With so many ways to trade currencies, picking tried-and-common methods can help you save time, money, and effort. By fine-tuning common and basic methods, a trader may construct a complete trading plan based on regular patterns that can be easily identified with little practise. Besides this, a trader can have an adequate idea of the price action of a certain forex pair.
While there are several chart patterns of varying complexity, certain common chart pattern groupings will assist you in learning a very easy trading method.
It is not enough to understand how the tools work; we must also learn how to utilise them. And with all of these new weapons in your arsenal, we should get those profits going. Let’s summarise the chart patterns we just learned and categorise them based on the signals they provide.
Reversal patterns are chart formations that signal that the ongoing trend is likely to change course. When a reversal chart pattern appears during an uptrend, it hints that the trend will reverse and the price will shortly head. In contrast, if a reversal chart pattern is observed during a downtrend, it indicates that the price will rise later.
Simply place an order beyond the neckline and toward the new trend to trade these chart patterns. Then aim at a target that is nearly the same height as the formation.
For example, if you detect a double bottom, place a long order at the top of the formation’s neckline and aim for a target high to the distance between the bottoms and the neckline.
Don’t forget to place your stops in the interest of proper risk management! A reasonable stop loss might be placed in the middle of the chart formation.
For example, you may split the distance between the double bottoms and the neckline by two and use that as the size of your stop.
A Double Top is a chart pattern in which the price reaches a high twice and then fails to break out higher on the second attempt.
Here are some characteristics of a double top chart pattern:
Double tops form during an uptrend and then reverse when the price breaks through the support line (Neckline). A more conservative approach would be to wait for the price to test the neckline. The neckline has now transitioned from a support to a resistance level.
A Double Bottom is a chart pattern in which the price holds a low twice and then fails to break down lower on the second attempt, continuing higher.
The pattern is characterised by a distinct drop in price, followed by a slight reversal (or bounce), followed by a second drop to the same or similar level as the first before another, significant reversal, such that the chart appears to take the form of the letter “W.”
The Double Bottom, along with its counterpart, the Double Top, is one of the most commonly recognised chart patterns.
A simple Head and Shoulders chart pattern is defined by three peaks, the outer two of which are close in height and the middle of which is the highest.
It is a bearish reversal chart pattern that starts with an uptrend and two higher highs (1 and 3) and two higher lows (2 and 4) that form the “left shoulder” and “head.”
Point 5 forms a lower high that is lower than points 3 and 1, forming the “right shoulder.”
This shows that the rising trend is coming to an end. However, the reversal is not confirmed until the price falls below the “neckline” at point 6 and moves below the previous low at point 4.
The pattern is confirmed when the price breaches through the neckline support (2 & 4).
It’s also worth noting if the ascent into point 3 is steeper than the ascent into point 1 and whether the ascent into point 5 is steeper than point 3.
If this occurs, it demonstrates how the bulls are getting less aggressive, and the upward momentum is running out of steam, increasing the likelihood of a reversal.
Many traders and analysts regard the head and shoulders chart pattern as one of the most trustworthy and accurate of all reversal chart patterns.
In summary, the head and shoulders chart pattern generally represents:
The neckline’s slope is also an important indicator:
The strength of this reversal is proportional to the rise before the pattern appears, as assessed by the declining amount following the breakout. Stronger preceding trends are more prone to dramatic reversals.
Volume is usually highest at the left shoulder, but it is most likely to deplete by the breakout point. Conditions are more favourable when the volume is increasing.
A reversal chart pattern is an Inverse Head and Shoulders, also known as a “Head and Shoulders Bottom.”
It’s similar to the classic Head and Shoulders pattern but inverted.
The pattern consists of three consecutive lows, with the middle low (“head”) being the deepest and the two outside lows (“shoulders”) being shallower.
The two shoulders would have the same height and breadth in an ideal world.
When an Inverse Head and Shoulders pattern is completed, it signals a bullish trend reversal.
When the price climbs above the resistance of the neckline, traders often open a long position.
The pattern starts with a downtrend, with two lower lows (1 & 3) and two lower highs (2 & 4) forming the first and second bottoms.
Point 5 establishes a lower low that is higher than points 3 and 1, forming the third bottom.
This shows that the negative trend is coming to an end. However, the reversal is not confirmed until the price breaks through the neckline at point 6 and moves beyond the previous high at point 4.
The pattern is confirmed when the price breaches through the neckline resistance and continues higher (2 & 4).
Volume patterns resemble the Head and Shoulders pattern.
Volume is often highest during the first two drops (1 & 3), then decreases through the right shoulder (5).
The price then closes above the neckline formed between the two highs (2 & 4), confirming the trend reversal.
It’s also worth observing if the decline into point 3 is less steep than the descent into point 1 and whether the descent into point 5 is less steep than the descent into point 3.
