Trading Patterns – What every day trader must master to be successful

  This guide regarding Forex trading patterns: what every Forex trader must master to be successful, shows you how to spot patterns and make informed decisions when Trading Forex. We study the past to recognize patterns to predict the future, the same is true in Forex day trading.  In the world of Forex trading including day trading if you want to be able to recognize when a currency pair will breakout then you need to understand the patterns of the past. The ability to recognize indicators and move on them before it is too late, will allow you to take optimal advantage to make a profit in these conditions. The best way to make sense of this and to familiarize yourself with these conditions is by using Forex trading patterns or chart patterns as they are often called.   What are Forex chart patterns?    When you correctly identify them, they reveal an impending explosive breakout. These movements in the market are what we want to spot before they happen, so we can jump on and ride them for maximum profit. Before we discuss charting, we must understand the main components of the charts that we are looking at, what are they and what do they mean?  

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Bars, Lines and Candlestick Charts

  Charts are a crucial part of trading since they are the visual representation of what prices have done in the past and in the present. The most popular day trading charts are candlestick charts, but line charts and bar charts are also commonly used. These chart types give very similar information, but they look completely different. These charts are separated into segments of time, and show the open and closed, as well as the low and the high of a price in a specific period.   Why are bars, lines and candlestick charts important?   There is an important relationship between price and time, and it will do well for Forex traders, especially if you are employing day trading strategies, to study the patterns that exist in these charts. Technical analysis of these patterns and how you should, in all probability, enter and exit in a trade will help greatly in developing your strategy, or methodology.   Have a look at the Bar chart below   If the opening price was higher than the closing price for the period you are looking at then the bar would be red, and we call that a “Bearish bar”. If the opening price was lower than the closing price for the period you are looking at then the bar would be green, and we call that a “bullish” bar.     Take a look at the candlestick pattern below, reflecting the same information as the bar chart above.     What Are Forex Chart Patterns?    Forex chart patterns are patterns based on past movements and indicators that seem to have a high probability of occurring in certain recognisable circumstances. These circumstances seem to indicate the movement of a trade in a given direction based on these past indicators and patterns to a high degree of probability, making it a pattern you can follow.  

Types of Chart Patterns

  There are three main types of chart patterns classified in Forex technical charting based on the potential price direction of the pattern.  

Continuation Chart Patterns

  A continuation pattern indicates that a new move is in all probability going to continue in the direction that it is already going. Pennants and rectangles are examples of continuation chart formations. Wedges can be part of this group but since it can also be a reversal it will be spoken about separately.  

Reversal Chart Patterns

  Reversal chart patterns appear at the end of a trend and these indications are showing that in all probability the movement of the price will reverse. Examples of reversal chart pattern movements are: Double (or triple) top/bottom, head and shoulders and ascending/ descending triangles. Reversal wedges could also be part of this group as well as continuation and so will be spoken about separately.  

Bilateral Chart Patterns

  These are the chart formations in which a price is definitely going to push in a new move, but you can’t say with a high degree of probability in WHICH direction that move will go towards. If you are unable to know the probable direction a move will go then why is this information valuable?  Because you can open a position in the direction of the breakout once it occurs.  And you will be ready for it because you know you are in this neutral position. Continuation/Reversal Chart Patterns I put this in here because in the case of certain Trading Patterns it can be either a continuation or a reversal.  A good example of this is the Wedges and will therefore be dealt with separately.  

Pennant Chart Pattern

  Like rectangles, pennants are continuation chart patterns formed after strong moves. After a big upward or downward move, buyers or sellers tend to pause in trading action before taking the pair further in the same direction. Because of this, the price usually consolidates and forms a tiny symmetrical triangle, which is called a pennant. Pennants could be bearish or bullish depending on the trend direction. The expected move is usually a measured move, meaning the target from the breakout point equals the size of the pennant itself. When you trade a pennant, you should open your position whenever the price closes a candle beyond the pennant, indicating confirmation of the formation. At the same time, your stop loss should be placed right beyond the opposite level of the pennant.     Buyers or sellers tend to jump in the action on a strong move, forcing the price to bust out of the pennant formation.  

Bearish Pennants

  A bearish pennant is formed during a steep, almost vertical, downtrend. After that sharp drop in price, some sellers close their positions while other sellers decide to join the trend, making the price consolidate for a bit.     As soon as enough sellers jump in, the price breaks below the bottom of the pennant and continues to move down.     Pennants tend to signal much stronger moves then other types of chart patterns.  

Bullish Pennant

  Bullish pennants, just like its name suggests, signals that the movement will go bullish, which means that there will be a continued climb in price after a pause.     In this example, the price made a sharp vertical climb before pausing to climb once again.    

Rectangle Chart Pattern

  The rectangle chart pattern is a trend continuation formation. In this trend the price starts moving sideways forming a rectangle, and other movement breaks out of the rectangle formation once it’s completed. This move is likely to be at least as big as the size of the rectangle. Rectangles could be bearish or bullish depending on the trend direction.    

