Forex trading these days revolves not just around a specific trait but has different roots that build up this vast financial tree. Since the inception of Japanese candlesticks, many technical traders have come up with various strategies to incorporate them. The up and down movement of the market creates different price action phenomena shown by the candles or bars. These chart patterns are considered extremely useful as trading them gives high probability positions and a good risk/reward. Some even mix them up with indicators and fundamentals to get the best possible setup.
Famous chart patterns in forex, and how can you identify them?
The following chart patterns are regarded as most popular among forex traders:
- Ascending and descending triangle
- Head and shoulders
- Double top and double bottom
- Cup and handle
- Pennant or flags
- Rounding bottom
Ascending and descending triangle
An ascending triangle is a signal for an uptrend in the market, formed when the price continuously tests a particular resistance and increasing trend line. As soon as the opposition is tested, the market moves slightly towards the bottom but charges again. This process forms an ascending triangle. Finally, the candles break past the stopping point and continue on their way. A descending triangle pattern constitutes a downtrend by an opposite method.
Image 1: An ascending triangle pattern. The price continuously bounces back to test the support line but fails to reach the initial minimum low. It shows that the buyers are coming in control and will soon break the resistance.
Image 2: The chart shows a descending triangle pattern. Notice how the market retests the broker support. Some traders use this as the entry point in their trades.
Head and Shoulders
The head and shoulder chart pattern is available with a large peak known as the head and two smaller side ones called shoulders. Traders predict a bullish or a bearish bias by looking at the price action. If the third peak falls to the neckline, then it indicated a bearish trend.
Image 3: As soon as the price falls to the support after the right shoulder, it continues its bearish trend. The reverse head and shoulder patterns give a bullish trend overall.
Double top and double bottom
These patterns are more commonly used to highlight reversals in the current trend. In a double top, the market reaches a peak but retraces to the neckline. The price gets to the high again only to reverse back, breaking the support or new higher low in this case and forming a new opposite trend.
Double bottom is antagonistic to double top.
Image 4: Yellow circles highlight the double top. As soon as the market tests the neckline, it falls below as the bears take over.
Image 5: The market does not give the best possible setup all the time. You have to learn to spot out the critical chart patterns. The picture shows a double bottom. Even though a market gap has occurred, the trader still takes a buy as soon as the price crosses the neckline.
Cup and handle
The pattern stays true to its name as you can identify a cup and its handle on the trading chart. It is a little pause to the overall bullish trend where the cup is the rounding bottom, and the wedge that forms afterward is the handle.
Image 6: After the asset forms the round bottom, it will make a wedge under the two red lines. The retracement is short-term, and soon the price will move to its bullish bias.
Wedges are of two types:
- A falling wedge has two lines, i.e., support and resistance (more steeper). The price continues to move downwards under the influence of these two. This pattern is indicative that the asset will reverse its trend and move upwards.
- A rising wedge is similar to a falling one, but in this case, the initial trend is upwards, and the support line is steeper compared with resistance. The asset will reverse its direction and move towards the lower end this time.
Image 7: A falling wedge. Notice how the price reverses.
Image 8: A rising wedge. Notice how the support line is steeper than the resistance.
Pennant or flags
Pennants may cause a continual or reversal in the market, and they can be bullish and bearish. A flag may come into existence when the price goes into consolidation after an uptrend. The initial ups and downs are bigger in contrast with the later ones. The image below can clarify what a pennant is.
Image 9: You can easily spot a flag in the chart between two red lines. The asset, in this case, chooses to move to the downside, indicating a reversal.
Rounding bottoms are simple to locate as they are available during an up or a downtrend. The market falls back or rests before proceeding in its direction or a potential reversal, which is the pattern we look at. As the asset is taking its breath, traders try and buy/sell halfway. This pattern gives a good option to add on a position as soon the price breaks the resistance or the support.
Image 10: The part highlighted in light purple is the rounding bottom. In this case, the price chooses to continue its trend towards the downside.
Benefits of Chart Patterns
The benefits of trading chart patterns are broad. They are detailed below:
- Chart patterns can be mixed up with other strategies, efficiently providing overall high probability setups.
- Calculating your stop losses and taking profits is easy, as you can do it by measuring the chart levels.
- Once you get a hold of it, these patterns are super easy to spot, making it easier to trade them.
- Price action traders are all about reading the charts, and they can be more consistent by learning these patterns.
- Even a beginner can learn them quickly.