We study the features of pattern formation and build trading strategies based on it
Tell me who your friend is and I will tell you who you are. Proponents of trend trading take the trend into their allies. However, to start a friendship you need to know the person. That is, to identify in which direction the quotes of currency pairs are moving. Some traders use analytical lines for this, others prefer moving averages, indicators or other technical analysis tools. However, the simplest rule is: a “bullish” trend is a combination of rising extremes, a “bearish” trend is a combination of lowering extremes. Thus, to identify a downward trend, at least two successively formed highs and lows must be available. The third peak may be the key to building a trading strategy.
On the four-hour USD / CAD chart, until the quotes touched the 1-2 line drawn through two declining highs, there were at least two signs of a reversal of the previously existing bullish trend. Firstly, a break of the trend line was recorded. Secondly, the lows began to fall simultaneously with the highs. As a result, point 3 was formed and the graphic configuration called “Three Touch” was completed.
The appearance of the pattern is the initial link in the trading system. Based on it, you need to construct a strategy. For greater certainty, it would be nice to have at hand confirming signals, which are usually called filters. They may include both price action tools and other areas of technical analysis. As our previous studies showed, models 1-2-3, Anti-Turtles and Three Indians show themselves well in the correction. In the case of USD / CAD, the appearance of the last pattern served as the basis for the conclusion of the transaction. The return of quotations to a minimum of the bar of the second Indian gave a signal about the possibility of entering the short. A protective stop order was set at the maximum rollback plus a few points, which allowed to maintain a short position after a slight increase in the US dollar against its namesake from Canada.
A position is closed using the “Shark” pattern of harmonious trading, studied in one of the previous materials. Its target is 88.6% located two figures below the entry point, which suggests a significant excess of potential profit over losses. In this example, the profit factor is 4 to 1.
Thus, the “Three Touch” model allows you to identify the area of convergence and is a prerequisite for building a trading system, but many traders, as a rule, do not have enough to conclude a deal. Additional signals are desirable, including previously studied patterns or indicator readings. For example, the divergence and the exit of the stochastic indicator from the overbought area will significantly increase the trader’s confidence in working out the above strategy.
In my opinion, “Three Touch” is a simple and intuitive model for trend trading. It can be identified on any type of chart, that is, it is built not only by extrema but also by closing quotes (in the case of a line chart). However, the trader must initially determine exactly where he will look for the pattern and which filter system will be useful for this. Otherwise, it is very difficult to cope with attempts to find a graphical configuration where it actually is not.