What is formation? What is formation in the stock market? These questions are at the top of the questions that many investors investigate. Technical analysis formation are very important data when trading. Therefore, trading with forex formations allows one to act more rationally with technical analysis knowledge.
Technical analysis patterns allow us to predict future price levels by looking at the past movements of financial products. Technically, it gives us the information in which direction the prices will move. Therefore, the formations should be followed carefully and should be taken into account.
However, it should be noted that not every pattern can give a successful future price prediction. Therefore, the fundamental analysis should be considered along with technical analysis. It will be the most logical move to follow the data and news with the economic calendar and take a position.
Forex and stock market patterns are also known as price patterns. Formations can be considered in two groups. These are trend reversal patterns and trend continuation patterns.
What is Formation?
The visual shapes and formations on a price chart that provide clues as to what values might do next are called patterns. By definition, formation means that more than one learner takes place harmoniously on a plane.
Patterns are distinctive formations created by the movements of prices on a chart and form the basis of technical analysis.
While determining the formations, it is necessary to benefit from the volume. Then we should focus on how we can use the formed formations. Technical analysis patterns can be used to see trends in the price movements of a financial asset.
Chart models visualize all selling and buying by combining the forces of demand and supply into a table. They provide a structure for analyzing the struggle between bears and bulls and help to define who is winning, enabling investors to position themselves accordingly.
After the formation is determined, it is necessary to analyze the support and resistance points, which are important terms. After these points are determined, positions should be taken. Technical analysis patterns are an important trump card in determining non-linear trends.
By looking at the previously formed formations, it is also possible to predict where the prices will go. Formations are critical parts of technical analysis, giving us an idea of whether there will be trend changes and in which areas the prices may shift.
Traders using technical analysis examine price movements that have occurred for a long time and use these price patterns to predict future price movements.
Because price patterns are defined using a series of lines or curves, it is helpful to understand trend lines and know how to draw them. Trend lines help technical analysts identify support and resistance areas on a price chart.
What are Trend Reversal Patterns?
As the name suggests, reversal patterns indicate that the ongoing trend is about to change direction. If a trend reversal pattern occurs during an uptrend, it indicates that the trend will reverse and the price will drop soon.
Conversely, if a trend reversal pattern occurs during a downtrend, it indicates that the price will rise later.
Patterns offer us a chance to predict the direction of prices. Some shapes on the chart give signals that the prices will change the trend. Of course, there is no rule that these signals will always be successful.
In order to comment on the trend change, the formation must be completed. Although most formations give us accurate signals, it is possible to get unsuccessful results if the transaction is entered before the formation of the formation is completed.
If you are new to technical analysis, you should definitely learn the formations well. Because there is a possibility of confusing formations that are similar to each other. It is important to be able to distinguish formations from each other. Therefore, it is best to progress by gaining experience in technical analysis.
In technical analysis, patterns often reveal transitions between rising and falling trends. The resulting price pattern and some trend lines are used to define price movements.
Double Top and Double Bottom Patterns
Let’s start with the double top and double bottom patterns, which are considered important trend reversal signals. Double top and double bottom show us that the market tested the support and resistance levels twice and failed.
In the double top formation, as you can see in the image below, two tops are formed and the tops occur when the price reaches a certain level that cannot be broken. With the break of the support level, a return to the downtrend is made.
In the chart above, you can see that two peaks have formed after a strong move. Note that the second hill cannot break the very top of the first hill. This is a strong sign that a reversal is about to happen because it shows us that the pressure to buy is almost gone.
Looking at the chart, you can see that price has broken the neckline and made a downward move. Remember that the double top pattern is a trend reversal pattern, so you can use them once there is a strong uptrend.
You should also be aware that the drop is almost at the same height as the two top formations. Keep this in mind as this will be helpful in setting profit targets.
The double bottom pattern is too a trend reversal pattern. However, this time, instead of falling, the rise welcomes us. These patterns occur after downtrends where double bottoms form.
From the chart above, you can see that after the previous downtrend, the price formed a double bottom because it failed to break below a certain level. Note that the second low fails to break the first low.
This pattern is a sign that the selling pressure is about to end and a reversal is about to happen. The increase in price occurs almost at the same level as the double bottom. The double bottom pattern is also a trend reversal pattern and can be caught after a strong downtrend.
Head and Shoulder Formation
The shoulder head shoulder formation, which is among the most reliable reversal formations, is mostly seen in uptrends. A peak (shoulder) is formed, supported by a higher peak (head), and then added lower peak (shoulder).
The reason for giving this name to the formation is that the shape is similar to the head and two shoulders of the human. It is defined as the support neckline passing under the shoulders in the formation.
The slope of the neckline can be either down or up. It gives a more reliable signal when the slope is down. You can easily see the shoulder head shoulder pattern in the image above.
The head is the 2nd peak and the highest spot in the pattern. Both shoulders form a crest, but do not pass the top of the head. You can create a spot by measuring the distance between the highest position of the neckline and the head. This distance shows approximately how much the price will move after breaking the neck.
When the price drops below the neckline, you can see that it moves at least the size of the gap between the neckline and head.
Head and Shoulders Bottom
The target is calculated like the shoulder head shoulder formation. A bottom (shoulder) occurs, followed by an also lower bottom (head) and then an extra high bottom (shoulder). These formations appear after prolonged downward movements.
Measure the gap between the neckline and head and this will give the approximate distance the price will go after breaking the neckline. Once you break the neckline, you can see the price increase nicely.
