Forex chart patterns

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Double bottom A pattern consisting of two bottoms that are located at roughly similar levels. Head and shoulders A pattern consisting of three peaks, with the middle peak being taller than the others. Inverse head and shoulders A pattern consisting of three valleys, with the middle valley being lower than the others.

Rising wedge End of an uptrend or continuation of a downtrend A pattern consisting of two up-sloping trend lines that consciously narrow as the market moves higher. Falling wedge End of a downtrend or continuation of an uptrend A pattern consisting of two down-sloping trend lines that consciously narrow as the market moves lower. Bullish flag Continuation of an uptrend A pattern consisting of a large price increase and a subsequent consolidation bounded by two parallel trend lines that point down.

Bearish flag Continuation of a downtrend A pattern consisting of a large price drop and a subsequent consolidation bounded by two parallel trend lines that point up. Bullish pennant A pattern consisting of two converging trend lines. Bearish pennant A pattern consisting of two converging trend lines. Ascending triangle A pattern consisting of a horizontal top and an up-sloping bottom. Descending triangle A pattern consisting of a horizontal bottom and a down-sloping top.

Bullish rectangle End of a downtrend or continuation of an uptrend A pattern consisting of two horizontal trendlines between which the price oscillates. Bearish rectangle End of an uptrend or continuation of a downtrend A pattern consisting of two horizontal trendlines between which the price oscillates. What Is a Forex Chart Pattern? Forex chart patterns are patterns in historical price data that can indicate when there is a greater probability of one thing happening over another.

Many people believe that prices evolve randomly and that there is no way to predict the future. Those who subscribe to this hypothesis avoid trading and invest in index funds. Others believe that prices are at least somewhat predictable. Those who belong to this group want to beat the market through fundamental analysis, technical analysis, or the combination of the two. Fundamental analysis uses financial data such as GDP reports or expectations of future interest rates to determine proper exchange rates.

Thus, while fundamental analysts rely on economic data, technical analysts examine patterns of past price behavior. Some forex patterns relate to only one or a few price bars. These are called candlestick patterns and not chart patterns. The distinguishing feature of chart patterns is that they take a long time to form and consist of several price bars. Edwards and John Magee were the first to provide a systematic overview of the most commonly recognized chart patterns.

The idea is that if you can develop an understanding of various forex chart patterns, you can become a better trader. Why Do Chart Patterns Occur? Chart patterns occur because people behave in similar ways as they did in the past.

The traditional academic view has always centered on the notion that investors are rational and market prices properly reflect whatever information is available to them. This suggests that regardless of how high or low the price is, it must be the correct price based on currently available information. Now, here we run into a problem—at least as far as chart patterns are concerned.

If currently available information is already priced in, only new information can cause price changes. How could past price data help you predict the future if the market reacts only to new information, which is obviously unpredictable? These people are the proponents of the economic theory referred to as the efficient market hypothesis EMH , introduced by Fama. Behavioral finance argues that people are not always rational , and their decisions are subject to various biases.

You can probably recall situations when you threw your analysis through the window and acted based on your feelings. Perhaps you were afraid of missing out on an opportunity or you held on to your losing position for too long. Irrationalities like these happen all the time because emotions such as fear and greed prompt people to do crazy things. Now, if people are consistently influenced by their emotions, it is logical to expect that some patterns are observable on price charts and repeat themselves around important psychological areas.

This last point is important. You can find chart patterns on any chart, but chart patterns at important psychological levels are more meaningful. Are Chart Patterns Reliable? Unfortunately, this question is hard to answer with a simple yes or no. It is safe to assume that your ultimate trading system will influence your success with chart patterns.

Chart patterns alone will get you into more trouble than they are worth. Just think about it: How difficult was it to find this article about chart patterns? Chances are, it took only a simple Google search. This is because chart patterns are publicly available information.

