SMC - Psychology behind chart patterns
There are some general rules you need to understand, for all scenarios involving chart patterns. And this is because they don't form all the time as the books describe, and you need to think outside the box, and look inside the patterns.
1. At any given price level in the market, there will always be people thinking that the price is good to sell or buy.
You can see this in red and green arrows. This is the ¨fight¨ between bulls and bears, before deciding the winner.
2. Every break can turn into a false break. This phenomenon is usually called SL haunting. A good example of this is the head, from head, and shoulders pattern.
3. Candlesticks patterns are forming at support and resistance levels, and they are creating accumulation areas of order volumes. This means that there will be high liquidity for the institutions to open trades. Volume Profile is added on the chart to point this out.
4. Same patterns that retail traders are seeing, there will be seen by institutional traders also. Institutions will usually push the price back after the break, to add to their position. You can see the price retesting support levels in all examples.
5. Each individual trader has different creativity, this means that the patterns will not always be seen on the chart, in the same way by all traders, and they will not be developed perfectly in all situations. Don't try to find the perfect pattern.
These are just a few examples of chart patterns
Chart 1 - Descending triangle - continuation pattern
Price is consolidating at a rounded price, chart example is 0,7. There are buyers hopping for the price to go up from there ( green arrows) and they are ¨protecting¨the support level.
At the same time, there are institutional sellers pushing down of 0,700 with every opportunity. This will not allow for TP of buyers to be reached, and it will end up with many buy trades, accumulating at the support area.
When the SL of buyers is getting hit, matching volume to the sell orders, the price will fall sharply. A retest will happen so that will give another chance to institutional traders to add more to their position.
Chart 2- Flag - continuation pattern
The same bull and bear fight, together with uncertainty, will move the price up and down, between support and resistance levels, around the psychological level of 1700.
High volumes will accumulate on both sides of the flag, and so, if the price will break on the downside, this means that the sellers have won, and the price will continue to fall. Price will retest the support level, for a second entry chance.
If the price is breaking to the upside then the pattern is invalidated. It is not recommended to trade in the opposite side of flag patterns, because those types of invalidation breaks, can often be false breaks.
Chart 3- Head and Shoulders - Reversal pattern
Price is reaching a resistance level, and a psychological 145 level.
Here there will be again, bulls and bears fighting. At the neckline will happen the same phenomena as with the triangle. Every time buyers are adding to the position, they will be stopped by sellers to get TP hit, so many buying volumes will accumulate at the neckline.
Another important event, is that there are traders entering short with SL at first shoulder, and then they will get SL hunting and get their SL hit. This will form the Head of the pattern.
The last shoulder is another failed attempt of buyers to reach TP.
The best entry is again on retouch of the support line, or neckline.
Chart 4 -Ascending triangle - continuation pattern
Same as chart 1.
Chart 5 - Side channel - double bias pattern
The price is reaching a support level, and a psychological 105 level, creating high volumes both at the support and resistance levels of the channel.
The same type of fight between buyers and sellers. Winners will be institutions that will need high liquidity for the desired direction of the trade.
Usually, the price will continue to move in the direction the channel was broken, but many times, there will be false breaks.
Chart 6 - double bottom - reversal pattern
Many times, what starts like a double bottom or top, can develop in some type of triangle, flag, or pennant.
In this example, the price is breaking thru an important psychological level, 80, and there are traders wanting to buy at this level, hoping they got a cheap price.
Price will develop the double bottom pattern, and also provide liquidity for institutional traders by hitting SL of buying orders at 80. Institutional traders will get 2 chances to buy at the lowest price, and another chance to add to the position on the retest.
NOTE: these patterns are forming in the best interest of institutional traders. When trading patterns, do not trade only the concept of patterns. Try to think outside the box, and always ask HOW and WHERE the institutions will benefit the most from the given situation.
Also, you always need to consider false breakouts, as an opportunity for institutions to get more liquidity and to add more to their position.
