Failure Swing Patterns

Identifying trend reversals at an early stage

Failure, Swing, Patterns, Trend Following, strategy, Technical Analysis, fx trader, forex

This article shows how to use Failure Swing Patterns in a Trend Following strategy and explains why these technical analysis patterns are among the most reliable graphical tools to identify trend reversals at an early stage.

In my last article published in FX Trader Magazine, ‘Trend Following – One more Step to Success’’, I shared my trading strategy. The article explained that it is absolutely imperative to have a trading strategy as it will allow you to better manage your trading expectations, as well as help you to develop your trading plan. We also said that even though traders using this trading strategy will often enter the market after a trend is well established, we took a step further and tried to spot new developing trends in their early stage. We underlined the fact that one of the methods to identify a weakness in the trend, as well as the possibility of the selected instrument to get into a consolidation phase, or even to reverse the current trend, is by using the Failure Swing patterns.

What is a Failure Swing Pattern

Failure swing patterns go back to the work of Charles H. Dow and his partner Edward Jones (Dow Jones & Company since 1882) back in the end of 19th century. The last tenet of the Dow Theory states that ‘Trend Remains In Effect Until Clear Reversal Occurs’. In that tenet, the Dow Theory discusses how Dow Theorists search for “failure swings” and confirmations to give definite signals of a trend exhaustion or trend reversal. The idea behind any pattern – ie. a continuation pattern like a Flag Formation, or a reversal pattern like Head & Shoulders – is that they repeat themselves over and  over again throughout time. The same with the failure swings patterns. In a failure swing, a primary trend fails to meet new highs in an uptrend or record new lows in a downtrend.

Failure, Swing, Patterns, Trend Following, strategy, Technical Analysis, fx trader, forexFig.1. Failure Swing Top & Failure Swing Bottom. Source: JFD Brokers

The Secret Behind The Failure Swing Pattern

Let’s analyse why the market fails to record a higher high in an uptrend and lower low in a downtrend. First of all, let’s define what moves the market. We have two basic types of orders, the buy action and the sell action. When someone is buying an instrument, it will help the selected instrument value to increase; thus the price to go up. On the other hand, when someone is selling, it will help the market price move downwards. When there is more buying pressure, meaning that more traders are buying the selected instrument, they are more chances for the instrument to move upwards or vice versa. Therefore, when buying orders (bulls) exceed selling orders (bears) then the market will move upwards and when selling pressure exceeds buying pressure the market will likely move downwards. When the market is moving, someone is winning, and at the same time someone is losing.

When the market fails to record a new high in an uptrend, or vice versa, it could be translated in two ways: the buyers took profits and were unwilling to buy again, or a huge group of sellers (bears) entered the market where it forced the price to go down. A lot of different reasons could cause these actions.

From a technical point of view, we can assume that a significant technical level coincided slightly below the previous top, where the buyers predicted that the price could struggle to break above it, alongside with a combination of a bearish moving average cross or an indication or a bearish cross from a technical indicator/oscillator. Another reason which could force the market to move down at this point could be an economic event or release which came out and affected the selected instrument. Following the economic event, a huge group of sellers probably entered the market while at the same time some stops were triggered as the price was falling, adding to the downward momentum. In both cases, if the group of sellers exceeds the group of buyers then the odds for the market to move lower are very high.