Forex Trading Patterns
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In a forex market, forex trading patterns are the ultimate trails that lead investors to perform excellent trading opportunities. When a trader trades financial assets in a forex market, losses or profits are generally made from price movements.
The price change is represented by using candlesticks. And after a series of 9 periods, these candlestick patterns will form a general trading chart. This chart will show the story of the price action of a specific underlying asset.
What is the meaning of chart trading patterns?
Forex chart patterns are a powerful tool through which a trader can perform technical analysis to represent raw price action. It even allows the trader to feel the sentiment and mood of the trade market.
Through forex chart patterns, traders can ride the entire market wave. And if the concept of technical patterns is understood clearly, it can often help choose lucrative trading opportunities based on minimal risk exposure.
Forex pattern trading signals should be traded with definitive price targets and stop-loss orders. This is done to limit risk exposure and to improve profit opportunities.
To get better results, chart patterns can also be combined with a few other analysis techniques, including candlestick patterns and technical indicators. This combination will support the generated trading signals.
As you look around, you will find a variety of chart patterns available in the market to start trading with. In addition, traders can look for patterns based on their trading skills and knowledge to identify and exploit upcoming trading opportunities.
In short, chart patterns have an enormous potential for generating lucrative trading opportunities at any given time.
Chart patterns are generally formed due to an interaction between sellers and buyers. And this interaction later led to numerous chart patterns, which are displayed on the chart daily.
Generally speaking, almost all chart patterns are looking forward to the supply and demand interaction.
Thus, this constant battle between sellers and buyers gives birth to various chart patterns you are probably trading.
How can you read chart trading patterns?
It is straightforward to see where the chart patterns work, but it is not easy to determine which areas it does not work. This is the point where the real issue occurs.
To avoid pain, you should ignore areas where you feel the forex chart pattern won’t work. To trade chart patterns like a pro, it is essential to have a comprehensive systematic approach to read them easily.
Now let’s discuss how you can identify chart patterns like a pro in a few steps. Three essential things which can be applied to any chart pattern are:
- First, you must assess the quality and size of chart patterns relative to the surrounding price action.
- The next step is the location of the chart pattern. Figure out where the chart pattern is located in a new trend. You also need to identify the pivot points and support & resistance levels.
- The last step is to assess the potential profit margin. A profit margin is useless to follow because it offers a minimum risk ratio of 1:1
Why do trading patterns form?
When analysing the foreign exchange market, technical analysis can be difficult to detect classical formations. First, classic patterns lead to a trader entering the trade after a significant impulse has already taken place in the quotes. After the trader enters, the price often goes sharply against him.
The overlap between trading patterns can also lead to opposed signals. A difficult decision must be made in such a situation, and making the right decision is even harder. Classic graphic patterns do not adhere to rigid frameworks.
It is not uncommon for the price to not reach the classical completion but to arrive at the local low perfectly. Experienced traders still use trading patterns, but they are not their primary tool. There is always the possibility of the chart rebuilding into another formation or simply disregarding it.
On average, only 50% of patterns work in practice. Graphs cannot provide guarantees, as the above thesis indicates.
Types Of Patterns
All chart patterns can fall into three groups depending on how the price moves. Patterns fall into three main categories.
Continuation chart patterns
In trend extension patterns, the price is already trending in the direction it is trending. If you have discovered such a pattern, you can predict the price will follow the same trend. There are three types of trend continuation patterns: wedges, rectangles, and pennants.
Reversal chart patterns
The trend usually exhausts when these patterns appear. When a clear paradigm emerges and the price trends, you will most likely see the price reverse after a reversal pattern appears.
The current trend may end when a reversal chart pattern appears. These patterns include double and triple bottoms, triple tops, head-and-shoulders patterns, inverse wedge patterns, rising wedges, and rising wedge and falling triangle patterns.
Bilateral chart patterns
It seems likely that the momentum will continue but in a different direction. A model of this kind can emerge when the market is flat or trending. In what ways can bilateral patterns be used? By watching these signs, you can enter new trades at the right time with an entry price at the breakout.
Engulfing candle forex chart patterns
A candlestick chart contains much more information than a simple line graph. Forex chart patterns allow us to measure price movements in all time frames. There are many Forex chart patterns, so we recommend choosing a strategy that relies on an easy-to-spot pattern.
Forex engulfing candle patterns provide excellent trading opportunities since they are simple to spot and demonstrate an instant change of direction.
