A modern person receives more than 80% of the information about the outer world through vision. “Visual pictures” are used as data for analysis and, after processing in the subconscious, form certain stereotypes.
Forex visual analysis uses this feature of human psychology to search for sustainable patterns of market behavior.
Charles Dow, the author of the famous stock index and editor of the Wall Street Journal, was the first modern trader to pay attention to the visual patterns of prices and formulate the principles for determining entry points of transactions with minimal risk.
The long-term observations formed the “typical” Forex patterns, that allow you to make the main market forecast – the continuation or reversal of the trend.
The Great Depression of the 30s made a lot of traders and technical analysts unemployed. Perhaps, the presence of free time caused an active development of stock graphics - the first articles by Gann, Schabacker, Elliott, and Wyckoff appeared.
The familiar Forex patterns were first systematized in the Edwards and Magee book called “Technical Analysis of Stock Trends”, 1948.
Today, special indicators have been developed for searching graphic models, but confident skills in searching for such models are required for any trader (see Using Graphic Tools).
Visual analysis is based, in addition to psychology, on the economic factors and reflects a constant search for balance between bulls and bears.
The models help not only determine the direction but also set approximate target levels that the price should achieve in the process of working out the figure.
The trader only needs to identify the patterns correctly and make a decision to enter the market according to the recommendations verified on the price history.
Let's take a closer look.
In fact, no “figures” arise by themselves on the price chart; you must independently “discern” them in the complex of bars. There are no obvious trading signals either – only the forecast of the most probable direction and some key levels.
Any trading technique works with two groups of figures: the continuation of the trend and its reversal. Technical analysts still identify double-interpretation figures with unlikely trading signals.
As a rule, the constructions are carried out at a closing price, although there are alternative opinions - on extreme (max/min) or weighted average values.
Trend continuation patterns define the current state of the market as a technical pause, after which the price moves in the same direction: various flag versions (pennants, wedges), rectangles and zigzags, as well as some price gap options.
Pivot figures suggest a change in the current trend, which requires the accumulation of market “interest” in a new direction. It means that such a model takes much longer to form.
The main ones are: “Head-Shoulders”, “Multiple Top-Bottom”, “Round Top-Bottom”, various types of “Butterflies”, as well as exotic figures “Bowl”, “Diamond”, “Spike”, “Dragon”.
Forex patterns under the general name “Triangles” are distinguished into a separate group, which, depending on the shape, can work either as continuation or as reversal patterns.
Before applying graphic analysis, you need to understand the following rules:
Graphic analysis must necessarily be supplemented by an analysis of trading volumes, since the result strongly depends on the fundamental background (see Using Indicators).
What is the result?
Models (especially reversal ones) give a reliable signal only if the movement is clearly “understood” by the majority of participants, and such periods are present on the market no more than 30% of the total time.
If the “market opinion” is unstable (speculation) or indefinite (flat), then any figures are random in nature and they will not be worked out according to the standard schemes.
Forex patterns allow you to correctly assess the overall picture, but, like any other analysis method, they do not give a 100% guarantee. The market most often does not work out the models completely and money management in such trading should be tough.
Remember: graphic analysis is not for scalpers, and you should not look for “patterns” on the M1-M5 (it's just a “price noise”!).
Sustainable models need deals lasting at least a few hours. If the graphic model was formed on D1, then you need to open and accompany transactions on this timeframe.
You need to work out only a fully formed figure, and not “fantasize” and “draw” on the price chart what is not there. You can never rely solely on visual perception and you always need to confirm the entry points with additional indicators.
As you can see, backtesting is quite simple activity in case if you have the right backtesting tools.
To check this (or any other) graphical analysis you can download Forex Tester for free.
In addition, you will receive 21 years of free historical data (easily downloadable straight from the software).