They are easy and costless to obtain. If forex chart patterns were very reliable, every market participant would closely monitor them. Once a signal was present, the market would be flooded with orders and the price would immediately rise or fall to the foreshadowed rate. On the one hand, this is clearly not the case. You might have an outstanding internet connection, but good luck beating the speed of Wall Street firms that spend millions of dollars on things like smart routers, algorithms, and high-speed connections to exchanges.

You can find just as many failed patterns as successful ones. On top of that, chart patterns are subjective. The psychological forces that are supposed to form these patterns also require time to play out. Patterns on higher charts such as the daily might be more meaningful than intraday patterns.

You can be sure that most market participants closely monitor the 1. European exporters such as Mercedes might worry that their products will not sell abroad if the EUR strengthens. The point is that a lot of market interest is clustering around a particular level. You know this because the market is hovering around that level for a long time.

Besides, spotting a pattern is just the beginning. What you do next will have a profound impact on your results as well as your perception of the reliability of chart patterns. How to Use Chart Patterns in Forex Chart patterns can serve as a basis for a wide variety of trading systems. They can help you carve out an edge over the market and make money in forex. While they are no silver bullet, they provide some information, which is better than having no information.

Chart patterns are often simple formations such as two failed attempts to achieve a new high price. What is the timeframe? Are other negative factors accompanying the pattern? How does the risk relate to the potential reward? Are important news releases scheduled? Successful trading systems that incorporate chart patterns also account for a variety of factors. We recommend that you bookmark our guides on how to create a trading strategy and how to create a trading plan.

That way, you can read them later, when you are finished with this article. A few notes before we get started: Entry and exit points With each chart pattern, you can use the formation height and add it to the breakout price to get the profit target. They look at how volume changes during the formation of the pattern, and might reject or favor set-ups based on that.

While this is fine, the forex market is decentralized. This means that whatever volume data you have, it relates to only a small portion of the market such as volume at your broker and might not represent the entire market. An art, not a science Chart patterns are subjective, meaning that different traders might do and interpret things differently. For example, someone might draw trendlines using wicks, while someone else might use closing prices.

Instead of worrying about every little detail, focus on what certain formations reveal about the balance between buyers and sellers. Sometimes you have to be more flexible and throw in some extra reps or rest a bit more. The same goes for chart patterns. Every situation will be slightly different, which is fine. Double Top The double top is one of the simplest patterns on charts. How to read the pattern: When the price reaches a new high, it shows conviction behind the uptrend. Each trend alternates between impulse and consolidation moves, so the correction following the high is to be expected.

The situation turns interesting when the price resumes its trend and reaches the high again. Instead of breaking through and putting in another higher high, the buying pressure evaporates and the price is unable to surpass its previous high. As you might know, uptrends are characterized by higher highs and higher lows. When the price fails to break above the prior high, it breaks the pattern of an uptrend and signals possible weakness.

Perhaps it will take a bit more time for buyers to attain a new high or perhaps sellers are about to take control. You can assume that sellers are strong enough to reverse the trend or at least drive the market into an extended consolidation. Both cases can be a good set-up for a short trade.

The double top pattern is completed when the neckline breaks. Traders often set a profit target by measuring the distance between the neckline and the high of the pattern and projecting it to the neckline break. Do not copy without permission. Double Bottom The double bottom is the mirror image of the double top. How to read the pattern: When the price reaches a new low, it shows conviction behind the downtrend.

As we have pointed out, trends consist of impulse and consolidation moves. The situation turns interesting when the price resumes its trend and reaches the low again. This is problematic because the downtrend should follow the pattern of lower highs and lower lows. When the price fails to break below the prior low, it signals a possible issue with the trend.

That said, this is not yet a buy signal. Now you can assume that buyers are strong enough to reverse the trend or at least drive the market into an extended consolidation. In both cases, you can favor a long trade. The double bottom pattern is completed when the neckline breaks. Traders often set a profit target by measuring the distance between the neckline and the low of the pattern and projecting it to the neckline break.

