Geometric trading strategies help day traders and long-term traders identify patterns that determine trend reversals and support and resistance levels. They add another layer of technical analysis so traders can base their decisions on more than psychology and the news.
While geometric trading, like any other strategy, has an inherent risk component, it delves deeper into price action and technical analysis. Basing trades on these components boost traders’ confidence and ensure they make the right decisions for the right reasons.
At Price Action and Income, we believe traders should have access to any knowledge that can shape their investment strategy. Our daily trade forecasts and premium education give any trader trying to add trading tools access to actionable insights that bring continued results.
What Is Geometric Trading?
Geometric trading is a method of trading that utilizes geometry to forecast trend reversals in price and time. There are a few factors to consider when trying to incorporate geometric trading into your strategy.
The first thing to understand about geometric trading is that to analyze geometric patterns, you have to implement your analysis over time.
Geometric Trading- a Function of Time
Geometric trading patterns all focus on price reversals. However, these patterns all have one thing in common- they occur across timelines. Some patterns show the direction of price while others depict when the price should shift. To gain a complete understanding of geometric patterns, traders should consider both time and cost.
Trading With Market Geometry- Price Action Principles
Two of the most valuable things market geometry identifies are support and resistance levels. Traders can use long-term timelines to uncover support signals to uncover bullish reversal patterns and use resistance patterns to uncover bearish trend reversals.
Using geometric trading methods can also help traders project future levels, though this is separate from technical analysis. Trying to predict future support and resistance levels will sometimes work and sometimes be incorrect.
That’s why it’s important to understand all of the indicators for geometric trading and use all of the necessary tools. If you don’t, your analysis is incomplete, and you won’t formulate a sustainable strategy.
Measuring Psychological Levels When Trading With Market Geometry
People are more comfortable with using round numbers when trading. Signals such as trend reversals and support and resistance levels tend to occur at whole numbers such as 1.230000 and 78.500.
Humans like to round things up or down to simplify numbers. Consider your meeting schedules or how much you believe your meals cost at restaurants. You likely won’t remember the exact pricing. You probably round up or down. The same thing happens with geometric trading.
1. Geometric Trading Using Elliot Wave Theories
The Elliot Wave Principle suggests collective investor psychology vacillates between optimism and pessimism. These back and forth movements occur in repeating cycles depending on intensity and time periods.
The mood swings create patterns that Elliot Wave traders analyze and use to predict future price movements. Elliot’s wave theory suggests that market prices move back and forth between an impulsive or motive phase and corrective phases. The impulse movements subdivide into five lower-degree waves that alternate between motive and corrective behavior.
Thus, waves 1 and 3 are impulses, while 2 and 4 are smaller retracings of waves. Corrective waves subdivide into three smaller-degree waves that start with a five-wave counter-trend impulse, a retrace, and another impulse.
2. Harmonics Patterns When Geometric Trading
Harmonic patterns form geometric patterns that utilize Fibonacci numbers to define concise turning points. Traders use these patterns to attempt to predict future price movements.
Harmonic patterns can determine both the duration of current moves and isolated reversal points. Traders run significant risks when taking a reversal position and the pattern fails.
3. Continuation Patterns
Continuation patterns are indicators the price of a given asset will continue to move in the same direction in the future. Technical analysts use these patterns to predict future continuation and occur in triangles, flags, or rectangles.
Triangle Continuation Patterns
Triangles are horizontal trading patterns. These patterns start at the widest point of the formation, and as the market continues to trade at a sideways rate, the range of trading narrows, signifying waning interests from both bulls and bears. After the triangle forms, the supply line diminishes to meet the demand.
Flag Continuation Patterns
Flags are continuation patterns that move in shorter time frames by countering the prevailing price trend. Traders use flag patterns to identify possible continuation patterns of previous trends from points at which price drifts against the same trends. If the trend resumes, price increases can occur swiftly, meaning traders who identify the pattern can capitalize greatly.
Rectangle Continuation Patterns
The rectangle pattern is a technical analysis pattern that shows significant support and resistance through horizontal lines. Traders can capitalize on rectangle continuation patterns by either waiting for a breakout from the formation or using the measuring principle.
Some things to remember about the rectangle continuation pattern:
- Rectangles occur when the price moves between horizontal support and resistance levels.
- Because the price moves up and down between support and resistance, rectangle continuation patterns indicate no prevailing trend.
- After a breakout, the rectangle ends, and the price moves in a direction opposite the rectangle.
- Traders can capitalize on the rectangle by buying near the bottom of the pattern or shorting near the top. Other traders prefer to wait for breakouts to trade.
4. Fractal Patterns
Fractal patterns are some of the most commonly used and basic patterns used in geometric trading. They are simple, five-bar reversal patterns that often occur amid more significant, more chaotic price movements.
Bearish turning points occur when a pattern forms with the highest high in the middle and two lower highs on each side. Bullish turning points occur in fractal patterns when the pattern has the lowest low in the middle and two higher lows on each side.
As you can see from the chart, fractal patterns are lagging indicators. They don’t form until two days after the reversal starts.
Traders typically use fractals with other indicators to give them some assurance. Common confirmation indicators include the Alligator and incorporating multiple moving averages.
5. Pitchfork Pattern
Andrew’s Pitchfork is a technical indicator using three parallel lines to reveal possible support and resistance levels, along with potential breakout and breakdown levels. Traders can use the Pitchfork Pattern by plotting three points near the end of previous trends and then drawing a line from the first point that runs through the midpoint of the other two points.
6. Head and Shoulders
Head and shoulders patterns have three peaks or troughs depending on whether they’re bullish or bearish. The outside two peaks or troughs are close to the “head” peak. These patterns predict bullish-to-bearish trend reversals or vice versa.
The head and shoulders pattern is considered one of the most reliable geometric trading patterns.
The head and shoulders pattern in the chart above shows a bearish trend reversal signal. Notice how the asset reaches its lowest point on March 15th. The two points to the left and right at February 22nd and April 1st show the shoulder plots.
7. Double Top
Double top patterns are exceptionally bearish geometric patterns that form when prices reach highs two consecutive times with a minimal decline between each. Once the asset price falls below the reduction (support level)
8. Double Bottom
Double bottoms are the exact opposite of double tops- strong bullish indicators with two troughs reasonably close together with a minor motive indicator in between. Once the asset prices break through the resistance level between the two troughs, the asset price should begin an uptrend.
9. Rounding Bottom
Rounding bottoms form when a series of price movements form a U-shape at the end of an extended downtrend. They signify a long-term price reversal. The pattern’s time frame varies from several weeks to months and most traders consider the trend rare. Volume and price typically move in tandem, where the volume confirms the price action.
Conclusion- 9 Patterns to Know for Geometric Trading
Geometric trading using these patterns can be a valuable tool for traders looking to add more confirmation for their moves. These patterns can signify trend reversals and resistance and support levels.
However, these tools aren’t failproof and traders should incorporate these patterns into their strategy, not use them as a fix-all solution to their trades. Geometric patterns can be helpful for swing trading as well as long-term plays. The trick is knowing how to spot these indicators and using multiple patterns to formulate a comprehensive strategy.
Price Action and Income is here to guide you on your trading strategy. We explain how to use proven techniques to increase your chances and sustainably add strength to your portfolio. Contact us today to discover how to use geometric trading to boost your portfolio.