How to Pick Tops and Bottoms in any Market

Daniel L
Category:  Trading Courses
For a trader, only one thing matters: to win. Of course, that’s not possible all the time.
In fact, most of the trades probably end up being losers. It is only normal.
What matters is that the sum of all trades is positive. To reach a positive outcome over a defined period, traders use different tools.
From technical analysis to fundamental one, from indicators to oscillators, from one trading style to another, everything must correlate in the grand scheme of things. On top of that, it all must fit into the proper money management strategy.
Money managers of all types deal with assessing risk. And, any portfolio has different parts that bear different risks.
Imagine you want to open a private pension account. You go to your bank and ask for such a program, and you’ll be offered the possibility to have a conservative, moderate and aggressive investment strategy.
The same in Forex trading. Different strategies have a different risk degree. Some require an aggressive attitude to market, while others are more conservative.
Picking tops and bottoms when trading the Forex market seems almost suicidal. Regardless of the approach, strategies that deal with tops and bottoms bear more significant risks than others.
This course aims to explain some popular patterns that form at the top or bottom of a trend. In doing that, we’ll use both Western and Japanese approach to technical analysis.
But this is a subject covered in detail by various sources. Instead of listing the same patterns again, the idea is to focus on the ones that don’t appear so often but are extremely powerful.
Among others, we’ll cover concepts like:
  • Dark-cloud cover and piercing
  • Doji as a reversal pattern
  • Triple bottoms/tops
  • Triangles
 

Chapter 1 – Triangles that Form at the End of Trends

When the market consolidates, it tends to form triangular patterns. As such, when you expect consolidation to take place (like when the market waits for a big news release), the first pattern that comes to mind is a triangle.
Triangles are wonderful patterns. Traders use a set of clear rules to deal with them, and the outcome is rewarding.
Ralph Elliott laid the best set of rules to use with a triangular pattern. While the concept of a triangle already existed in the Western approach to technical analysis, no one looked at triangles the way Elliott did.
Therefore, a triangle:
  • Has five segments, labeled with letters, starting with the letter a.
  • Has two trend lines that define the pattern: the a-c and b-d trend lines.
  • Ends when the price breaks the b-d trend line.
For traders, the focus stays with the b-d trend line. Most of these triangles appear as a continuation pattern. Or, in the middle of a trend.
However, in some cases, they act as reversal patterns. When this happens, the first leg of the triangle, or wave a, represents the actual top or bottom.

The EURGBP chart above shows such a triangle at the end of a bullish trend. What followed was pure technical analysis:
  • The price broke the b-d trend line
  • Retested it
  • And then was rejected aggressively, with wave a being the actual top

Chapter 2 – Dark-Cloud Cover and Piercing as Tops/Bottoms

Now that we have discussed a pattern part of the Western approach let’s have a look at Japanese candlesticks. Mostly reversal patterns, they aim to show a trend’s reversal.
The dark-cloud cover and the piercing patterns are similar, only that they form at the end of different trends. As such, the first one forms at the top of a trend, while the last one at the bottom.
A bullish and a bearish trend must exist, for traders to consider trading these patterns.
The pattern has only two candles. This is the most significant advantage the Japanese candlesticks have over the Western pattern recognition approach.
Consider the triangle mentioned in the previous chapter. It took plenty of candles for it to reverse the previous trend. What if there’s a pattern to show the same thing earlier?
For a dark-cloud cover, the two candles that form the pattern must be opposite. Namely, one bullish and one bearish.
On top of it, the bearish one must retrace the bullish candle minimum 50%, but less than 100%. Just like in the chart below:


Yes, that’s the same EURGBP chart used for the triangular formation. And, the dark-cloud cover formed right at the end of the e-wave.
In other words, it gave aggressive traders a reason to enter on the short side earlier. Why waiting for the b-d trendline’s break when one can have a better entry?
Naturally, the piercing pattern forms at the end of a bearish trend, and the two candles show bullish conditions.
Other Japanese candlesticks patterns to form at the top or bottom of a trend are:
  • The candle. One candle that shows hesitation, having the same opening and closing levels.
  • Bullish and bearish engulfing
  • Morning and evening stars
  • Hammer and shooting star

Chapter 3 – Triple Tops and Bottoms

Double and triple tops and bottoms are part of the classic technical analysis. For ages, traders/speculators looked at market behavior at the end of a trend.
That is, after the fact. Next, they documented the patterns and established a set of rules to use next time.
The main problem with most of the classic patterns is that the entry comes only after the pattern forms. And, in some cases, this can take quite some time.
Double tops and bottoms form more often than triple ones. Even on the Forex market, triple tops/bottoms rarely appear.
But when they do, they signal a sharp reversal. Take this USDCAD from below.

Just recently, it topped at the 1.30 mark. It just didn’t have the power to break through.
After the third attempt, the bears took control and sent the pair in a vicious eight hundred pips bearish move.
Triple tops or bottoms almost always have a triangular componence. Can you spot a triangle on the chart above?


The market did break lower, the b-d trend line was retested, and bears celebrated victory.
However, while not a rule, there’s a saying in Forex trading: triple tops and bottoms rarely hold. In this case, it did hold, but for how long?
 

Conclusion

Traders look at markets from different perspectives. Some feel more comfortable investing, hence having a bigger time-horizon for their entries.
Others like quick action and take plenty of trades each day. In both cases, reversal patterns offer the potential for higher results.
But they come with higher risk. Unless a sound money management system is in place, the trading account has difficulties to grow.
Such a system:
  • Has a well-defined risk and reward. An appropriate risk-reward ratio for the Forex market today is somewhere between 1:2 and 1:2.5. It means that for every pip risked; there’s the potential of earning two or two and a half pips. Moreover, the system must apply to all trades.
  • Works best with Japanese candlesticks patterns. Because they allow for an earlier entry, traders have an “edge,” in the sense that the risk-reward ratio can reach elevated levels.
  • Must allow riding trends. For this to happen, moving stops at break even and trailing stops work best.
To sum up, managing risk is everything. You can do whatever you want, having the riskier approach to trading as one can imagine, and do alright if there’s money management in place.
Because most of the times picking tops and bottoms represents countertrend trading, most traders refuse to focus on reversal patterns. However, they’re among the most profitable ones.
 
 
 
 
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