The Number One Clue a Chart Pattern Is Likely to Fail

10/22/2010 12:01 am EST

Focus: FOREX

I warn of “long bars” near the completion of a pattern in nearly every trade I put on FX360.com. The reason for this is that they are the number one signal that a pattern is likely to fail. Of course, some patterns are going to fail and some patterns are going to win; there is nothing anyone can do about that, and no one wins them all.  However, long bars are the number one red flag that indicates we should not take a trade when utilizing our geometric pattern recognition that we use on FX360.com.

Geometric pattern recognition is a methodology that attempts to find points of significant support or resistance.  In other words, we are looking for a reversal in price action. If the price is falling, we are looking for it to begin to rise at the point we suggesting going long. If the price is rising, we are looking for it to fall at the point we suggesting going short.  

Since we are looking for reversals, we want to enter our trades with as little momentum as possible. The more momentum a currency pair has, the more force it requires to reverse. Long bars are simply an indication that there is a lot of momentum, or force, that will have to be reversed at the entry point. In turn, long bars near the entry of the trade decrease the probability that the trade will reverse as the pattern suggests.

There is no simple way to measure what a "long bar" is, and there are several reasons for this. First, every currency pair has a different range. A 100-pip bar on the NZD/USD is relatively longer than a 100-pip bar on the GBP/CHF. Additionally, each pattern is different. Some patterns are much smaller than others, so it is difficult to put a "pip" value on a long bar. Even if we defined a long bar as a percentage of the CD leg (of an ABCD pattern, shown below), this could vary whether we were viewing the pattern on a 30-minute chart or a two-hour chart.  

Click to Enlarge

So how do we determine long bars? If CD is one very long bar, that one is obvious. However, sometimes, long bars are more subjective. The easiest way to tell is to look at the price symmetry. A quick way to determine asymmetry is if the CD leg has a much steeper slope than AB. This indicates CD moved more rapidly than AB, and therefore, CD likely has more momentum than AB. If CD completes before the hypothetical D (as in this chart), it is likely their are long bars. If AB and CD have approximately the same slope, we call this a "symmetrical" pattern. Also, when taking a trade, we want to look for deceleration into the entry, not acceleration. Therefore, if there is a long bar at the beginning of the CD leg, but the pair decelerates so that the overall slope of CD is roughly equal to AB, the trade is probably okay to take.

The moral of the story is that if it looks like the pair is accelerating into the entry or there are clear long bars, simply wait for the next trade. The market provides a never-ending stream of trading opportunities. Even if you miss one that would have been profitable, it is not the end of the world because there will be more than enough trades in the future. In conclusion, if you suspect there are long bars, there probably are. It may be tempting to enter that trade you have been waiting on for a day or two, but in the long run, it is better to pass on long bars and wait for patterns that are symmetrical.

By Bradley Gareiss, technical analyst, GFTForex.com

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