W chart pattern - How It Works

Contents:

W pattern is a formation on a price chart that indicates a bullish reversal after a downtrend similar to Double Bottom. The pattern is used in the long-term technical analysis, helping traders to identify changes in the market sentiment. The general direction of the trend is important in terms of daily positioning and intraday trading as deals in the correct direction improve the overall efficiency of a trading approach and increase profits. This post is aimed to explain the details of W chart patterns and show how they can be used in binary options trading.

What is a W chart pattern?

The W chart pattern is a graph formation with the shape of the Latin letter W. It occurs after a sustainable long-term downtrend and has twin bottoms with equal or higher lows. Another representation of a similar price action leading to a long-term reversal in the trend’s direction is the Double Bottom chart pattern. Typically, W pattern has tall and sharp declines of candlesticks before charting the bottom. The reversal is considered confirmed when prices close above the highest peak before the first bottom.

How does W chart pattern look like?

The best way to spot a W bottom pattern on a graph is to switch the visual representation from candlesticks to lines.

Here is an example of how the pattern looks like:

What does the W chart pattern mean?

Imagine we’ve found a letter W pattern on a daily price chart of gold with the single line as the type of view.

Now, let’s have a closer look at the same formation with candles:

The screenshot shows four stages of the W chart with Japanese candlesticks:

Point A is a local bottom in the previous downtrend;
The price continued declining and charted the first stage of the W letter from A to B;
A short-term and limited bullish rebound happened from B to C;
The downtrend resumed from C to D, however, the bears failed to draw a lower low. This is an important condition for the long-term analysis as if the sequence of lower lows remained, then the bullish reversal would be unlikely;
Starting from point D, the upside swing accelerated the bullish power and the price crossed the breakout level from below. Typically, the price action pauses here or rebounds to the breached resistance now support horizontal line;
The bullish price action resumes and the uptrend starts.

The main idea is that strong trends do not reverse in a single moment. The demand/supply ratio has to be rebalanced, all of the previous selling pressure has to be absorbed by the buyers, short-sellers might have another attempt to proceed with the bearish action. It is crucial for the effectiveness of the pattern to chart a higher low as the second bottom of the formation, and renew the previous low. So the sequence of lower lows will be breached and the sellers would lose the momentum. Thus, the buyers will step-in with heavy-volume demand, pushing prices higher.

A big W is a double bottom with tall sides. Price often confirms the double bottom and approaches the height of the left side trend start before retracing and forming a handle. Once price completes the handle, the rise resumes.

How to use the W chart pattern?

As long as the W pattern is a part of long-term analysis, binary options traders could have two choices of using the reversal formation. The first one is a bit aggressive and it does not require the breakout confirmation. It could bring a higher profit as the early entry allows benefiting on better prices. However, this approach might lead to unwished losses as the breakout confirmation might not come and the downtrend will continue. In this case, traders should stop the trading cycle once the rate breaks below the recent low (B).

Another method of using W charts is more conservative. Traders should wait for the breakout before entering the market. If prices breach the resistance, then an additional confirmation of the pattern comes in and the likelihood of the bullish reversal is getting higher. However, most of the breakthroughs are followed by a bounce back to the previously breached resistance line, which should act as horizontal support. So the entry is a bit late compared to the first example. On the other hand, if the uptrend was sustainable, conservative traders would regain the level of profits later. Sometimes it happens that the price action charts another left leg of the formation (third bottom). So the acceleration of the uptrend might have delays. Here is the full list of conditions to buy call options on W pattern.

Conditions for aggressive buying of CALL options

A long-term sustainable downtrend has to be noticed before the W pattern occurred;
The shape of declines (red candles) has to be tall and straightforward;
After the price charted the second bottom with the local low higher than the first bottom, traders should start buying call options at the price level D;
If the price action goes in the right direction and the breakout happens, traders should continue buying CALL options;
If the first bottom’s level (B) was breached from above, then traders should stop the trading cycle.

Conditions for conservative buying of CALL options

The W bottom pattern has to be confirmed by the breakout;
After a bounce back to the horizontal line (former resistance now support), traders should start buying CALL options;
The trading cycle should be stopped after an additional bearish signal was noticed.

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There is also one more trading approach. The main idea is that the analysis could be performed on a long-term chart, while the trading could be done with shorter expiration time. For example, if a trader noticed the W pattern on the daily timeframe and it was confirmed, then several trading sessions have to be extremely bullish as the sellers would step out of the market. Such a buying pressure could lead to several rallies on intraday time frames during active hours in European or North American trading session. Thus, trading cycles of buying call options with 15-, 30- and 60-minutes might be lucrative in terms of a large percentage of consecutive deals in the money.

Examples of patterns

Below is another example of W pattern trading. Before calculating the breakout levels, traders switched to the line-type of visual representation for the daily chart of the USD/CAD currency pair.

After the analysis, a W chart was spotted:

The screenshot below shows how the same pattern looks like with a candlestick way of the graph. There is a clear confirmation that the downtrend changed the direction and a new uptrend started. So binary options traders could switch their trading cycle to start buying call options in intraday strategy, increasing the effectiveness of their trading systems and maximizing profits.

Conclusion

W pattern trading does not appear on price charts too often. However, the formation is widely used in the technical analysis to spot long-term reversals of the previous downtrend. The main idea is that the price action similar to the Double Bottom formation leads to the inability of the bears to continue pushing prices lower, and the downtrend is getting exhausted. The weakening bearish momentum forces the call-options buyers to step-in with the heavy-volume entries and reverses the action north. In most cases, Wchart have to have a breakout confirmation to increase the efficiency of trading, however, a more aggressive approach suggests buying call options of the second bottom of the W-shaped graph.

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