Bowl and Inverted Bowl Formations
The bowl pattern is seen on falling market returns, while the inverted bowl pattern is seen on rising market returns.
A bowl pattern is defined by a series of price movements that graphically form a “U” shape. It is located at the end of extended downward trends and indicates a reversal in long-term price movements.
The timeframe for this pattern can range from a few weeks to several months and is considered a rare occasion by many traders. Ideally, volume and price will move in tandem, where volume confirms price action.
While the horizontal movement continues, although the downtrend ends, the market continues to move horizontally because the buying is not at a sufficient level. Therefore, it can also be seen as a continuation pattern. Trading volume is lowest in the middle of the bowl.
In the following process, the purchases start to increase, albeit a little. As purchases increase, prices rise. If a break occurs when the resistance point is reached, the formation is completed. When the resistance level is broken, the trading volume should also increase. After the resistance is broken, the rise is expected to be as much as the depth of the bowl.
Inverted bowl formation is considered an important sell signal. It is seen at the points where the prices are highest. Prices remain flat at low volumes for a while on the highs.
Then low volume drops are seen. If the break occurs when the support level is reached, the spread will be confirmed. Prices are expected to be as much as the depth of resistance and inverse bowl peak.
What are Trend Continuation Patterns?
They are also known as compression formations. Prices sometimes get stuck in the trend and look for direction. As supply and demand balance each other, there is a pause in prices. When the balance is disturbed, sharp movements can be observed in the market. There are several continuation patterns that technical analysts use to indicate that the price may continue the trend. Examples of continuation patterns are triangles, flags, pennants, and rectangles.
Patterns that show that the trend will move in the previous direction after the price squeeze are called trend continuation patterns. Trend continuation patterns are chart formations that indicate that the current trend will continue.
These are also commonly known as consolidation patterns because they show how buyers or sellers take a quick break before heading in the same direction as the previous trend.
Trends generally run in a straight line, not moving higher or lower. They pause and move sideways and gain momentum to continue the overall trend.
For continuation patterns, stops are usually placed above or below the actual chart formation.
A triangle is formed when the price action on a financial instrument becomes more and more compressed. There are three types of triangle patterns: ascending, descending and symmetrical. In triangle formations, the direction of the price cannot be predicted in advance. Only after the triangle is broken does the direction become clear.
Triangle patterns represent the price move into a tighter range as time goes on and provide a visual snapshot of the struggle between bulls and bears.
The triangle pattern is generally classified as a “continuation pattern,” meaning that after the pattern is complete, it is assumed that the price will continue in the direction of the trend it was moving before the pattern was formed.
Symmetrical Triangle Pattern
It is a formation formed when the ascending level is less than the previous price and the falling level is more than the previous low. What happens during this formation is that the market hits lower and higher lows.
This means that neither buyers nor sellers are pushing the price enough to establish a clear trend. This means that there is a draw in the struggle between buyers and sellers.
As the two trends converge, we can predict that a breakout is imminent. We don’t know which direction the explosion will take, but we do know that the market will most likely explode. Eventually, one of the parties will give up.
In order to see the direction of the trend, it is necessary to wait for the completion of the formation. When this pattern is completed, the current trend generally continues.
Ascending Triangle Pattern
This pattern, which is accepted as a continuation pattern when in the middle of rising trends, is considered as a reversal pattern at the end of downtrends. When the pattern is broken, the price is considered to move up.
To make sure that the pattern is complete, it is necessary to observe whether the movement continues after the resistance line is crossed. False breaks occur in a certain proportion of the formation. Therefore, it should be waited for completion.
Descending Triangle Pattern
These are the formations where the top of the ascent is formed at a lower price level than the previous one, while the lower limit maintains a certain support level. The descending triangle pattern is a continuation of the downtrend.
It is the opposite of ascending triangles. Descending triangle chart patterns have a series of peaks forming the upper line. The bottom line is a support level that the price cannot break.
In the chart above, you can see the price slowly making higher highs, which tells you that sellers are starting to gain ground against buyers. Most of the time, the support at the end of the price is broken and the decline continues. But in some cases, the price may also break above the triangle.
It is necessary to wait for the completion of the formation. Placing an entry order at the top of the triangle and targeting as high as the height of the pattern will yield nice payoffs.
Flag and Pennant Formations
These formations are the name given to corrections that describe periods of a temporary pause in the trend. It continues in the trend direction. After a huge up or down move, sellers or buyers often pause before moving in the same direction.
Therefore, the price often comes together and forms a small symmetrical triangle called the pennant. While the price is still consolidating, more sellers or buyers will usually decide on the powerful move and force the cost to break out of the pennant formation.
Flag and pennant patterns are seen at the mid-levels of the trends. Transaction volumes decline. After the fracture, an increase in volume is also observed. Then the trend continues in the same direction. When they occur in a downtrend, it is seen that they are completed in a shorter time.
A rectangle pattern is a chart pattern that occurs when the price is bounded by parallel support and resistance levels. It is defined as a period of consolidation or indecision in the struggle between buyers and sellers.
The price tests the support and resistance levels several times before finally breaking out. Afterward, the price may trend towards a breakout, whether it is up or down.
In the above example, we can clearly see that the price is limited to two basic price levels that are parallel to each other. A downtrend occurs when the price consolidates for a while during the downtrend. When the opposite happens, that is, if a rectangular formation occurs during an uptrend, the price will show an upward trend.
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