Forex chart patterns play an important role in identifying entry and exit levels and effectively managing your trading activity. By using chart patterns, a trader can form a trading plan and know when to get in and out of position.
But, like many other cases in trading, the challenge is to learn how to identify these patterns and how to use them correctly. Keeping that in mind, let’s take a look at some of the most common chart patterns in the forex market and find out why it is important to identify and use all these patterns as part of your trading.
Key Points to Take Away
- Chart patterns are a great trading method that helps traders to determine the next market direction and find entry and exit levels.
- The most popular trading chart patterns in forex trading are head and shoulders, double top and double bottom, cup and handle pattern, flags and pennants, ascending/descending, and symmetrical Triangles.
- Because of ‘the power of the herd’ phenomenon and the repetitive nature of financial markets, chart patterns play a huge role in identifying market trends and knowing when to get in and out of positions.
What Are Chart Patterns in Technical Analysis?
As the name implies, price chart patterns are shapes or formations created in a trading chart that help traders to predict the next price movements of financial securities. In trading, these chart patterns are considered to be a vital part of technical analysis as they assist traders in seeing repetition in price action.
By knowing to identify chart patterns, a trader can find out what the asset might do next, and where to place buying and selling orders. All these patterns can be identified over any time frame in a trading chart, meaning intraday, daily, weekly, and monthly.
Top 5 Forex Chart Patterns Every Trader Should Know
Generally, chart patterns can be classified into three categories – Continuation, reversal, and bilateral chart patterns. If you really get into trading with forex chart patterns, you’ll find lots of forex patterns that you can use (according to Wikipedia, there are 42 candlestick patterns).
Having said that, you should get started by knowing the most common and popular forex chart patterns.
1. Head and Shoulders (Top and Bottom)
The head and shoulders pattern is one of the most popular and effective chart patterns among forex traders and in general. This chart pattern is being used by traders and investors to identify a reversal of a trend and is mostly used for a breakout trading strategy.
As you can see in the chart, once the price breaks below (or above) the neckline (support/resistance levels), this chart pattern signals a reversal in the market trend.
2. Double Top and Double Bottom Formation
Double top and double bottom chart patterns indicate a reversal in the price action following a double (or triple) testing of the highs and lows.
For example, a double top chart pattern is basically a reversal chart pattern that occurs when the markets reach two peaks and then break below the support level. A double bottom pattern works the same way but in the opposite direction, meaning it has two bottom peaks before it starts an upward moving trend.
3. Cup and Handle Chart Pattern
For some traders, the cup and handle pattern is often regarded as a joke or a punch line. But despite the skepticism of some people, this chart pattern is an integral part of technical analysis and one of the most commonly used shapes by day traders and long-term investors.
Mostly, the cup and handle is a bullish trend technical analysis pattern that signals an uptrend following a correction in the price action.
Once the price breaks above the highest levels of the handle, then according to this pattern, the price is expected to rise further.
4. Bullish and Bearish Flag Pattern
The flag pattern is another commonly found pattern in trading charts and one of the most popular chart patterns in technical analysis. As the name suggests, this continuation pattern is formed when a certain market consolidates before continuing the prior trend in the same direction by creating a shape of a flag.
As you can see in the image below, in a bullish flag pattern a trader buys the asset once the price breaks above the resistance lines, with the expectation that the trend will continue. A bearish flag pattern obviously works the same way but in the other direction, meaning it indicates the continuation of a downward trend.
5. Ascending/Descending and Symmetrical Triangles
Triangles are certainly a very common chart pattern in technical analysis, largely because a triangle is an extremely important shape in nature as well as in trading charts. In general, triangles are continuation patterns that help traders to identify an entry point during a trend.
There are three main types of triangle patterns that work on the same principle – ascending triangle pattern, descending triangle pattern, and symmetrical triangle pattern. According to triangle patterns, a trader buys or sells the asset once the price breaks above or below the base (adjacent) side of the triangle.
Why is It So Important to Follow and Identify Chart Patterns in Forex Trading?
Obviously, you might wonder whether using these chart patterns actually work and why is it so important to use them as part of your trading? Well, here’s the thing – markets are repetitive. And, chart patterns are simply another way to identify repeating patterns in the markets. It could be cup and handle, head and shoulders, etc – but the bottom line, it works.
Moreover, nowadays, the markets are mostly composed of many day traders and computers that use the same indicators and patterns to get in and out of positions. Consequently, the power of the herd has a direct impact on price changes and market sentiment. If you are not aware of the ‘power of the herd’ phenomenon in the markets – a herd instinct can be best described as the behavior of people to join the masses and follow the actions of other investors. Because technical analysis is mostly based on the decisions of the informed masses, chart patterns can be used as an excellent way to predict price movements of FX currency pairs and other financial instruments.
The bottom line, using chart patterns is a great tool to analyze FX currency pairs. If you spend enough time looking at trading forex charts, you’ll be able to identify these chart patterns without having to combine technical indicators. Further, knowing how to combine one of the popular forex trading strategies and identify chart patterns will make your trading decisions run more smoothly. After all, the markets are sort of a jungle so chart patterns can definitely help you see things in a more organized way.
What forex chart pattern should you look for?
This very much depends on the type of trader you are if you already have experience in the market or the type of trader you are going to become in case you are a newcomer to the forex market. For example, trend traders typically use continuation chart patterns while those who prefer to trade ranging markets often use reversal patterns.
What are the most successful chart patterns?
It’s difficult to know what’s the best chart patterns as it is subjective to the trading style of different traders. Also, using chart patterns does not guarantee you’ll become a profitable trader but it certainly increases your chances to make smart trading decisions.
What are some other patterns to use in forex trading?
Apart from the chart patterns we mentioned above, some other effective and popular chart patterns include the bullish and bearish rectangle pattern, pennant patterns, the Doji candlestick pattern, and wedges patterns.
How to use pivot points in forex trading?
Pivot points are price levels used by traders as a market indicator for the next price movements. In essence, you can use a technical indicator to find out the pivot point of a certain market or find these levels on various sites online.