Bearish Rectangle

  A bearish rectangle is formed when the price consolidates for a while during a downtrend. This happens because sellers have a pause in activity before jumping back into the trade to drive the price lower again.     In this example, price broke the bottom of the rectangle chart pattern and continued to shoot down.     Once the pair falls below the support, it tends to make a move that is about the size of the rectangle pattern.  

Bullish Rectangle

  Here is another example of a rectangle, this time, a bullish rectangle chart pattern. After an uptrend, the price paused to consolidate for a bit. Can you guess where the price is headed next?     The price moved all the way up after breaking above the top of the rectangle pattern.     Just like in the bearish rectangle pattern example, once the pair breaks, it will usually make a move that’s about the size of its previous range. When you trade rectangles, you should put a stop loss beyond the opposite extreme of the formation. Notice that this trading pattern is like the pennant, the difference is the swings of the rectangle formation occur within the same price zone.  

Reversal Chart Patterns 

Double Top

  A double top is a reversal pattern that is formed after there is an extended move up. The “tops” are peaks which are formed when the price hits a certain level that cannot be broken. After hitting this level the price won’t be able to break through and sort of bounce off of it but then return to test the level again. If the price bounces off that level to rise again then you have a double top.  In other words, we have a double top pattern when the price creates two tops approximately on the same level. And on the contrary, we have a double bottom pattern when after a downtrend the price creates two bottoms approximately on the same level. Triple top and triple bottom formations are exactly the same but with three tops or bottoms depending on the case.     This is a strong sign that a reversal is going to occur because it is telling us that the buying pressure is just about finished. With the double top, we would place our entry order below the neckline because we are anticipating a reversal of the uptrend.     Looking at the chart you can see that the price breaks the neckline and makes a nice move down. You will also notice that the drop is approximately the same height as the double top formation. Keep that in mind because that’ll be useful in setting profit targets.  

Double Bottom

  The double bottom is also a trend reversal formation, but this time we are looking to go long instead of short. These types of formations happen after an extended downtrend when two valleys or “bottoms” have been formed.     You can see from the chart above that after the previous downtrend, the price formed two valleys because it was not able to go below a certain level. Notice how the second bottom wasn’t able to significantly break the first bottom. This is a sign that the selling pressure is about finished, and that a reversal is about to occur.     The price broke the neckline and made a nice move up. Take note of how the price jumped by almost the same height as that of the double bottom formation? Remember, just like double tops, double bottoms are also trend reversal formations. You’ll want to look for these after a strong downtrend.      

Head and Shoulders Pattern

  This is one of the most reliable chart patterns out of all that we have outlined and discussed. Head and shoulders are a reversal formation and indicate a topping reversal after a bullish trend and is most often seen in uptrends. Head and shoulders patterns are formed by a peak (shoulder), followed by a higher peak (head), and then another lower peak (shoulder) that really does seem to form the namesake “head and shoulders”. A “neckline” is drawn by connecting the lowest points of the two valleys with a line. The slope of this line can either be up or down. Typically, when the slope is down, it produces a more reliable signal. When the price closes a candle beyond the neckline, the head and shoulder formation is fully formed and can be recognized, and we can then prepare to enter the market with a position.     With this formation, we would put an entry order below the neckline. We can also calculate a target by measuring the high point of the head to the neckline. This distance is approximately how far the price will move after it breaks the neckline.     You can see that once the price goes below the neckline it makes a move that is at least the size of the distance between the head and the neckline. We know you’re thinking to yourself, “the price kept moving even after it reached the target” but it is very important to keep in mind that you want to stick to your plan and not get in a habit of being overly greedy. Rather make your profit and not take risks.  

Inverse Head and Shoulders

  The inverted Head and shoulders are like a man doing a head stand.  It is the head and shoulders formation; except this time, it is upside down. The inverted head and shoulders typically appear after a bearish trend and calls for a bottom in price.     Once again, it’s just like the Head and Shoulders pattern but just upside down.  With this formation, we would place a long entry order above the neckline. Our target is calculated just like the head and shoulders pattern. Measure the distance between the head and the neckline, and that is approximately the distance that the price will move after it breaks the neckline.     You can see that the price moved up nicely after it broke the neckline. If your target is hit, then be happy with your profits and once again, don’t be too greedy.  

Ascending Triangle Pattern / Descending Triangle Pattern/Symmetrical Pattern

  There are three types of Triangle Patterns.  Ascending, Descending, and Symmetrical.  

