Analysts’ most critical concern is recognizing the price trend. Does it go up or down? Does it return or continue? Analysts have reached actual results for this question.
The trend line is one of the most critical components of classical analysis. The method I want to teach you today is the Fan Principle, which forms by 3 trend lines. Why is it called fan principle? Because of the similarity to the Chinese Fan (Shan), they named it Fan Principle.
This state forms at the end of ascending and descending trends. So you should know that it is such a reversal pattern. Interestingly, this pattern reminds me of the Bump-and-Run Reversal Pattern.
I will teach you these patterns well, and definitely, you will not confuse them with each other after seeing these patterns on the chart with a lot of practice after learning.
The fan principle is one of the best methods I use for my daily analysis. I owe almost 12% of my monthly profit to the fan principle and patterns like it. So pay attention to my words carefully so you can benefit from them too.
Fan Principle at the top
When the price increases in an upward trend and hits a strong resistance. The price can’t make a higher peak; it is enough to draw a trend line from the first valid bottom to the last bottom.
This is our first trend line which was initially a support trend line, and after breaking, it became a resistance trend line.
You draw the second trend line from the same point to the lower bottoms that the price made. This support trend line does not allow the price to go down. So the price fluctuates between this support trend line and the upper resistance trend line.
This second line is usually 45°and is our main trend line. If the second trend line breaks, it becomes a resistance trend line, and the price makes lower lows. You can just draw another trend line with less slope from the same valid bottom to the lower low, which is made after breaking the second trend line.
This is our third trend line. The price has lost almost all its momentum and entered a channel with a low slope. In this case, the second trend line becomes a resistance trend line.
And the price fluctuates between the third trend line and the second trend line. In this case, a fan principle has been made. In technical analysis, the lines that make up the principle fan are called the speed line.
When the third trend line breaks, you can enter a short position; but don’t rush because there are other things I have to teach you. Of course, the break of the third trend line must be a true break. I have explained this subject in previous articles.
Now the third support trend line becomes a strong resistance trend line. This rule works correctly in many cases, and the price trend turns to a downward trend after it. Market makers close their position at the first top, and the market volume decreases after the failure of each trend line, so in these areas.
Fibonacci is a tool for detecting price retracement and areas where the price can pull back on; or react on these areas. This was a simple definition of Fibonacci retracement, and I will talk about it completely in the following articles. What does Fibonacci have to do with the peaks and valleys of the Fan Principle?
It is interesting to know that Fibonacci plays an essential role in Fan Principle. Fan principle trend lines are often formed in such a way that if we check the price pullbacks on this line, we will see that these pullbacks have also reacted to the Fibonacci areas. Is this the price miracle or Fibonacci magic?
By the way, We can use this tool to detect pullback points. We should consider Fibonacci numbers between 0 and 1. For example, the bottoms can place on the 0.236, 0.382, 0.5, 0.618, and 0.786 lines. Of course, Fibonacci tools have other uses.
I use tools like the pitchfan to draw fan principles. I recommend using this tool because it draws the lines more accurately and provides the Fibonacci tool. Considering the height of the principal fan X, we see that the trend lines are divided in such a way that the pullbacks are placed on the Fibonacci lines.
- In the standard mode, after breaking the first line, the price shouldn’t make a higher top.
- To form a principle fan, we need at least three trend lines. The number may increase, but we shouldn’t have less than three trend lines.
- The slope of the first line should not be high because, in this case, even if it breaks a price pullback on the second trend line, there is a possibility that the upward trend will continue, and this pullback is only a balancing of the price momentum.
In fact, the less the slope of the trend lines, the more valid the fan principle is. In some cases, the third trend line becomes almost a horizontal line, which is an excellent sign for the price to return. In these patterns, wait for confirmation and enter the market.
- To ensure the trend reversing, the angles of the three trend lines should be equal.
- Sometimes, the second top is placed at the same price as the first one, and in this area, a Double-Top pattern forms which is a reversal pattern. In some conditions, the price can make a Head-and-Shoulders pattern in the fan principle area.
However, it is better if the second top is lower because it signals to reverse the trend. But I have my own personal strategy. The market does not always work according to our wishes and does not have an ideal form. If the second top is a little higher, I will take a risk in this area, but I need to get strong confirmation.
Trade on the fan principle at the top
When the price breaks the third trend line, we can enter a short position; of course, we can also enter at the last kiss, where the price touches the third trend line for the last time at the pullback. You can set the stop loss above the highest top in this area.
The take profit should be equal to the distance from the highest peak to the point where the price hits the third trend line.
You can see one of the positions I got on the BTC/USDT chart in the 5minute time frame. 23 august 2022
I had three trend lines at this price, and when the price broke the third trend line with a valid breakout candle, I entered a short position below the breakout candle at 21184.06 USDT.
My take profit was equal to the distance from the highest peak to the point where the price hits the third trend line, and I placed it at 20969.81 USDT. And I placed my stop loss above the last top at 21329.10 USDT for a higher risk-to-reward ratio.