The real body of an up candle will engulf the real body of a preceding down candle in a downtrend. This pattern is a bullish engulfing pattern. On the other hand, an uptrend will cause the real body of the down candle to engulf the real body of the previous up candle. It is a bearish engulfing pattern.
Because the previous candle has already turned, these Forex chart patterns are highly tradable.
The engulfing Pattern can be used to sell when a bearish trend is forming, and a stop loss can be placed above the previous swing high. Traders should place their stop loss below the previous swing low when trading bullish engulfing patterns.
List of common chart patterns in a trade market
Below is the list of famous forex chart patterns which a trader can use right now:
Head and shoulders pattern
The Head and shoulders pattern is a famous chart trading pattern. A head and shoulders pattern resembles human anatomy, as their name suggests. A Financial instrument (e.g., currency pairs) experiences this phenomenon when they reach highs during an uptrend, then find resistance there and return to a trend line (the neckline), then reach yet another high before returning to the trend line, and finally reach a third high before falling below the trend line.
A head appears in the middle of two shoulders. The head and shoulders pattern offers many potential opportunities to traders who correctly understand and trade it.
In this pattern, the larger peak is positioned at the slightly smaller peak on either side of it. This chart pattern plays a significant role in predicting any bullish-to-bearish price reversal for a trader.
The first and third peaks are smaller than the second in this chart pattern. But all three of them fall back to the same support level, forming a condition of the neckline.
Once the third peak has fallen back into a support level, it starts to break into a bearish downtrend!
A double top is yet another common forex pattern. Traders utilise this pattern used for simply highlighting trend reversals. An asset price will experience a high peak before it retracts back to the support level.
Double bottom pattern
The double bottom chart pattern indicates the period of selling. This pattern causes the asset price to drop below the support level. But before it drops itself again, it will rise to the resistance level.
But as the market becomes more bullish, the trend will reverse and start an upward motion. In short, the double bottom is known to be a bullish reversal pattern because it displays the end of the downtrend and shifts itself towards the uptrend.
Next, we have a rounding bottom, another most common chart pattern to signify a reversal or a continuation. While in an uptrend, the price of assets may fall back a bit before it starts rising one more time. The term bullish continuation defines this situation.
Most traders with retail investor accounts choose to capitalise on this pattern by purchasing halfway around the rounding bottom. They even capitalise on the continuation when it breaks itself above the resistance level.
Cup and handle
The cup and handle pattern is nicknamed a bullish continuation pattern. This pattern is generally used for displaying a certain period related to bearish market sentiment.
This pattern is similar to the rounding bottom pattern and has a handle similar to the wedge pattern.
At the rounding bottom, the asset price is expected to enter a temporary retracement known as a handle. This is because this retracement is confined to two parallel lines resulting in a price graph.
In the end, the asset will reverse out of handle and thus continue itself with an overall bullish trend.
Ascending triangle pattern
Ascending triangle works as a bullish continuation pattern because this trading pattern signifies the continuation of the trading uptrend!
These triangles can quickly be drawn on Forex charts by placing horizontal lines alongside the swing highs, which are the support and resistance levels. Likewise, ascending trend lines are also drawn alongside swing lows, the support level.
Thus, ascending triangles have two or more identical peak highs due to which horizontal lines are drawn. These trend lines signify the uptrend of ascending patterns in future market movement.
Descending triangle pattern
Triangle patterns can be either ascending or descending. The Pattern gives Forex traders a bearish signal that the price will trend downward upon completion. There are two lines of support and resistance in this Forex pattern.
Because this descending triangle pattern usually precedes a downward trend, it is mainly considered a continuation chart.
This is not an exact science, and a breakout won’t always occur in the direction expected in a triangle chart. Stop losses are crucial to your trading strategy to protect yourself from any unexpected price movements – as part of your overall risk management plan.
The symmetrical triangle is a bearish and bullish trend based on market conditions. This pattern is formed as soon as the price breaks with higher troughs and lower peaks.
Even if the trend is bearish, the symmetrical triangle will still display upward reversals.
Inverse head and shoulders
In the inverse head and shoulders pattern, the price is low when the trend is down, and the price pattern is opposite the previous one. In this way, the peak of the “head” and the peak of the “shoulders” are lower than the neck level, as is the case in the standard figure.