Take a look at this guide Head and Shoulders The head and shoulders pattern is a fairly complex formation consisting of three peaks, with the center peak being the highest of the three. This forms the left shoulder. From the low point of the left shoulder, the bullish advance continues and significantly surpasses the previous high.

After some time, the price reaches a new peak and now enters a more prolonged consolidation. This forms the head. A final advance from the low of the head starts but it quickly fails, and the market turns down. This forms the right shoulder. The right shoulder is lower than the head and roughly in line with the left shoulder. The pattern is completed when the price breaks below the neckline, which is the line connecting the low of the shoulders.

The neckline can slope in any direction and is a good predictor of the severity of the price decline. You can project the height of the pattern to the neckline break and set your profit target accordingly. An example of a successful head and shoulder set-up is shown below: For a beginner trader, the head and shoulders pattern might be more difficult to recognize. You can always zoom out a bit from the price action or switch to a line chart. Inverse Head and Shoulders The inverse head and shoulders pattern is the bearish equivalent of the head and shoulders.

It can be found at the bottom of downtrends and indicates a bearish-to-bullish trend reversal. How to read the pattern: Following a falling market, the price bumps into a bottom and then rises to form the left shoulder. From the high of the left shoulder, a bearish decline starts. It progresses significantly below the previous low to form the head of the pattern. Then the price begins to rise again. A final decline from the high of the head starts to form the right shoulder.

This trough is higher than the head and about equal to the bottom of the left shoulder. From the bottom of the right shoulder, the price starts to rise again. Once it breaks above the connected high points of the pullbacks neckline , the pattern is complete.

Below are an example of a winning inverse head and shoulder set-up: We have a separate guide on Head and Shoulders patterns that you can access via this link if you want to learn more about them. Rising Wedge The rising wedge pattern forms when the market makes higher highs and higher lows within a shrinking range that slopes upward.

This pattern is trickier than those we have discussed so far because its signal depends on the trend. That is, a rising wedge in an uptrend signals reversal while a rising wedge in a downtrend signals continuation. The price makes higher highs and higher lows, which fulfills the characteristics of a healthy uptrend.

The reason the rising wedge acts as a reversal signal despite being indicative of a strong trend is the extent of the price increase. If you take a closer look at the pattern, you will notice that the lower trendline rises at a steeper angle.

While the market keeps reaching higher highs, the subsequent consolidations are shorter and shorter. This happens when investors are so enthusiastic that every time the market dips, they rush to buy and immediately bid up the price. Unfortunately, this can go on for only so long before the interest dries up and the market collapses. The above picture M shows a rising pennant pattern. The consolidation phase is marked by the price staying within the trend lines, forming a triangle.

The pattern is validated once prices break above the pattern with a candle close above the trend line. Prices tend to continue in the direction of the previous trend after completion of the pattern. Falling Pennant Pattern Picture N : Falling Pennant pattern A falling pennant is a bearish continuation pattern formed during a downtrend. The prices should be in a downtrend, and the pattern has to be formed within the downtrend.

The consolidation phase, once broken, will lead to the continuation of the current trend. Pennants are mostly formed during a trend and could be traded by new and experienced traders. The pattern tends to form frequently and provide good additional entry points. Many traders add multiple positions to ride the trend more profitably.

Back to top Most profitable forex patterns Double tops, double bottoms, head and shoulders, rounded top, Rounded Bottom, triangles, and Pennants are a few profitable patterns to name. However, most patterns can be traded profitably and would provide a higher risk and reward ratio. A comprehensive pdf of forex patterns can be downloaded here.

A comprehensive pdf of forex patterns can be downloaded here Back to top Forex candlestick patterns Additional confirmation is necessary after the completion of the chart patterns. Candlestick patterns and chart patterns can go hand in hand and can be used for additional confirmation of price action. Candlestick patterns like Hammer, Hanging man, Harami, Pin tops, and Engulfing candles can be used to confirm chart patterns.

Mere completion of the pattern does not warrant immediate price movement, so traders need to look for additional confirmation of price action before deciding to place the trades.

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