If this occurs, it demonstrates how the bears are getting less aggressive, and the negative momentum is running out of steam, increasing the likelihood of a reversal.
A Head and Shoulders formation in a downtrend signifies a major reversal.
The strength of this reversal, evaluated as the increasing amount following the breakout, is proportional to the decline before the pattern appears, much like in the straight Head and Shoulders pattern.
Stronger preceding trends are more prone to dramatic reversals.
A rising wedge is a chart pattern created by drawing two ascending trend lines, one for highs and one for lows. The top trend line similarly goes to the right and has a lower slope than the lower trend line.
A rising wedge has at least five reversals: three for one trend line and two for the opposing trend line. It is considered a bearish reversal chart pattern. The slope of the trend line corresponding to the highs is lower than the slope of the trend line corresponding to the lows, showing that the lows are growing faster than the highs.
The resultant shape is a progressively narrower wedge, which forms this chart pattern and its name. Rising wedges are often mistakenly thought of as continuation patterns for an overall upward trend since the trend lines that characterise them are ascending.
The apparent rising price trend encourages bullish traders to continue purchasing, while bearish traders continue to sell off their positions, maintaining the strong upper line of resistance. Because the price refuses to break through the higher level of resistance, buying pressure progressively diminishes, the lower level of support is breached, and the price breaks down and starts a strong downward trend.
The rising wedge should be seen as a strong sell signal and a hint of an imminent trend reversal. The inverse of a falling wedge is a rising wedge. Following a downtrend, the rising wedge displays a feeble rally that, in most situations, ends up breaking through the lower line, extending the previous trend.
Upward breakouts in falling wedges are less frequent, but they do happen and are more likely than downward breakouts. Keep an eye out for the Rising Wedge when it coincides with an uptrend: Because of its adaptability, it might be a reversal pattern rather than a continuation pattern.
Breakouts are often predicted in the pattern’s second half, towards the middle. Volume is most likely to decline as the pattern develops.
A falling wedge is a chart pattern that is made by drawing two descending trend lines, one for highs and one for lows. It’s a bullish reversal chart pattern. The slope of the trend line representing highs is lower than the slope of the trend line representing lows, showing that highs are declining faster than lows.
A successful Falling Wedge pattern needs at least five reversals (two for one trend line and three for the other). The resulting shape is a progressively narrowing wedge, thus the pattern’s name. Because the falling wedge’s trend lines are descending, falling wedges are often mistaken for continuation patterns for an overall downward trend.
The apparent downward price trend invites bearish traders to continue selling while bullish traders continue buying, resulting in a strong lower line of support remaining in place. Because the price will not break through the lower level of support, selling pressure progressively decreases, the higher level of resistance is broken, and the price breaks out and starts a strong upward trend.
The falling wedge is a strong buy signal suggesting a trend reversal is on the way. A rising wedge is the inverse of a falling wedge. Falling wedges often occur after a climax trough (also known as a “panic”), which is a quick reversal of an uptrend on high volume.
In this scenario, the price inside the falling wedge is not likely to fall below the panic mark, resulting in a breakthrough of the upper trend line. Volume is most likely to fall during pattern formation. Wedges with high volume at the breakout point should perform better. Gaps prior to the breakout are considered to boost performance as well.
When a falling wedge follows an uptrend, the price falls gradually. In the majority of situations, the price will end through the upper line, following the prior trend.
A continuation pattern is a widely used forex pattern described as a series of price movements that indicate a temporary halt in the prevailing trend, but the current trend should continue after the break.
There are two patterns of chart patterns: continuation patterns and reversal patterns. Continuation patterns suggest that when the chart pattern is completed, the price will continue to move in the same direction as before.
To keep things simple, continuation chart patterns continue the current trend. Typically, continuation patterns are traded by waiting for a breakout and entering a (long or short) position in the direction of the breakout. The breakout should ideally be in the SAME direction as the trend.
Not every continuation pattern will result in a trend continuation, in which the price resumes moving in the current trend. Some will result in a trend reversal, in which the price moves opposite to the current trend.
You’ll know which one it is by waiting for the breakout. Chart patterns are used to illustrate the activities of buyers and sellers by visualising the forces of supply and demand. You can observe when demand forces (bulls) are in control and when supply forces (bears) are in control.
Chart patterns create a “picture” of the battle raging between the bulls and bears by serving as a “visual summary” of all buying and selling activity. Chart patterns and technical analysis may help traders determine who is winning the battle and position themselves accordingly.
Simply place an order above or below the formation to trade these patterns (following the direction of the ongoing trend, of course). Then, for wedges and rectangles, aim for a target at least the size of the chart pattern. When it comes to pennants, you may aim higher and target the height of the mast.
