The Bow Tie pattern is a simple trading system based on the intersection of three moving averages.
The basic rules for the bow tie pattern:
This pattern is identified by using a 10-day moving average (SMA), a 20-day exponential moving average (EMA) and a 30-day EMA. The trader can find out the exact average price for the previous 2 weeks or 10 full trading days thanks to the 10 – day SMA.
To determine long-term moving averages, exponential MAs are used, which “weight” the data.
Buy transactions are carried out according to the following rules:
To do this, you need to use SMA (period 10), exponential EMA (period 20), and EMA (period 30).
1) It is necessary that the lines of moving averages converge and re-diverge and line up in this order 10-SMA above 20-EMA and above 30-EMA. In this case, the described pattern will appear on the chart.
2) The price must roll back at least 1 bar, i.e. the price should form a lower high and low.
3) Place the pending buystop order immediately above the resulting maximum.
Additional indicators and patterns can be used for additional confirmation.
Since the formation of this pattern in most cases indicates a change in the trend, significant price pullbacks are possible, so the stop loss must be placed outside the local minimum.
When taking short positions, opposite actions are used.
After long bullish as well as bearish trends, the best transitions are made. When the market starts to reverse, many traders are positioned on the wrong market side. Because of this, a bow tie is formed after a new high or low in the foreign exchange market is established. After that, your chances of catching a strong emerging trend increase.