The most popular graphical models in the Forex market
From the variety of methods of analyzing the foreign exchange market, a trader can identify typical methods to save strength, time and money. A trading strategy can be based on frequently recurring graphical models, which can be easily found with certain skills. Despite the general complexity of graphical analysis methods, bars, Japanese candlesticks and Ishimoku indicator can be used as simple trade indicators.
There are two most common graphical models, the use of which as trading signals is quite simple: head and shoulders and a triangle
Head and shoulders (H&S)
If the “head and shoulders” formation is observed in an upward trend, it signals a downward reversal of the market, and vice versa. In an upward trend, there is a new high with a subsequent rollback, then a higher high with a rollback and a lower low. In a downward trend there is a drop in prices to a minimum with a subsequent rollback, then an even lower minimum (head), rollback and a higher minimum (second leverage) (see Figure 1). A turn is considered to have taken place when the neckline is broken (trend line) connecting two highs (in case of a downtrend) or two lows (in case of an uptrend).
Figure 1: EUR/USD Daily chart – Head & Shoulders figure
The “head and shoulders” form provides a great opportunity for trading, as a trader can immediately determine the entry point to the market, the level of stop-loss and possible profit. Figure 1 shows the daily chart of EUR/USD with the formation “head and shoulders”. For this example, the market entry should be at the point of breakdown of the “neckline”, i.e. 1.24.
Stop-loss can be set slightly below the right shoulder at 1.2150 (for conservative traders), or slightly below the “head” (in this case the risk increases, but the probability of getting a stop-loss instead of a profit decreases).
To determine the minimum target profit level when reversing a downward trend, it is necessary to determine the distance from the “head top” to the “neck” line and add it to the point of breakdown of the “neck”.
For the above example, the target profit level is 1.2700-1.1900 (approximately) = 0.08 + 1.2400 (break-down point) = 1.31. The target level is highlighted in the white square in the right corner of the chart in Figure 1.
Triangles are often found on short-term charts and are divided into symmetrical, ascending, descending triangles. Such classification of triangles is purely conditional from the point of view of trading signals. Graphically, the triangle is a constant narrowing of the range of price movements. Figure 2 shows a symmetrical triangle that allows the trader to immediately determine the entry points to the market, stop-loss and profit target levels.
The entry point is a triangle breakthrough (level 1.4032 for this example). To determine the target profit level it is necessary to postpone the height of formation from the entry point (1.4032). In this case, the formation height is 25 points, so the target level is 1.4057.
Figure 2: 5-minute EUR/CAD chart – symmetric triangle
Candlestick charts contain much more useful information than line charts, bars or histograms. For this reason, Japanese candlesticks are an extremely useful tool for estimating price movements on almost any time period.
There are many candlestick models, but the most popular model for trading in the Forex market is the absorption model. Absorption model provides excellent trading opportunities, as it is easily recognized on the chart, and price movements in the opposite direction are immediate and strong enough. For a downward price movement, the reversal signal is the upside candlestick absorption of the previous downside candlestick (bullish absorption).
For an uptrend, a reversal signal is a downward candle absorption of a previous uptrend candle (bearish absorption). Trading on this graphical model is easy in practice, as a reversal candlestick can be a signal of a strong market movement in the opposite direction to the current trend.
A trader can take part in the emerging trend with simultaneous use of stop-losses. Figure 3 shows the bullish absorption, which became a prerequisite for an upward trend. The entry point is the opening price of the bar following the absorption candlestick (in this case, 1.4400). The stop-loss is slightly below the minimum of the absorption candlestick (at the level of 1.4157). This graphical model does not allow you to determine the target profit levels (more detailed information about Japanese candlesticks is given in the article Basic combinations of Japanese candlesticks).
Figure 3: EUR/USD daily chart – bullish absorption model
The Ishimoku indicator itself is not useful in practice, but is used in conjunction with the price chart. The Ishimoku indicator is based on the use of past price data to form the current dynamic support and resistance lines. From a practical point of view, if the price is higher than the cloud, it is recommended to take long positions, and the cloud itself will act as a support.
If the price is below the cloud, it is recommended to take short positions, and the cloud will act as a resistance. The Ishimoku cloud is a continuation figure and allows the trader to identify entry points to the market that are not visible at first glance. If there is a directional movement, a trader can use this indicator for several market entries (Figure 4) (for more information about the Ishimoku indicator, see the article Using the Ishimoku indicator for Forex trading).
Figure 4: USD/CAD – Ishimoku cloud
In September 2010, during the downward trend there were 8 potential market entries, when the price of the currency pair entered the cloud, but could not overcome it. As an entry point into the market it was possible to use the moments of the price’s return from the cloud, because this situation signals the completion of the correction and continuation of the downward movement. The outer edge of the cloud can be used as a trailing stop as the cloud moves down with the price movement. The Ishimoku indicator works most effectively for trend currency pairs containing USD
There are many trading methods based on the use of graphical models for determining entry and exit points to and from the market. Head and Shoulders” and “Triangle” formations can be easily applied in practice to determine the moments of position opening and setting stop-losses and Take Profits.
Absorption figures allow a trader to quickly determine the trend reversal and open a deal in the direction of a new movement using a competent stop-loss. The Ishimoku indicator allows you to use a lot of market entries with a trailing stop-loss within a long-term trend. As you develop your professional skills, you can combine the use of different graphical models to create your own unique trading system (to learn how to trade on Forex you will be helped by the article 9 steps of a successful trader)