In this position, I made a profit of $4,200 while my stop loss was $3,100. Just don’t forget one thing, always start from higher time frames for technical analysis, and try not to trade against the trend of higher time frames. And always have a road map to trade in Bitcoin and other assets.
Fan Principle at the bottom
We doubt the return of the price when the price cannot make a lower low in the downward trend. Price fails to make a lower top and a lower low, so we draw a resistance trend line from the first top to the last top. This is our first trendline.
If the price breaks the first trend line, it becomes a support trend line and keeps the price up. Let’s draw another trend line to the higher peaks from the same top as before. This is the second trend line.
Usually, the slope of this trend line is 45°. And its breakout means the failure of the primary trend and increases the possibility of the reverse. In case of a breakout, this line becomes a support trend line, and we draw a third line on higher tops.
At this moment, the price makes a fan principle that if the third line breaks and the price rises, we can enter a long position. Of course, the break of the third trend line must be a true breakout.
To ensure the return of the price, it is better that the angles between the trend lines are equal. In the break of each trend line, the market volume increases sharply. This pattern is seen in one-sided markets a lot, such as stock markets.
We can also use Fibonacci tools in the fan principle at the bottom too; in these areas, the price can react on the Fibonacci lines and give a pullback. Fan principle lines can be formed in such a way that price pullbacks react on Fibonacci lines too.
For example, the price can retrace the 0.236, 0.382, 0.5, 0.618, and 0.786 areas and make tops on these lines. Meeting points of trend lines and Fibonacci lines can be very strong support or resistance areas. In the photo below, you will understand what I mean.
- In the standard mode, after breaking the first line, the price shouldn’t make a lower low.
- To form the fan principle. We need at least three trend lines.
Of course, the trend lines can be more, but usually, three lines are enough to enter the position.
- The first trend line’s slope and the price’s momentum should not be too high.
For better performance of the fan principle, it is better to have a low slope of the trend lines. It means that the momentum of the price decreases, and the probability of trend reversal increases. Even in some cases, the third trend line can be horizontal.
- to increase the performance of the principal fan; It is better if the angles between the trend lines are equal
- Sometimes, when there is a lot of selling pressure, it is possible that the price can’t make a higher bottom, and the second bottom is made at the same price as the previous one, which creates a Double-Bottom pattern and is a return pattern.
Sometimes there is even a possibility of forming an Inverse Head-and-Shoulders pattern.
However, the second bottom should be slightly higher than the first one. Because it shows the strength of the buyers and is a positive signal for the return of the price. In some cases, the second bottom is a little lower than the first, and you can ignore it, but the risk of the position increases.
Trade on the Fan Principle at the bottom
You can enter a long position when the price breaks the third trend line, or you can also enter at the last kiss, where the price touches the third trend line for the last time at the pullback. And set your stop loss below the lowest bottom. The take profit should be equal to the distance from the lowest bottom to the point where the price hits the third trend line.
In the picture below, I show you one of my favorite positions I got at the Forex market. It was a good position, and I am thrilled that I was able to use the fan principle to make a profit from the market.
I found this position in the Forex market; it was on the EUR/USD chart at the 5-minute time frame. When the price broke the third trend line, I entered a long position above the breakout candle at 1.00061 USD; and placed my stop loss below the last bottom at 0.99919 USD because of having a higher risk-to-reward ratio.
The take profit was equal to the distance from the lowest bottom to the point where the price touched the third trend line, and I placed it at 1.00288USD. In this position, I made a profit of $3500 while my stop loss was only $1900.
The wonders of the number 3
Why do we have three trend lines in the Fan Principle? Well, the number three is one of the magic numbers in the market. For example, we have three types of trends: ascending trend, descending, and range bound. In Elliott waves, we have three types of locks.
Many patterns have three tops/bottoms, such as head and shoulders, and triple tops and triple bottoms. For various reasons, the number 3 can be called the sacred number of technical analysis. Which other numbers do you know are important in technical analysis?
The slope of the trend lines
We have three types of slopes:
- A trend line with a high incline (1st trend line).
In this trend line, the price momentum is very high, and we have an unstable trend. Breaking this line means stabilizing the price and reaching a more stable trend line with a lower slope.
- The average slope of 45°(2nd trend line).
This trend line is very stable and robust. Many traders consider the 45° trend line the main trend line and count on it. The break of 45° makes a much higher possibility of reversing the market.
- The low slope of the (3rd trend line).
This trend line is fragile, and when it breaks, the probability of turning back and changing the trend in this failure is very high. For this reason, we enter the position after breaking the third trend line.
You got acquainted with the trend line and fan principle. From now on, you can analyze the chart with a better view and ensure your profit will increase. If you practice this method that I taught you. You get excellent profits from the market.
But be careful not to enter the market without practice, because you may lose your money. Don’t forget to have proper capital management. Thank you very much for being with me in this article.
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