Profitable Chart Patterns in Forex and Stock Market: Fibonacci Analysis, Harmonic Pattern, Elliott Wave, and X3 Chart Pattern

By Young Ho Seo

About This Book

 

This is an introductory book for the chart patterns, which can predict the turning point in the financial market. This book provides the introductory guide for Forex and Stock market trading with these price patterns. The patterns covered in this book include Fibonacci Price Patterns, Harmonic Patterns, Elliott Wave, and X3 Chart Patterns. We provide one unified scientific framework over these chart patterns with some practical examples. This book also provides the detailed description on both geometric and numerical support and resistance in the special chapter. At the end of the book, we provide you the several practical tutorials to help your understanding with these chart patterns. Each chapter provides the self-testing questions to ensure your understanding except few chapters. If you want to read my other two books including "Guide to Precision Harmonic Pattern Trading" and "Scientific Guide to Price Action and Pattern Trading", I recommend to read this book first because this is an introductory book.

• Language: English
• Publisher: www.Algotrading-Investment.com
• Release date: Jul 25, 2019
• ISBN: 9781393764137

Young Ho Seo

Young Ho Seo is an Engineer, Financial Trader, and Quantitative Developer, working on Trading Science and Investment Engineering since 2011. He is the creator of many technical indicators, price patterns and trading strategies used in the financial market. He is also teaching the trading practice on how to use the Support, Resistance, Trend line, Fibonacci Analysis, Harmonic Pattern, Elliott Wave Theory, Chart Patterns, and Probability for Forex and Stock Market. His works include developing scientific trading principle and mathematical algorithm in the work of Benjamin Graham, Everette S. Gardner, Benoit Mandelbrot, Ralph Nelson Elliott, Harold M. Gartley, Richard Shabacker, William Delbert Gann and Richard Dennis. You can find his dedicated works on www.algotrading-investment.com. His life mission is to connect financial traders and scientific community for better understanding of this world and crowd behaviour in the financial market. He wrote many books and articles, which are helpful for understanding the technology and application behind data mining, statistics, time series forecasting, fractal science, econometrics, and artificial intelligence in the financial market.

Book preview

1. Turning Point and Trend

If you want to become profitable trader, the first thing you need to understand is turning point and trend in the financial market. If you read many trading articles and books, you will find the diverse opinion over turning point and trend. Many people view turning point and trend as two separate subjects. However, it might be better to understand turning point and trend as one whole subject. Let us try to understand the trend. To do so, let us take human as an analogical example. We are born, we grow up, we become mature, and then we die. During this process, we can observe that there are four main stages. These four stages are universal across many creatures and objects observable in the earth.

Birth – Growth – Maturity – Death

Trend also goes through these four stages. Let us take an example in the financial market. For example, if we hear that Apple Inc. has some temporary problem in their smartphone supply line, this could stir up the stock price of Samsung Electronics because the demand for Samsung’s smart phone will be increased. Once this news is spread on the financial market, the upward trend will be born for Samsung’s stock price. At the beginning, this news could be known by few people. Later, more and more people could hear this news. Hence, Samsung’s stock price can build up upward momentum. However, this momentum will not last forever. Once people start to recognize that price rallied too high and some people start taking the profit by selling the stocks, the upward momentum can slow down. Especially, if we hear that Apple recovered the temporary problem in their smartphone supply line, the trend could die completely. As shown in this example, Birth, Growth, Maturity, and Death are the life cycle of trend (Figure 1-1).

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Figure 1-1:  Process of birth of new trend in stock market

Now let us revisit the definition of turning point and trend. Turning point is the beginning of new trend after the death of an old trend. Hence, turning point strategy refers to the strategy that tries to pick up this new trend as early as possible. This sometimes involves picking up the turning point at the birth stage of the trend. In financial trading, trend strategy typically refers to the strategy that tries to pick up the trend during the growth stage. Hence, most of trend strategy we know is in fact momentum strategy. When the growth of trend is strong, many technical indicators are designed to react on this strong growth.

Therefore, most of trend strategy provides you entry at the growth stage not at the birth stage. For example, if you trade on the buy signal when 20 moving average line crosses over the 50 moving average line, you do need strong upwards movement to lift the 20 moving average line over the 50 moving average line.

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Figure 1-2:  Buy entry confirmed by moving average cross over strategy

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In contrast to this, in turning point strategy like Fibonacci price patterns, Harmonic patterns, Elliott wave patterns and X3 patterns, we are looking for the newly born trend instead of the trend in growth stage. Hence, the main difference in turning point and trend strategy is when to enter during the life cycle of trend. Typically, we are seeking to enter near the birth of trend in the turning point strategy. In trend strategy, we are seeking to enter at the growth stage of trend. From Figure 1-2 and Figure 1-3, you can probably see the big difference between these two strategies.