Stops are usually placed above or below the actual chart formation for continuation patterns. When trading a bearish rectangle, for example, position your stop a few pips above the rectangle’s top or resistance.
Following are some examples of continuation chart patterns:
A flag pattern is a continuation chart pattern that gets its name from its similarity to a flag on a flagpole. Despite being less popular than triangles and wedges, traders consider flags as exceptionally reliable chart patterns.
A flag is a relatively rapid chart formation that appears as a small channel following a steep trend that develops in the opposite direction. It has a downward slope after an uptrend. It has an ascending slope after a downtrend.
The preceding trend is crucial for pattern formation. A “flag” is an explosive, strong price move that forms a nearly vertical line. This is referred to as the “flagpole.” Bearish (bullish) traders begin selling (buying) their holdings when the flagpole forms, eager to capitalise on instant profits.
However, this does not result in a rapid decline (increase) in price since bullish (bearish) traders begin buying, hoping to profit from future price increases (decreases). The resulting descending (ascending) trend channel resembles a downward-sloping (upward-sloping) parallelogram, giving the chart the appearance of a flag, thus the name.
When the flag’s trend line resistance breaks, it signals the start of the second leg of the trend move, and the price moves forward. The pole formation, representing virtually a vertical and parabolic initial price move, distinguishes the flag from a typical breakout or breakdown.
Flag patterns may be bullish or bearish:
Breakouts happen in both directions, although practically all flags are continuation patterns. This indicates that flags in an uptrend are expected to break out higher, whereas flags in a downtrend are expected to break out downward.
Pennants, like rectangles, are continuation chart patterns that form after large moves. After a big upward or downward move, buyers or sellers usually pause a breath before moving the pair in the same direction.
As a result, the price usually consolidates and forms a tiny symmetrical triangle known as a pennant. While the price is still consolidating, additional buyers or sellers usually decide to take advantage of the strong move, causing the price to break out of the pennant formation.
During a steep, nearly vertical downtrend, a bearish pennant forms. Following the sharp drop in price, some sellers decide to close their positions, while others decide to join the trend, consolidating the price for a short period.
When enough sellers jump, the price breaks below the bottom of the pennant and continues to move. As can be seen, the drop resumed after the price produced a bottom breakout. We’d place a short order at the bottom of the pennant with a stop loss above the pennant to trade this chart pattern.
That way, if the breakdown was a forgery, we’d be out of the trade right away. Pennants signal significantly stronger moves than other chart patterns, where the following move’s size is approximately the formation’s height.
The height of the previous move (also known as the mast) is often used to estimate the size of the breakout move.
Bullish pennants, as the name implies, indicate that the bulls are going to recharge. This suggests that the sharp rise in price will resume after the short period of consolidation when bulls gather enough energy to take the price higher again.
In this case, the price climbed steeply before taking a breather. The bulls are stomping and revving up for another run. After the breakout, the price made another strong move higher, just as we predicted.
To avoid fakeouts, we’d place our long order above the pennant and our stop order below the bottom of the pennant. As previously stated, the size of the breakout move is approximately the height of the mast (or the size of the earlier move).
Pennants, you see, may be small in size, but they may signal huge price moves, so don’t underestimate them.
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A rectangle is a chart pattern formed when the price is bounded by parallel support and resistance levels. A rectangle exhibits a period of consolidation or indecision between buyers and sellers as they take turns throwing punches, but neither has dominated.
Before breaking out, the price will “test” the support and resistance levels multiple times. The price may then trend in the direction of the breakout, whether to the upside or downside. The pair were clearly bounded by two key price levels parallel to one another in the above example.
All we have to do now is wait for one of these levels to break and enjoy the trip.
During a downtrend, a bearish rectangle forms when the price consolidates for a period of time. This occurs because sellers may need to take a breather before lowering the pair anymore. In this example, the price broke through the bottom of the rectangle chart pattern and continued to shoot.
We might have made a nice profit on this trade if we had placed a short order right below the support level. When the pair falls below the support, it usually makes a move the size of the rectangle pattern. In the preceding example, the pair moved beyond the target, giving the chance to catch extra pips.
Here’s another rectangle chart pattern, this time a bullish rectangle. Following an uptrend, the price paused to consolidate for a short period of a bit. Can you predict where the price will go next?
If you answered yes, you are right! Look there, that nice upside breakout right there!
Take note of how the price moved to the top of the rectangle pattern after breaking through it. We might have made some pips on the trade if we had placed a long order on top of the resistance level!
As in the example of the bearish rectangle pattern, when the pair breaks, it generally makes a move that is AT LEAST the size of its previous range.
A triangle chart pattern depicts a conflict between bulls and bears by including price moving into a tighter and tighter range over time.
Stop loss and take profit - Risk management tools — 2023The triangle pattern is classified as a “continuation pattern,” which means that when the pattern is completed, the price is expected to continue in the trend direction it was moving before the pattern appeared.
