Ihab Salloum[ad_1]
Reversal Patterns: A Reliable Bearish Reversal Tool
Reversal patterns are a very efficient technical tool. One of the most common and reliable bearish reversal patterns is the “Double Top”. A classic Double Top pattern is formed when the currency pair reaches a certain high, retraces and then reaches again the previous high level. If the pair does not break the previous high level (so that a second top is formed), the probability of a bearish reversal is very high. Like most technical analysis tools, the larger the time frame, the more accurate is the trading signal generated by the pattern.
Swing Forex Trading and Double Top Pattern
For swing forex trading, it is recommended to scan the daily and the 4 hour graphs of multiple currency pairs on a regular basis. The scanning takes only a few minutes per week and the potential is huge. For example, between April 2008 and August 2008, a classic Double Top pattern has been formed in the daily EUR/USD graph, providing a strong bearish reversal signal.
Seizing the Opportunity and Validating the Direction
The opportunity to go short on the basis of this Double Top pattern occurred near the second top of the pattern starting mid July 2008. When the a second top has been formed, it was the right timing to consider placing a “sell” order.
However, most newbies traders might place a sell order in this situation on the basis of the Double Top pattern alone. This is a typical mistake that reflects a wrong trading approach. A technical pattern only IMPLIES that a trading opportunity might be there. You must remember that trading is all about managing risks vs. reward. Therefore, a pattern is a good starter but you must check whether you can validate the direction implied by the pattern with other factors. In the above EUR/USD example, it is absolutely imperative to look for additional factors that can validate the probability of a short position:
Additional Factors for Validating a Short Position
1. All Times High Level: A very important factor in this case was the fact that the EUR/USD reached an “all times high” level (around 1.600) in both tops of the EUR/USD daily Double Top pattern. An “all time high” level is considered a very significant resistance area which strengthens the bearish Double Top pattern.
2. Economic Data and Other USD Pairs: The relevant economic data as well as the behavior of other major USD pairs such as GBP/USD and AUD/USD also supported a bearish reversal in the EUR/USD.
3. Technical Indicators: Finally, you may use some common technical indicators such as moving averages and parabolic SAR. If you are a swing trader you should ignore short term signals and hold the position open for a few days at the minimum.
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