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Figure 1-3:  Buy entry confirmed by harmonic pattern (Image Source: Optimum Chart)

In our example, we considered only one trend. In practice, situation is tougher because we will have many financial and political news released in 24/7 days. Hence, we have to deal with the collection of trends instead of one trend. Some trends will be cancelled off each other and some trends will be adding up to form bigger trend. As a result, sometimes, this collective trend can have a clear direction. However, sometimes, we may not see clear direction from this collective trend but just ranging movement. At the same time, we could have many short-lived trends confusing our entries. Therefore, our trading strategy is subjective to probability of success rate regardless of that you are using turning point strategy or trend strategy.

In trend strategy, your entry will be at the strong trend movement during the growth phase. This might be good if our entry is not too late. However, if we are late, then we will encounter the loss from early enterers starting to materialize their profits. In turning point strategy, we are trying to pick up the new trend as early as possible in their birth stage. Therefore, it gives you the opportunity to become early enterer. Hence, the profitable range is longer than typical trend strategy. In addition, you can also quit your position much earlier than other trend strategy players can.

The longer profitable range means that we need fewer trades to achieve good profits. At the same time, there are some weaknesses of the turning point strategy too. For example, turning point strategy might signal buy or sell entry too early while the ongoing trend was not finished. Since both trend and turning point strategy have their own strength and weakness, it is possible that you can compromise between turning point strategy and trend strategy too. For example, you do not immediately trade at the turning point signal but you can wait until you observe that some price movement is following the new trend direction. Therefore, this becomes semi-turning point strategy. Many of good traders use semi-turning point strategy since they are the hybrid of turning point strategy and trend strategy. The fact is that skills to predict the turning point is important for successful trading regardless of you are trading with turning point strategy or semi-turning point strategy. Even though you are trading with trend strategy, it is still advantageous to have good skills in predicting turning point. Hence, the methodology of predicting turning point was sought after by many legendary traders in the financial market nearly 100 years. It is one clear piece of winning logic for successful trading helping You act faster than other trader.

Figure 1-4:  Profitable range for turning point strategy, semi –turning point strategy and trend strategy

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Questions on Turning Point and Trend

Please attempt to answer to all these questions after you have read about turning point and trend within 10 minutes.

1. Among these four, which one is not the four main stage of trend development?

a) Birth

b) Chaos

c) Growth

d) Death

2. Which one provides fastest buy entry among these?

a) Semi turning point strategy

b) Trend strategy

c) Momentum strategy

d) Turning point strategy

3. Which one is the wrong statement?

a) Some trend can have extremely short lives.

b) In real world, we need to deal with one resulting trend.

c) In real world, most strong trend will move the market.

d) In real world, we get ranging move because combined trends do not show clear direction.

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4. Which one is the right statement?

a) Turning point and trend are not related.  

b) There are some stocks, which do not show turning points.

c) There are some stocks only growing up

d) Outcome of our trading strategy is subjective to probabilistic nature.

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5. Which one is the right statement?

a) Currency trading and stock trading shares many analytical techniques.

b) Financial trading is not connected to math.

c) Financial trading is not connected to physics.

d) History of financial trading is less than 90 years.

6. Which one is the right statement?

a) Sometimes, turning point strategy can signal buy entry too early when the ongoing trend is not ended

b) Sometimes, trend strategy can signal buy and sell entry too late.

c) Semi turning point strategy is hybrid between turning point and trend strategy.

d) High leverage is always necessary for my trading.

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7. Which one is the right statement?

a) We can make profit in long run without risk management in forex and stock market trading. 

b) Consistent profit comes from knowledge on the trading strategy and risk management discipline.

c) Buying lotto and financial trading is the same.

d) To become a trader, you need to be good at math.

8. Which one is the right trading strategy describing this entry?

a) Moving average cross over

b) Fibonacci Retracement (Fibonacci Price pattern) trading

c) Harmonic Pattern Trading

d) X3 Pattern Trading

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9. Describe the weakness of turning point strategy and strategy to overcome the weakness

10. Describe the weakness of trend strategy and strategy to overcome the weakness

2. Patterns are Good Predictor of Turning Point

To have the good skills in predicting turning point, it is important to understand why turning point occurs in the financial market. Now let us question backwards Do we have any stock price in smooth growth curve or smooth declining curve? Smooth curve or straight line is good because it is easy to predict their next movement. Unfortunately, we will never have this sort of easy situation for our trading.