A triangle pattern is generally formed when it comprises at least five touches of support and resistance. For example, three touches on the support line and two on the resistance line. Alternatively, vice versa.
Triangle chart formations are classified into three types, similar to the three little pigs: symmetrical triangle, ascending triangle, and descending triangle.
A symmetrical triangle is a chart formation in which the slope of the price highs and the slope of the price lows converge to create a triangle. What’s occurring is that the market is making lower highs and higher lows throughout this formation.
This indicates that neither buyers nor sellers are pushing the price far enough to establish a definite trend. If this were a battle between buyers and sellers, it would end in a draw. This is a sort of consolidation as well.
The chart above shows that neither buyers nor sellers were able to push the price in their favour. When this occurs, we get lower highs and higher lows. As these two slopes approach one other, it indicates that a breakout is imminent.
We don’t know which direction the market will break out, but we do know that it will most likely break out. One side of the market will eventually collapse. So, how can we capitalise on this?
Simple.
We may place entry orders above the slope of the lower highs of the symmetrical triangle and below the slope of the higher lows. We can just hitch a ride in whichever direction the market moves since we already know the price will break out.
If we had placed an entry order above the slope of the lower highs in this example, we would have been taken along for a nice ride up. If you had placed another entry order that was lower than the slope of the higher lows, you would cancel it as soon as the first order was hit.
An ascending triangle is a sort of triangle chart pattern that occurs when there is a resistance level and a slope of higher lows. During this period, there is a particular level that buyers cannot seem to exceed. However, as evidenced by the higher lows, they steadily push the price up.
The higher lows in the chart above indicate that buyers are gaining momentum. They keep putting pressure on that resistance level, and as a result, a breakout is unavoidable. The issue now is, “Which direction will it go?” Will buyers be able to break through that level, or will resistance be too strong?”
Many charting books will tell you that the buyers will win this battle in most cases, and the price will break out beyond the resistance. However, our experience has shown that this is not always the case.
Sometimes the resistance level is too strong, and there is just not enough purchasing power to push it through. The majority of the time, the price will rise. We’re trying to make the point that you shouldn’t be obsessed with the direction the price moves but rather that you should be prepared for movement in ANY direction.
In this situation, an entry order would be placed above the resistance line and below the slope of the higher lows. In this case, the buyers lost the battle, and the price plummeted! The drop was approximately the same distance as the height of the triangle formation.
We might have caught some pips off that dive if we had positioned our short order below the bottom of the triangle.
As you may have realised, falling triangles are the inverse of ascending triangles (we knew you were clever!). A run of lower highs forms the top line in descending triangle chart patterns. The lower line represents a support level that the price does not seem to be able to break.
The chart above shows that the price is steadily making lower highs, indicating that sellers are starting to gain ground on buyers. Most of the time and we do mean MOST of the time, the price will finally break through the support line and continue to decrease.
However, in certain cases, the support line may be too strong, and the price will bounce off of it and make a strong move higher. The good news is that we are unconcerned with the price. We simply know something is going to happen.
In this case, we would place entry orders above the upper line (lower highs) and below the support line. Price ended up breaking over the top of the triangle pattern in this case. Following the upside breakout, it surged higher by almost the same vertical distance as the triangle’s height.
Placing an entry order above the top of the triangle with a target as high as the formation’s height would have yielded nice profits.
Bilateral chart patterns are more tricky to interpret since they signal that the price may move in either way. What sort of signal is that?
This is when triangle formations fall into play. Remember how we said that the price might break to the upside or the downside with triangles? To trade these chart patterns, think about both scenarios (upside or downside breakout) and place one order on top of the formation and another at the bottom.
If one order is triggered, you may cancel the other. You’d be a part of the action either way. Double the pleasure, double the possibilities! The only problem is that if you put your entry orders too close to the top or bottom of the formation, you may catch a false break.
So be careful, and don’t forget to place your stops!
If you enjoyed learning about chart patterns, head to our articles on forex candlestick patterns and the various chart types used on popular trading platforms.
There are several trading methods that all use price patterns to locate entry and stop levels. Forex chart patterns such as the head and shoulders and triangles give entries, stops, and profit targets in an easily visible pattern. The engulfing candlestick pattern indicates a trend reversal and potential participation in that trend with a defined entry and stop level.
The matter of concern is that one should never completely rely on patterns and open their positions merely on the basis of pattern signals. There are hundreds of things to count before you start real forex trading. Be sure to extend your knowledge of patterns by reading this article on Harmonic patterns.
Forex chart patterns are the way of learning forex trading. The researchers have spent thousands of hours assessing the chart patterns and finding a way to predict the price action of certain financial assets. It is also a form of trading language by which professional traders communicate and develop new strategies.
