For the forex trader, a critical aspect of their technical analysis is the reading of forex chart patterns.
However, understanding is not enough.
Whether day-trading intraday or swing trading the forex market, knowing how to trade and profit from them is how traders can advance themselves.
These chart patterns depend upon the fundamental principle that movements in price produce recurring and therefore, predictable patterns.
Successful Chart Pattern Trading
Some traders will overlay these patterns with technical indicators or candlestick patterns. Including overlays can reduce the bias of misinterpretation or bias the trader might have.
Overtrading or emotionally driven trading can do catastrophic damage to a trader’s account. Overlays can reduce that risk by slowing the trading decision and eliminating low probability trades.
We’re going to take a look at the most common chart patterns. Each has its distinctive features, but all are best understood in the context of the current price trend revealed by the chart.
Most will indicate a likely continuation or reversal of an existing trend.
Continuation and Reversal: The Two Main Types of Chart Patterns
Continuation Chart Patterns
Joining a strong trending move is the most simple and popular trading strategy.
But because no trend is ever seen as a straight line on a chart, timing entries correctly can be challenging. There will always be pullbacks and periods of consolidation.
Fortunately, these tend to form predictable continuation patterns, and in doing so they frequently offer very attractive entry opportunities.
Triangles, flags, pennants and rectangles, are the most important of these chart patterns, and they’re very common in both up and downtrends.
They seldom if ever appear as perfect geometrical shapes, but to the trained eye they can nevertheless provide excellent evidence of the underlying price action, which is vital information for us as traders.
Triangle Chart Patterns
Triangles typically present as either ascending (uptrend), descending (downtrend), or symmetrical (either up or downtrend).
The ascending triangle appears when a strong bull trend hits a resistance level that the highs of a number of consolidation candles fail to break.
At the same time, these candles form a series of higher lows, demonstrating continued buying pressure from the bulls.
Ascending Triangle Pattern
As price approaches the apex of this right-angled triangle there will likely be a breakout to the upside as the resistance of the bears is broken.
Descending Triangle Pattern
Flip this pattern, and you have the classic descending triangle.
A strong downtrend hits a support level and price tracks sideways, reaching a number of lower highs, before finally breaking out to the downside.
Symmetrical Triangle Pattern (Bullish/Bearish)
Unlike the ascending and descending variants, symmetrical triangles may appear in either up or downtrends. With symmetrical triangles, the most likely outcome is a continuation of the existing trend.
Flags and Pennants
Similar to triangles, flags and pennants are among the commonest of all chart patterns. They appear regularly in both up and downtrends across all time frames.
Generally, the pennant will be more like a triangle in appearance than the squarer looking flag. However, the precise formation is much less important for us as traders than an understanding of the underlying price action, which is very similar in both cases.
Typically, both patterns begin with a prominent bull or bear candle. This is followed by a horizontal or slightly up/down consolidation towards a support or resistance level. This is often an Exponential Moving Average (EMA) line.
Swing traders often regard price approaching these support or resistance levels as a signal to resume buying or selling.
If enough swing traders re-enter the market there is likely to be a breakout in the direction of the existing trend.
Rectangles
Often very similar to bull or bear flags, rectangles form when price consolidates horizontally during a trend. Price will touch the horizontal trend lines several times. These upper and lower boundaries are the resistance and support levels that lock the trading range.
Like all ranges, these patterns can be tricky to swing trade. , Price may breakout to either the high or low side so the more conservative approach is to expect a continuation of the existing trend.
Cup and Handle Chart Pattern
The classic cup and handle forms within a bull trend. At some point, a pullback will begin, and that point marks the left rim of the cup.
Price then gradually falls, and consolidates to form a flat or rounded bottom. Then it will climb back to form a right rim at or slightly below the level of the left.
A handle now forms as price tracks horizontally or in a gently falling wedge. When we see a right rim, left rim and handle forming at a similar price, it’s a good indication of an important resistance level.
But the recovery from the bottom of the cup also tells us that the bulls are back in the market. They will be trying to force price higher. So we will look to trade a breakout above the close of the left rim bull candle.
The low point of the cup handle is generally a good stop-loss, but ideally, we will want to see a short and near-horizontal handle. If price goes below the half-full level of the cup it is generally an indication that the pattern has broken down and is no longer valid.
Inverted Cup and Handle Chart Pattern
As the name suggests, the inverted cup and handle is simply the reverse of the bullish cup and handle and is therefore a bearish continuation pattern.
Price falls in a downtrend before pulling back to form the left rim of an upside-down cup.
It then consolidates to form a flat or gently curving top before falling again to form the right rim.
Price then moves horizontally or slightly upwards to form the cup handle, before the bear trend resumes.
As with the bullish pattern described above, the closer to the horizontal the handle, the stronger the subsequent downward move is likely to be.
And if the price moves above the halfway point of the cup, it’s a likely signal that the pattern has failed.
To trade the inverted cup and handle, we will look for an entry when the price breaks below the left rim of the cup.
Just above the high point of the handle will be a sensible placement of a stop loss order.
Trend Reversal Chart Patterns
Riding a trend, perhaps using a trailing stop to lock in profits [link], can be a tremendously profitable strategy.
Unfortunately, no trend lasts forever so we have to expect that at some point the market sentiment regarding a currency pair is likely to change and throw the trend into reverse.
