touch with the crypto community and talk about what they find important in trading or have any questions about. Let’s start!
DueDEX: Great. Could you please give a brief introduction to patterns for new traders? What are they? Why are they important?
Patterns are certain conditions that repeat themselves over time within a given range or structure. There are three main groups of patterns:
Reversal Chart Patterns
Continuation Chart Patterns
Neutral Chart Patterns
These are swinging or balanced zig-zag shapes within a price range that can be equilateral, converging or diverging. The price swings around a center line, with tops and bottoms defining its maximum and minimum ranges.
A pattern develops over time, building up symmetry or a balanced price direction/movement. Then comes an asymmetrical disruption of this price moment, resulting in a breakout.
Patterns are well documented in theoretical trading literature. However, if you look at statistics you will notice that some are more reliable in predicting potential breakouts. Here, we will try to focus on common patterns that offer good probabilities of success. They include double tops, double bottoms, (inverse) head and shoulders, rising and falling wedges, triangles, flags, and cup & handle patterns.
DueDEX: Very interesting, thank you very much ThreeSteps. Could you please explain how to draw common chart patterns?
ThreeSteps: First, you must choose a time frame you want to trade on. As a general rule, remember that the larger the time frame, the more reliable should the pattern be. A long term pattern may take weeks to form, but once a breakout takes place chances are good that momentum will hold in that direction.
I have found patterns on 1-minute charts and they do work. But they also tend to exhibit more fakeouts and noise, so my suggestion is to use these to further narrow down a larger time frame entry.
For example, let’s suppose you want to buy on a 4-hour chart and the price is either at support or resistance level. In this case, I would look at smaller intraday time frames - like 30 minutes, 5 minutes, 3 minutes, and 1 minute - to be even more precise when entering my position. But once I have done that, I know my entry is targeted toward the 4-hour chart and I don’t need to be too concerned with short-term noise.
When the market is moving fast, however, patterns may also be reliable on lower time frames, mostly because a certain emotion is dominant.
Now that we have chosen a time frame, how do we look for patterns? You should ask yourself if the price is trending or going sideways and consolidating. Always be aware of the larger pattern/range that you are trading in so that your lower time frame entry is positively oriented with the larger time frame and the trend is in your favor.
DueDEX: Great. We were wondering if there is any limit to how low you would go in terms of time frames when looking for patterns?
ThreeSteps: As far as I am concerned, not really, but since I know many traders are interested in trading long-term positions I would suggest keeping the smallest time frame above 1 hour. To have a peek into intraday, the 4-hour time frame is good, but mostly you want to work with the daily and weekly time frames to determine your longer-term entries and exits.
DueDEX: Thanks ThreeSteps. Is there any other technical indicator you particularly like to use in combination with trading patterns?
ThreeSteps: In general, I like to keep things simple with just the relative strength index (RSI) and sometimes the Moving Average Convergence Divergence (MACD). They can hint towards divergences and show if the trend is getting stronger or weaker. These details can certainly help to either reassure you or make you more cautious about a trade.
DueDEX: Got it, simplicity is an asset! At DueDEX we were also wondering if you could please go through the relationship between patterns and trading volumes?
ThreeSteps: Assuming the market is liquid enough, volumes can provide interesting insights. For example, let us imagine we have the so-called “falling wedge” pattern, meaning the price is making consistently lower lows. If these lower lows are accompanied by less and less volume we could conclude that there is a lack of sellers while the order book moves lower.
In such cases, we can have more confidence in opening a trade and expect buyers to rally back to push the price upwards.
These tactics work in either direction.
DueDEX: We have a couple more issues we'd like to discuss. One is how to work with the stop-loss and take-profit functions in different chart patterns.
ThreeSteps: That depends. As far as triangle patterns are concerned, a stop-loss would be placed at the price that was lowest or highest - depending on whether we have a bullish or bearish triangle - before the breakout.
In general, the break-out point where the pattern is active is always a good point to put a stop loss, no matter what pattern we are looking at.
DueDEX: Our final question concerns those times when patterns can turn out to be invalid. Could you please elaborate a bit on that?
ThreeSteps: A chart pattern is invalid if it closes below the established trend line that confines its repeated range.
It sometimes happens that the price falls out of a pattern, closes below the resistance level, and then shoots above past it. These are market makers moves pushing buyers out of their trades so there is enough liquidity for them to buy. Afterward, they will start to push up the price followed by a breakout.
In this case, having a stop loss close to the lower support trend line can be essential to exit with minor losses. After observing this so-called “spring effect”, one could enter a position again and hope that the momentum continues to go up.
The markets are often full of these ‘irrational’ moves. As many traders would argue, risk-management really is what allows us to make consistently profitable trades without major losses.
DueDEX: Great, thank you very much for your time ThreeSteps!