A Guide to the Most Common Forex Patterns
You probably already know that the price chart for a security is the starting point of all analysis. Even those who are sceptical of technical analysis still use charts in their trading to some extent. There is a very good reason behind this, which is that Forex charts provide traders with a large amount of information.
Furthermore, there are certain patterns which occur in the price charts and form the basis of various trading strategies. In this article, we will explore some of these Forex patterns and show you how to spot them and use them to your advantage!
With such a huge variety of ways to trade currencies, understanding the most common trading methods can save a lot of time, money, and effort. By using popular and simple approaches, a trader can design a complete trading plan using Forex patterns that frequently occur and can be easily spotted with little practice.
Whilst some of these methods can be advanced and sophisticated, there are some simple methods that take advantage of the most regularly traded elements of those patterns. In the following sections, we will provide you with a cheat sheet of some of the most common Forex candlestick patterns!
The Head and Shoulders Pattern
You will probably have come across the head and shoulders pattern, or at least have heard of it, as it is quite popular and is fairly easily spotted. It appears on all time frames and can be applied by day. Furthermore, entry levels, stop levels, and price targets make the formation easy to implement, because the Forex pattern supplies significant and easily seen levels.
Let's look at how the head and shoulders pattern is formed:
- The Left Shoulder - the price rise followed by a left price peak, accordingly followed by a decline
- The Head - the price rises once more forming a higher peak than the left shoulder
- The Right Shoulder - a decline happens once more, followed by a rise forming a right peak that is relatively lower than the head
With an inverse head and shoulders, the Forex pattern is the same as shown above, but in reverse. It is important that traders wait for the pattern to be completed after they set a neckline or trendline that connects two highs in a bottoming pattern, or two lows in the topping pattern of the formation. Almost all or partially completed patterns should be watched. However, no trades should be performed until the the pattern breaks the neckline.
The most common entry point is a breakout of the neckline, with a stop above or below the right shoulder, depending whether the pattern is regular or inversed.
As for the profit target, for a regular head and shoulder pattern, you need to establish the difference between the high of the head and the lowest point of both shoulders, this figure is then subtracted from the breakout (i.e. entry) price. For an inverse head and shoulders pattern, the process is very similar, but in reverse. The low of the head is subtracted from the high of the shoulders, the resulting figure is then added to the breakout price. Whilst this system is not ideal, it provides an approach for trading the markets based on logical price moves.
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The Triangle Patterns
As the name suggests, these chart patterns have a triangular shape. The triangle patterns consist of two of the following trendlines: flat, ascending or descending, and the price of the security moves between the two trendlines. There are three types of triangle Forex patterns which differ in their importance and construction:
- The symmetrical triangle
- The ascending triangle
- The descending triangle
The Symmetrical Triangle
Let's start with the symmetrical triangle, which is often considered to be a continuation chart pattern that signals a period of market consolidation, consequently followed by the resumption of the preceding trend. It is formed by a descending resistance line and an ascending support line.
The two trendlines in the formation of this triangle should have a slope converging at a point, which is commonly known as the apex. The security price will bounce between these trendlines, towards the apex, and will then typically breakout in the direction of the foregoing trend.
In the case of being preceded by a downward trend, a trader's task is to concentrate on a break below the ascending line of support. However, if it it has been preceded by an upward trend, the next step is to look for a break above the descending line of resistance. It is important to note that whilst this pattern favours a continuation of the previous trend, this is far from always the case. The break in the opposite direction of the previous trend should signal the new trend's formation.
The Ascending Triangle
The ascending triangle is a bullish pattern which provides an indication that the security price is heading higher. This chart pattern is formed by two trendlines - a flat trendline being the point of resistance and an ascending trendline in the role of price support.
The security price moves between these trendlines until it breaks out, usually upwards through the line of resistance. This chart pattern will typically be preceded by an upward trend, therefore making it a continuation pattern.
The Descending Triangle
The descending triangle pattern is the opposite of the ascending triangle pattern, in that it provides a bearish signal to Forex traders, informing that the price will likely trend downward upon accomplishment of the pattern. This pattern consists of a flat line of support, and a downward-sloping line of resistance.
The exact opposite to the ascending triangle, this chart pattern is mainly considered to be a continuation chart pattern. That is due to the fact that it is typically preceded by a downward trendline.
It is important to note that this is not an exact science and, as with all these triangle patterns, the price will not always breakout in the expected direction. That is why it is important to implement a stop loss into your trading, to protect yourself against any unexpected price movements.
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The Engulfing Candle Forex Pattern
Forex Japanese candlestick charts provide a lot more information than simple line graphs. For this reason, candlestick chart patterns are a useful tool for measuring price moves on all time frames. Since there are a lot of candlestick patterns, we suggest paying attention to a strategy which is based on a pattern which is easy to spot and is especially useful in Forex trading.
The engulfing pattern is an outstanding trading opportunity, as it is simple to spot and the price action determines a powerful and instant change in direction.
In a downtrend, an up candle real body (i.e. the space between the open and close price) will entirely engulf the preceding down candle real body. This is a bullish engulfing pattern. Conversely, in an uptrend, a down candle real body will wholly engulf the foregoing up candle real body. This is a bearish engulfing pattern.
This pattern is highly tradable as the price action strongly indicates a reversal, since the previous candle has already been entirely reversed.
Traders can take part in the beginning of a potential trend, setting a stop loss above the previous swing high where the pattern occurred, when the engulfing pattern is bearish. When trading a bullish engulfing pattern, the stop loss could be placed below the previous swing low.
There is a wide range of trading approaches using patterns in prices to find market entries and stop levels. Forex patterns that include the head and shoulders and triangle patterns provide ready made stops and entries, as well as profit targets within a patter which can be seen with little effort.
The use of the engulfing candlestick pattern provides an insight into trend reversal, as well as potential participation in a new Forex trend with an identified entry and stop level.
A savvy trader has the opportunity to combine all these well known patterns and methods and perhaps create a distinctive and customisable trading system of their.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.