Figure 2-1: Trend shapes defined by Scientist and Engineer

Even though some company’s stock price grown up for last 10 years like Google (Alphabet Inc.), we will continuously see down price move (i.e. swing low) after up price move (i.e. swing high) and vice versa. To the chartist, this sort of move is defined as price swings or zigzag movement. The zigzag price path is due to both fundamental reason and psychological reason. People do not like if the stock price is over-valued or under-valued under the given fundamental for the stock. For example, if the company has the surprise earnings, then stock price can go up high. However, once people think it went too much, price would start to come down. People do not see the attractive price if the stock price is going up too quickly in the short period. In this case, without too much valid reason, stock price can just come down. We are just scared to see anything goes too extreme psychologically. Likewise, if stock price is going down fast due to some bad fundamental news, in theory, we should not buy the stock. In practice there are some people think that stocks are cheap to buy. Hence, price start to make its own correction. Like this, financial market has the endless feedback loop ensuring the price is not moving in one direction. Instead, price will move down after bullish rally and price will move up after bearish rally. This mechanism forms the zigzag price path. Hence, stock and currency price series will continuously show turning point, either high to low or low to high.

Figure 2-2: Zigzag price movement in Google (Alphabet Inc.)

So what are the good ways of handling the buy and sell decision in stock and currency market? Fortunately, you are not the only one suffering from this decision problem. Many pioneer traders visited the same question before. In their conclusion, to study this sort of zigzag price path, the best way is to look at the patterns that are made up from zigzag price path. Hence, we will be cutting out some of the patterns from the long price series and then we will exam the cut out patterns with a special microscope designed for this purpose. Many legendary traders opened up ways to study these patterns. The focus in the pattern study is to find repeating patterns that are able to capture the profit with good success rate. History of these patterns goes back nearly 100 years.

Firstly, the simplest and easiest method is use of Fibonacci price patterns. In Fibonacci price patterns, we cut out the patterns made up from three or four zigzag points to predict the potential turning point. These patterns are respectively used to measure retracement and expansion. The peculiar point to the Fibonacci price patterns is that we use Fibonacci ratios derived from Fibonacci sequence numbers. Common Fibonacci ratios used by traders include 0.382, 0.500, 0.618, 0.782, 1.000, 1.272, 1.618, etc.

Figure 2-3: Fibonacci price pattern example

The second method to study the patterns that are made up from zigzag price path is Harmonic pattern. In Harmonic pattern, we will cut out the patterns made up from four to five zigzag points to predict market turning point. The history of the Harmonic pattern goes back to the Gartley’s book Profits in the Stock Market in 1935. At that time, Gartley described the trend reversal pattern, made up from five points, on page 222 of his book. The pattern become popular in 1990s (Pesavento and Shapiro, 1997). Since then, many traders developed the common interest in looking for the similar patterns described in the Gartley’s book. Since Harmonic pattern uses Fibonacci ratios, some people consider Harmonic pattern as an advanced Fibonacci price patterns.

Figure 2-3: Harmonic pattern example

The third method to study the patterns that are made up from zigzag price path is Elliott Wave theory. Unlike previous two methods exam the cut out patterns from the long price series, Elliott created a general theory in studying zigzag patterns. This general theory is called the Elliott wave principle or Wave principle. The advantage of Elliott Wave theory is that it is comprehensive as the theory provides multiple trading entries on different market conditions. Disadvantage of Elliott Wave theory is that it is more complex comparing to other trading techniques.

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Figure 2-4: Elliott Wave 12345 pattern example

The fourth method to study the patterns that are made up from zigzag price path is X3 Pattern framework. X3 Pattern framework is the latest pattern detection methodology. It extends the retracement and expansion ratios to define various profitable patterns in simple and intuitive manner (Seo, 2017). X3 Pattern framework allows to define the patterns that are made up from zigzag price path in one unified pattern framework. In addition, X3 pattern framework allow you to explore the classic patterns and non-classic patterns that are not described in the Fibonacci price patterns, Harmonic patterns, and Elliott Wave patterns. Once you have learned the basic logic of defining profitable patterns using X3 Pattern framework, you would be able to customize the existing patterns and to create new patterns to improve your trading performance.

Figure 2-5: X3 Pattern example

We have briefly outlined four methods to study turning points. Detecting these patterns can be done manually. However, you can also use an automated scanner. The technology of detecting price patterns was developed since the appearance of electronic trading platform. Hence, automated pattern scanners are around with us nearly few decades. However, for the educational purpose, we will recommend to detect these patterns manually in this book. When you are detecting these patterns manually, you will have the insight around the automated pattern scanner too. If you are start relying on automated pattern scanner without practicing manual pattern detection, you will get less benefit from the automated pattern scanner.

For manual pattern detection,