In the previous lesson, we talked about formations, the formation of which means with a high degree of probability the continuation of the prevailing trend. Today we will find out what formations look like, which are a signal of a change in the current trend. This is very useful information because recognition of such a formation can contribute to a substantial profit for the investor or to limit possible losses. Let us remember that the clearer a given formation is, the greater its potential for effectiveness. As formations of trend change, we distinguish, among others:
- Head and shoulder formation.
- Inverted head and shoulder formation.
- Double top and double bottom formation.
- Saucer formation.
Head and shoulder formation (RGR)
In this formation we deal with two arms (two peaks), in the center of which is the highest peak called the head. RGR formation has considerable potential when it is in an upward trend. It is called a pro-decline formation. A distinctive feature is the decrease in volume at the formation of each new peak. The left peak (left shoulder) and right peak (right shoulder) are shaped at a slightly lower level than the middle maximum price (head). The confirmation of the formation of the formation is the subsequent decline occurring with a large volume. We calculate the minimum fall range by measuring the height of the formation from the neck down. An interesting fact is that the neck line does not have to be horizontal, there are also "mutated" formations - having two heads.
Inverted head and shoulders formation (oRGR)
This formation is the opposite of RGR. Due to its nature, it is considered a pro-growth figure - suggesting an increase in the price of the asset in the future. This structure announces the end of the downward trend. The difference between RGR and ORGR is the behavior of the volume. With ORGR, the volume during the formation of the right arm should not only increase, but also exceed the average of the previous two wells and be characterized by a dynamic increase in its size during breakout. Also important is the way the neck line is pierced, which will testify to the quality of the entire formation. The dynamic growth preceded by a large turnover promises a more permanent trend reversal than an increase at a falling volume. The amount of price movement after knocking out of the formation should be at least equal to the height of the head measured from the neck line. ORGR is a formation more difficult to interpret due to, among others that it occurs much less frequently than RGR.
And another example:
Double peak formation
Its shape resembles the letter "M". As the name of the formation indicates, it consists of 2 distinct peaks and is a inheritance formation. The formation of the two highest peaks is accompanied by an increase in turnover, with the turnover at the second peak usually being lower. And another example:
Double bottom formation
This formation, unlike the previous one, is considered a pro-growth formation, and its shape resembles the letter "W". Breaking out of the formation should be accompanied by an increase in volume, which should be a signal to buy. The formation breaks out when the resistance line breaks through, and the theoretical range should be equal to the height measured from the formation's base to its peak. Below we can see that the formation was a signal for us to change the moods that have prevailed on the market so far. The RSI indicator marked with an arrow also began to follow an upward trend, which was an additional reason to suppose that there will be a price break through resistance. The range of growth confirms the validity of our scenario.
Below are some more examples: Double top and double bottom formations are one of the more commonly used technical analysis formations. It should be remembered that in order to fully use their potential, appropriate risk management should be used, which is the key to success in the market.
The formation of the saucer quite often appears on the charts after a period of clear bear market or declines on a given instrument. The nature of the saucer makes estimating the size of a possible rate increase quite difficult. The longer the accumulation period lasts, the greater its significance and possible movement after formation.
And another example:
We have already discussed both the formations that confirm the prevailing trend and the ones that are the first signal saying that the market is starting to change its current direction. Accuracy in determining formations on the chart, sticking to the rules and proper interpretation of what we see is very important here. This will allow us to reduce the risk that we will assess incorrectly formed formations. It is also worth remembering that technical formations do not always coincide with the truth. However, when they are identified in the chart, they help determine the upcoming price movement. At the same time, let us be "back of the head" aware that sometimes the market will want to ignore the formation that we have drawn, which can result in a powerful cold shower. Let's be alert and approach everything with a lot of prudence.