Ascending Triangle

  This type of triangle chart pattern shows that sometimes there is a resistance level at the top end and a slope of lows that go higher and higher each time, creating this ascending triangle shape. There is a certain level here that just is resisting breaking through, however, the price begins to gradually be pushed up as can recognized by the lows going higher each time.     They keep putting pressure on that resistance level and as a result, a breakout is bound to happen.  But which direction will it go, is the main question. Most books on charting will say that \the price will break past the resistance, but this is certainly not always the case. The resistance can be too strong to break and therefore not push through.  You can expect the direction to go up but be ready for the movement to go in either direction.     Unlike the ascending triangle pattern which has tops, the descending triangle has bottoms, which lay on the same horizontal line and lower swing tops. Although many people consider these chart patterns as neutral, their chance to reverse the trend is a bit higher. Thus, I put them with the trend reversal chart patterns.  

Descending Triangle

  In descending triangle chart patterns, there is a string of highs that go lower and lower each time and which forms the upper line. The lower line is a support level in which the price cannot seem to break.     Now most of the time the price will eventually break the support line and continue to fall. In some cases, however, the support line will be too strong, and the price will make a strong move up.     As you see, ascending and descending triangles are very similar to the rising and falling wedges. When an ascending/descending triangle is confirmed, we expect a reversal price movement equal to the size of the formation.  

Bilateral Chart Pattern – Symmetrical Triangle

  Symmetrical triangles have two sides, which are approximately the same size.  This happens because the slope of the price’s highs and the slope of the price’s lows come together to a point where it looks like a triangle that is symmetrical. What is happening during this formation is that the market is making lower highs and higher lows, which means that neither the buyers nor the sellers are pushing the price far enough to make a clear trend. If this were a battle between the buyers and sellers, then this would be a draw.   As these two slopes of the triangle get closer to each other, it means that a breakout is getting near. The direction that breakout will be is unknown, but we do know that the market will most likely break out. Eventually, one side of the market will give in.     When a symmetrical triangle occurs on the chart, we expect the price to move in an amount equal to the size of the formation. However, the direction of the breakout is typically unknown due to the equivalency of the two sides of the triangle.  The only thing to do is to wait to see which direction the breakout will occur. If you trade a symmetrical triangle, you should place a stop loss right beyond the opposite end of the breakout side.  

Continuation/Reversal in the case of Wedges 

Corrective Wedge Pattern

  Wedges are very interesting chart patterns. The reason is that wedges could be a trend continuation or trend reversal formation. Wedges signal a pause in the current trend that signals that Forex traders are still deciding where to take the pair next. There are two types of Wedges: corrective wedges and reversal wedges. There is no difference in overall appearance between these two types of wedges. They look absolutely the same – for example, a regular rising wedge and a regular falling wedge. The corrective/reversal character is determined by the previous price movement. The corrective wedges show as a short-term period of movement against the trend, followed by a return to the previous trended movement direction. A corrective wedge has the potential to push the price toward another trending move equal to the size of the wedge itself. This is how corrective wedges appear. Reversal rising/falling wedges look absolutely the same way as corrective rising/falling wedges but with one key difference, of the relation between the wedge and the trend direction. Every rising wedge has bearish character. This means a rising wedge reverses bullish trends and continues bearish trends. At the same time, every falling wedge has bullish character. So, falling wedges reverse bearish trends and continue bullish trends. A rising wedge is formed when price consolidates between upward sloping support and resistance lines. Here, the slope of the support line is steeper than that of the resistance. This indicates that higher lows are being formed faster than higher highs. This leads to a wedge-like formation, which is exactly where the chart pattern gets its name from. With prices consolidating you can see that the breakout can happen either to the top or bottom. Whichever direction the pattern moves you need to be able to spot it and be ready to move with your entry orders.     In this first example, a rising wedge formed at the end of an uptrend. Notice how price action is forming new highs, but at a much slower pace than when price makes higher lows.     Here, the price broke down to the downside which means that there are more Forex traders desperate to be short than be long. They pushed the price down to break the trend line, indicating that a downtrend may be in the future. Just like in the other Forex trading chart patterns we discussed earlier, the price movement after the breakout is approximately the same as the height of the formation. Now let us take a look at another example of a rising wedge formation. Only this time it acts as a bearish continuation signal.     As you can see, the price came from a downtrend before consolidating and moving to higher highs and even higher lows.     In this case, the price broke to the downside and the downtrend continued which is why it is called a continuation pattern as the trend continues in the same direction. A rising wedge formed after an uptrend usually leads to a reversal of direction of movement (downtrend) while a rising wedge formed during a downtrend typically results in a continuation of movement in the same direction. (downtrend).  

Falling Wedge

  Just like the rising wedge, the falling wedge can either be a reversal or continuation signal.  It is formed at a bottom of a downtrend, indicating that an uptrend would come next. As a continuation signal, it is formed during an uptrend, implying that the upward price action would resume.     The falling wedge serves as a reversal signal. After a downtrend, the price made lower highs and lower lows. Take note that the falling trend line connecting the highs is steeper than the trend line connecting the lows.     Upon breaking above the top of the wedge, the pair made a nice move upwards that is approximately equal to the height of the formation.

In Summary

Frequently Asked Questions

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