H&S bottom playing out in EURUSD

7.15 gmt

The EURUSD has completed a H&S pattern on the hourly charts when it closed above 1.3390. The minimum measured move should take us to 1.3490, and probably to a test of the recent high at 1.3520.

I’ve found certain technical patterns very reliable. Among them is the H&S top and H&S bottom. I have read a lot of the literature  there is on classical technical analysis, including Elliot waves and a bit of Gann. Technical analysis was developed in the early part of the 20th century and the early researchers literally went over thousands of daily charts for individual stocks and tabulated the outcome of patterns like H&S tops and bottoms, double tops and bottoms, triangles, wedges, pennants, etc. Based on the statistical validity of the observations, they felt confident to follow the patterns.

All the books I read discussed mainly the US stock market averages, individual stocks and some commodities. Nobody had done a similar rigorous analysis on the modern forex market. I wanted to know if the conclusions of technical analysis derived from early 20th century, open outcry stock markets were valid in modern electronic forex markets. About 2 years ago I decided to satisfy my curiosity. I downloaded historical forex data going back to 2001 and spent many weeks researching the effectiveness of various classical technical patterns. I was surprised, and pleased, to find that the classical patterns worked just as well in today’s forex market as they did in the past. In fact, this research led me to my ‘system’ based on simple classical technical analysis. This research gives me the confidence that as long as I meet the statistical requirements, over time, my system must be profitable. The requirements are :

i) The markets I trade must be very liquid. That is why I only trade the major pairs.

ii) I must take all signals. I cannot pick and choose. I cannot in advance know if a particular signal will be the big winner or loser. In my research I had counted every instance of the patterns, so in implementing the system I had to keep the same conditions, i.e. I must take each instance of the patterns.

One other helpful insight from this research was knowing how my system will  work under different circumstances. One can design a system to work best in particular situations, and I have chosen to focus on intermediate swings. Another system will work well for intra-day or perhaps even 5 minute charts. I know that my system does very well if the market has trends lasting 2-5 days, 50-200 pips or more, and does not do well in choppy markets where the trends last only 3-4 hours and 30-50 pips.

There are some common mistakes about technical patterns in general, and H&S patterns in particular, that many novice traders make. The most common mistake is getting excited about a potential pattern. One very important lesson in technical analysis is that we must wait for the pattern to validate. If one looks back at the history in the charts, there are hundreds of potential H&S, potential double tops / bottoms. The pattern is only validated when there is a close above (or below) the neckline in the timeframe that one is considering. Never anticipate the completion of the pattern. A second mistake traders make is to apply the conclusions of the pattern in one timeframe to prices in another timeframe. e.g. if an H&S is forming on the daily chart, an hourly close above/below the neckline does not mean the pattern is complete. The daily close has to be above/below the neckline. A third observation is that patterns on the hourly / daily are more tradeable than patterns on weekly and monthly charts.

 

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3 thoughts on “H&S bottom playing out in EURUSD

  1. Raheem Suleman

    Interesting finding. Do you know of any charting package which will automatically indicate H&S formation? If you check out http://www.motivewave.com charts, they will plot out EW signals on the chart for you on any time frame. Would be nice to have something similar for H&S. Thanks

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    1. ZenFXTrader

      I know some software can draw trendlines, support and resistance, but I haven’t heard any that recognize patterns like H&S. In any case, I think a human can identify patterns better than software, and the effort will help you get a ‘feel’ for charts and markets. I find Elliot wave theory too unreliable in smaller time-frames, but it is uncannily predictive in the big picture, i.e. over years and decades.

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  2. Colin

    Hi
    I have been following your blog for a while now, and Just wanted to say thanks for sharing your knowledge & trades with us, really interesting to see more of your reasoning for taking the trades that you do, also just wondered if there would be any chance of you posting some of your TA with some charts, so we can see how you interpret certain studies, such as the HS you are currently talking about.
    Thank again

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