Introduction
A dragon pattern is a “W” or “M” shape reversal pattern which resembles a Chinese dragon. This pattern indicates that in the near future, the market is about to face a price reversal. This reversal is either bullish or bearish. The bullish and bearish nature of the dragon depends on the shape of the dragon.
This blog will address both types of dragons concerning the trading strategy.
Components of a dragon pattern
There are four important components of a dragon.
- Head
- Feet
- Hump
- Tail
1. Head
The head of the dragon is the begging of the dragon pattern. It indicates the prior trend. In the case of a bullish dragon, the prior trend is bearish. On the other hand, a bearish dragon forms above a prior bullish trend.
2. Feet
There are two feet of the dragon. The positioning of the feet is so the second foot is a little below the first foot. If the second foot is bigger in size, the reversal is usually greater.
In the case of a bearish dragon, feet are formed in the inverted position as the dragon’s body is reversed.
3. Hump
It is a slight rise in the prices compared to the feet of the dragon. It is located between two feet but at a higher level in the case of a bullish dragon. In the case of a bearish dragon, the hump is below the feet.
4. Tail
It is the last point of the Dragon’s body. It is the point where a breakout in the market takes place. In the case of a bullish dragon, the price begins to rise after the formation of a tail. The market begins to take new highs, and the bullish sentiment takes place. It is the time when the number of buyers begins to take over the market.
In the case of a bearish dragon, a bearish breakout takes place after the tail of the dragon. In this case, the number of sellers dominates a market and prices begin to face a fall.
Types of Dragons
Two types of dragons appear on a trading chart. Both these types behave oppositely regarding a market reversal. The types of dragons are,
- Bullish dragon pattern
- Bearish dragon pattern
The comparison between these two types is given below in the table.
| Features | Bullish Dragon | Bearish Dragon |
|---|---|---|
| shape | It resembles the letter “W.”  | It resembles the letter “M.” |
| Prior trend | bearish | bullish |
| Market breakout | Bullish breakout | Bearish breakout |
| Forecast | The number of buyers begins to take over the market. | Bears begin to dominate the market as the number of sellers increases. |
Trading strategy
As you are aware now that there are two types of dragon setups. So, we need to form two types of trading strategies.
Trading strategy for a bullish setup
The trading strategy for a bullish setup is divided into the following steps.
- Entry
- Take profit
- Risk management
Entry
After the formation of the second foot of the dragon, the bullish dragon is confirmed. The best time to enter a trade is once the bullish sentiment of the market begins to appear.
To find the best entry point, draw a trendline that passes through the head, hump, and the point after the second foot. This point forms an ideal entry point. Later to this entry point, the prices take a slight dip, and the bullish break out takes place.
Take profit
Two options exist for taking the profit if dealing with a bullish dragon pattern. Suppose you are more interested in short trading. you can take a profit just above the tail of the dragon, equivalent to the head or equivalent to the Hump, when prices begin to rise.
In a long trade, you have to wait for a breakout in the prices. Usually, the prices take a spike after a bullish dragon appears. The more patient and professional traders wait for the full spike to take a significant profit.
Risk management
Risk management is a vital step when trading a bullish reversal dragon. I recommend you place the stop loss below the second foot of the dragon. It will significantly protect your potential losses if the dragon doesn’t behave as usual and the price reverses.
Trading strategy for a bearish setup
Bearish dragon is a rare phenomenon. If you encounter a bearish dragon, follow the following trading strategy.
Entry
Once this dragon appears on the chart, the best time to enter a trade is below the second foot. Draw a trend line from the head of the dragon which crosses the hump. The point where the trend line crosses the area near the second foot is a significant point for entry into a trade.
Take profit
In a short trade, you can take profit by drawing a parallel line to the head of the dragon. On the other hand, if you take a long position, wait for the bearish market breakout to take a profit.
Risk management
To minimize your losses, place the stop just above the first foot. It will help you to protect your account in case the price doesn’t obey the dragon rule.
Alternate trading strategy
Dragon pattern trading somehow relates the double top and double bottom chart pattern. A bullish dragon resembles a double-bottom pattern. On the other hand, a bearish dragon is almost similar to a double-top chart pattern.
A trader can also form a trading strategy around a dragon pattern in a double top/bottom way. The following tools are important for trading a dragon pattern in a double top/bottom style.
- Trend lines
- MACD
- support/ resistance zones
- Fibonacci retracement levels
Success ratio
Dragon pattern trading method is a well-reputed and revered method. If a trader uses the right technical analysis and tools to form a trading strategy. The success ratio can increase up to 80% or even more in some cases.
Conclusion
A dragon trade pattern is quite a reliable but very rare phenomenon. The correct recognition of this pattern can be a little tricky. I suggest you use this pattern to enhance your trading experience with the confluence of other trading indicators or technical tools. A proper confluence of technical trading tools with dragon trading patterns can surprise you with positive results.