These scenarios are personal interpretations based on 15 years of experience in trading, but if you do not agree with something, then it is OK, because every seller has a matching buyer, so then, you are just on the other side of the trade :)
1. At any given price level in the market, there will always be people thinking that the price is good to sell or buy.
You can see this in red and green arrows. This is the ¨fight¨ between bulls and bears, before deciding the winner.
2. Every break can turn into a false break. This phenomenon is usually called SL haunting. A good example of this is the head, from head, and shoulders pattern.
3. Candlesticks patterns are forming at support and resistance levels, and they are creating accumulation areas of order volumes. This means that there will be high liquidity for the institutions to open trades. Volume Profile is added on the chart to point this out.
4. Same patterns that retail traders are seeing, there will be seen by institutional traders also. Institutions will usually push the price back after the break, to add to their position. You can see the price retesting support levels in all examples.
5. Each individual trader has different creativity, this means that the patterns will not always be seen on the chart, in the same way by all traders, and they will not be developed perfectly in all situations. Don't try to find the perfect pattern.
These are just a few examples of chart patterns
Chart 1 - Descending triangle - continuation pattern
Price is consolidating at a rounded price, chart example is 0,7. There are buyers hopping for the price to go up from there ( green arrows) and they are ¨protecting¨the support level.
At the same time, there are institutional sellers pushing down of 0,700 with every opportunity. This will not allow for TP of buyers to be reached, and it will end up with many buy trades, accumulating at the support area.
When the SL of buyers is getting hit, matching volume to the sell orders, the price will fall sharply. A retest will happen so that will give another chance to institutional traders to add more to their position.
Chart 2- Flag - continuation pattern
The same bull and bear fight, together with uncertainty, will move the price up and down, between support and resistance levels, around the psychological level of 1700.
High volumes will accumulate on both sides of the flag, and so, if the price will break on the downside, this means that the sellers have won, and the price will continue to fall. Price will retest the support level, for a second entry chance.
If the price is breaking to the upside then the pattern is invalidated. It is not recommended to trade in the opposite side of flag patterns, because those types of invalidation breaks, can often be false breaks.
Chart 3- Head and Shoulders - Reversal pattern
Price is reaching a resistance level, and a psychological 145 level.
Here there will be again, bulls and bears fighting. At the neckline will happen the same phenomena as with the triangle. Every time buyers are adding to the position, they will be stopped by sellers to get TP hit, so many buying volumes will accumulate at the neckline.
Another important event, is that there are traders entering short with SL at first shoulder, and then they will get SL hunting and get their SL hit. This will form the Head of the pattern.
The last shoulder is another failed attempt of buyers to reach TP.
The best entry is again on retouch of the support line, or neckline.
Chart 4 -Ascending triangle - continuation pattern
Same as chart 1.
Chart 5 - Side channel - double bias pattern
The price is reaching a support level, and a psychological 105 level, creating high volumes both at the support and resistance levels of the channel.
The same type of fight between buyers and sellers. Winners will be institutions that will need high liquidity for the desired direction of the trade.
Usually, the price will continue to move in the direction the channel was broken, but many times, there will be false breaks.
Chart 6 - double bottom - reversal pattern
Many times, what starts like a double bottom or top, can develop in some type of triangle, flag, or pennant.
In this example, the price is breaking thru an important psychological level, 80, and there are traders wanting to buy at this level, hoping they got a cheap price.
Price will develop the double bottom pattern, and also provide liquidity for institutional traders by hitting SL of buying orders at 80. Institutional traders will get 2 chances to buy at the lowest price, and another chance to add to the position on the retest.
NOTE: these patterns are forming in the best interest of institutional traders. When trading patterns, do not trade only the concept of patterns. Try to think outside the box, and always ask HOW and WHERE the institutions will benefit the most from the given situation.
Also, you always need to consider false breakouts, as an opportunity for institutions to get more liquidity and to add more to their position.
These scenarios are personal interpretations based on 15 years of experience in trading, but if you do not agree with something, then it is OK, because every seller has a matching buyer, so then, you are just on the other side of the trade :)
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