It should rise that the price will rise by at least the distance between the neckline and the peak of the “head” after breaking the neckline. The asset is purchased when inverse head and shoulders break out.
Bull and bear flags
Indecisive Forex markets tend to exhibit bull and bear flag patterns. The flagpole represents the upward movement of a currency pair. As the price stalls or even declines a bit, for the most part, it remains relatively flat during a consolidation period (the flag pattern). Prices usually continue on their previous trend once that period ends.
By comparison, a bearish flag displays a downward trend (the flagpole). A period of consolidation appears with a relatively flat or even upward trend in the price (the flag pattern). Complex instruments generally continue on a downward trend after a price consolidation.
The more patterns you can identify, the more money you can make since you can predict with relative confidence when a price will rise or fall.
Candles with engulfing patterns engulf their previous day’s bodies, which are very easy to identify. The previous day’s real body covers the candle that follows the downtrend in a bullish engulfing. A bearish engulfing occurs when engulfing occurs by a down candle real body from the previous day following an uptrend.
An engulfing pattern indicates a complete reversal of the previous day’s movement, indicating a potential breakout either bullishly or bearishly.
Butterfly patterns may appear complex, but they are quite easy to identify. ABCD patterns consist of swings high and low from the Pattern’s origin point (X), followed by reversals corresponding to Fibonacci extension ratios between each point. “B” is the meeting point of two triangles, or wings, in the Pattern.
In a bullish pattern, the butterfly pattern may look like a capital “M,” whereas in a bearish pattern, it may look like a capital “W.” Often, this Pattern indicates that price movement will continue in the trending direction once it develops.
Cup and handle
There is an easy way to identify the cup and handle Pattern. The Pattern involves the price falling and gradually rising to its original value typically throughout 1-6, months-although it can occur over a range of weeks to years.
A “cup” appears when the price rises back to the original value, then drops and rises to form the “handle”. This handle typically has a retracement between 30% and 50%, but exceptions exist.
In particular, if it develops over several months, this pattern is often considered a bullish indicator. In cases where the bullish technical indicator develops rapidly or over a prolonged period, it is less reliable.
Triple top and Triple bottom
According to the term “Triple Top”, there are three price peaks and a maximum upward trend in quotes, as opposed to “Double Top”. Therefore, the chart rises and falls three times locally.
It is necessary to proceed with the sale after the third fall since the bottom line was broken. In a triple-bottoming pattern, the top appears at the bottom instead of at the top. Thus, a purchase occurs after the bottom breaks.
It features a period of consolidation that can lead to a breakout after a flagpole, which is one of the more basic patterns in Forex. Pennants form during this consolidation period. In contrast to a rectangle pattern, a pennant pattern can be capitalised on by forecasting the breakout direction with other indicators and putting a stop-limit order on the other side to limit losses.
Five consecutive minor reversals are marked by a broadening top and a substantial decline. An important characteristic of price changes is that they are more extreme than their predecessors at the point where the price changes course.
When this happens, a broadening formation usually indicates the beginning of a bearish trend. It appears there is a butterfly pattern developing, but the fifth trend reversal and ascent beyond previous highs suggest the formation of a broadening top is underway. To confirm this Pattern, “B” and “D” must break out beyond the lower trend line.
A hammer candlestick pattern is useful to determine when price action has hit a “bottom” for a currency pair. Traders might take advantage of the long wick at the bottom of this price to open a position ahead of the upswing.
How to trade Forex using patterns
A novice trader should practice identifying patterns rather than blindly trusting them, as this is a surefire way to lose his deposit. The formations only provide accurate predictions in half of the cases, but they are still useful. It’s always easier to predict price movements on a chart with a pattern than without one.
This way, you can get a more accurate picture when you combine the methods of graphical technical analysis and other approaches. A “Triangle” pattern formation can explain by an accumulation of orders forming during the formation, so other traders can also see it.
Otherwise, the stop loss would have been placed below the support line (orange mark) without seeing the Pattern. In this case, we place a stop order in the pattern field (red mark) and take profit at the local high (blue mark).
This trade has an excellent SL/TP ratio of one to two (green mark). If the ratio were not orange (orange mark), it would be three to two. Hence, trading purely by patterns is not worth it. However, you can make the right decisions based on the market situation by analysing patterns.
Chart pattern trading strategy – Major rules to follow
Now let’s highlight a few essential strategies or rules you should follow while using chart patterns in a trade market.