It might be because of a major political or economic news event. It might be for no obvious reason at all.
But there are a number of common patterns that can help us spot likely reversals and plan our trades accordingly.
Wedge Patterns
Rising wedge patterns and falling wedge patterns occur within bullish and bearish trends. They’re both types of continuation chart patterns.
They can easily be identified by two converging trend lines connecting series of higher highs and higher lows (uptrend) or lower lows and lower highs (downtrend).
While wedges do look somewhat like continuation triangles, they are generally regarded as a reversal pattern because the narrowing of the trading range as the trend lines converge is evidence of indecision, indicating that the trend may be beginning to lose momentum.
Bottom Chart Patterns
V Bottom Pattern
The V bottom is one of the most common patterns. It is formed at the end of a downtrend when the price reverses sharply, creating a distinctive V shape.
Typically this happens when the price hits an existing strong support level, signaling buyers to come back in.
The pattern can look somewhat similar to a cup and handle.
The key difference is that while the cup forms a flat or gently curving bottom, the V bottom features a much sharper drop in price followed by a sharp reversal.
The beginning and end of the V are typically at very similar price levels and may be marked by brief periods of consolidation.
As traders, we will look to enter when the price breaks above the beginning of the V, with a stop below the bottom point.
Since this pattern begins with a sharp decline in price, it’s reasonable to ask how we can guess that price is about to reverse rather than just continue downwards?
The answer is in the type of candles that form at the bottom.
One very common such candlestick is known as the hammer and is a bullish candle comprised of a short body and a longer lower wick or shadow.
The long wick indicates that the bears were able to drive the price down but were unable to keep it there.
Bullish traders then re-entered the market and were able to drive price back up until the candle closed above its opening.
Another common reversal candle is the doji, which is comprised of a short body and two roughly equal wicks.
Dojis are indecision candles; they can be either bullish or bearish. the tug of war indicated by the equal wicks suggests that an existing trend is losing impetus and that a reversal may be imminent.
A doji at the bottom of a downtrend is known as a Morning Star. It gives a good indication that a V bottom may be forming. As traders, though, we will wait for confirmation before taking a long position.
As with all these patterns, it‘s important to understand that on real charts they are rarely seen in perfect diagrammatic form.
In a V Bottom there will often be consolidations during both the up and down moves. And there may also be smaller V patterns within a larger one.
That’s why it’s crucial that we focus on what individual candlesticks are telling us about the price action as well as looking for patterns.
A variation of the V bottom, for example, is known as the Tweezer Bottom.
It consists of two candles alongside each other at the bottom of a downtrend – both of which fail to breach a key support level.
Typically the third candle indicates the beginning of a strong bull move and traders will look to go long when prices passes the high of the first candle.
By now you’ve probably realized that almost all of these forex chart patterns have their opposites.
So Tweezer Tops at resistance levels are also common set-ups.
We can also look for inverted V formations.
Like the classic V bottom, they will also often feature dojis (in this case known as the Evening Star – or inverted hammer candlesticks).
In their extreme form, they have very short or almost invisible body and long wick and are sometimes known as “Gravestones”.
As always, an understanding of the underlying price action is far more important than what we call particular candles or patterns.
The Evening Star Reversal
Head and Shoulders
The head and shoulders is one of the easiest forex chart patterns to spot, and many traders also regard it as one of the most reliable indicators of the imminent reversal of a trend.
In its classic form, this pattern predicts the likely end of an uptrend, but the inverse head and shoulders can also indicate a forthcoming bearish to bullish reversal.
To trade the head and shoulders we will first look for a pullback or horizontal consolidation during a strong bull trend.
This will form the left shoulder. A new upward move followed by a sharp downturn then forms the head. In the final element of the pattern, a second horizontal consolidation forms the right shoulder.
The line connecting the left and right shoulders is known as the neckline and is a key support level. As traders, we will therefore look to go short when price breaks below the neckline and confirms the start of a new downtrend.
Turn the head and shoulders pattern upside down, and you have the inverse head and shoulders, which is used by many traders as an indicator that a downtrend is about to reverse.
The shoulders and head form in a similar way, but in this case the neckline becomes a resistance rather than a support level, and traders will look to enter on a break above it.
Double Top and Double Bottom Patterns
Both the double top pattern and double-bottom patterns are popular with traders.
They form when bulls or bears make two failed attempts to break through support or resistance levels.
A double top, which looks like a letter M, is formed when an uptrend hits a resistance level.
Price then falls back, often to support at an EMA level, before rising to test the resistance again.
If this second test also fails to breach the resistance level, the price may reverse decisively to begin a new downtrend, and bears will look to get in when the price breaks below the initial pullback.
Double bottoms, which look more like a letter W, form in a similar way, but indicate the likely end of a downtrend, and the beginning of a new uptrend
A less common variation of these patterns is when a third top or bottom is formed before the trend finally reverses.
The Road to Mastery
These just a few of the dozens of forex chart patterns and candlestick formations that offer trading opportunities every day.
But, it’s important to remember that none of them is infallible and they are rarely if ever geometrically perfect.
Differently named patterns often closely resemble each other and there may also be patterns within patterns.
The most successful traders are those who have trained their eyes, through long hours of study and practice, to recognize the best set-ups. They understand the price action that is producing them and are able to use other indicators – especially volume – to confirm their trades.