Rule no 1: See if the market is consolidating or is in trend mode
This rule plays a significant role because some chart patterns are in consolidation mode, and some stay in trend mode according to market movements.
The continuation pattern signals the trader that the trend will stay constant. And a reversal pattern will signify the end of one trade and the start of the latest trend in the market. One best example of a reversal pattern is a double-top pattern.
Suppose the market is consolidating or in trend mode with this information. Traders with retail investor accounts can quickly determine which chart pattern is best for them based on the trading environment.
Most price action traders fail to achieve the desired profit target because they do not follow this golden rule. Instead, they trade each pattern without seeing the whole picture.
Rule no 2: Figure out which pattern you want to use
Ask yourself whether you are comfortable trading with continuation chart patterns or trade reversal patterns.
Once you have decided on your favourite choice, you can design a particular trade set-up.
It is always best to trade with good chart patterns to acquire them in real-time.
Rule no 3: Follow chart pattern strategy to reach a good price location
Typically, the chart patterns work with the excellent price location to add confluence to the forex trade. Always trade Forex and CFDs with an authorised financial services provider that is regulated by Financial Sector Conduct Authority (in South Africa)
Price location is an area on a forex chart to expect a specific price reaction. This price location can be support and resistance levels. Technical indicators can also be displayed by combining the two chart patterns.
What are the disadvantages of trading with chart patterns?
1. Chart patterns can most often deliver false signals
It is not guaranteed that chart patterns will always deliver 100% accurate results. In short, a good pattern is not possible all the time.
It is suggested that traders should always take advantage of those opportunities in which reward/risk ratios are pretty compelling enough.
2. Chart patterns are time-consuming to form
For an investor or trader, patience is the key. And extra patience is required when they are forming chart patterns.
A lot of time is consumed to generate high-probability signals on a chart pattern to show actual and valid results. This might be psychologically burdening for the traders to watch out for a price action that works in their favour.
3. Chart patterns are just adequate for the short term
Most of the chart patterns provide valid signals for a limited time duration. This means that traders are left with a small opportunity to benefit from generating profitable chart patterns.
A minor delay can cause the trading Forex signals to no longer show effective results with a maximum risk/reward proposition.
4. Chart patterns can inspire subjectivity
With the help of chart patterns, traders can get a natural feeling of being part of the forex market. However, traders have a high chance of becoming more subjective than objective when trading chart patterns.
Subjective trading CFDs can be dangerous for traders because they are more guided by general guidelines and never follow strict rule-based systems. A Forex pattern can continue for one trader and a reversal formation for other traders.
1. Which chart is best for forex trading?
The best chart for forex trading is TradingView. This chart is highly recommended by multiple traders having access to the free version and various advanced features.
2. Is it hard to identify forex patterns?
You can identify the forex patterns in a “W” shape based on two low points. Thus, you will find this bullish chart pattern following a downtrend in which the price drops to a new low. It increases itself slightly and then dips back down to the lowest point. Once it reaches the second low point, the price is expected to increase again.
3. Are chart patterns repetitive?
You can access valuable data once you learn about the stock market chart patterns. Of course, the patterns repeat themselves again and again. But the most significant turning point is that the exact pattern repetition will rarely occur.
4. Can forex chart patterns predict the forex chart price?
Forex chart patterns cannot work perfectly for predicting the forex price chart. One biggest misconception about technical analysis and chart patterns is that it’s a reliable approach for predicting market moves and does not constitute investment advice.
5. Why do chart forex patterns fail?
A forex chart pattern will display failure results if a specific chart pattern is not materialised as it was anticipated. 58.42% of retail investor accounts lose money when trading CFDs using chart patterns. Trading on the Forex and CFD markets is always a high risk. And thus, it fails to achieve the desired potential in the market. This will cause the price action to start moving in an opposite direction.
To summarise the whole discussion, it is evident that chart patterns play a reliable role in tracking the price movement or seeing when it changes in the forex market.
Traders can identify prevailing marketing conditions through chart patterns and determine existing support and resistance levels. Plus, it is equally helpful in anticipating the possible changes in a forex market to catch rising trade opportunities.
Jason Morgan is an experienced forex analyst and writer with a deep understanding of the financial markets. With over 13+ years of industry experience, he has honed his skills in analyzing and forecasting currency movements, providing valuable insights to traders and investors.
Forex Content Writer | Market Analyst