What do traders use to predict the price direction? Technical indicators, candlesticks, and of course, chart patterns. Overall, there are many trading patterns that occur on the price chart daily. That's why they were divided into three groups. What are these groups? How do you remember all these patterns? Read our guide to have comprehensive knowledge about chart patterns.
A chart pattern is a combination of support and resistance levels formed by candlesticks in a specific shape which helps to define whether the market will move in the same direction or turn around. There are three types of technical analysis patterns: reversal, continuation, and bilateral.
A chart pattern is a combination of support and resistance levels formed by candlesticks in a specific shape.
Look at the picture below. Here is one of the most famous trade patterns - head and shoulders. As you can see, candles are placed so that the pattern resembles a head and shoulders. Based on the candlesticks' location, we can define the support level. Later, we will tell you how to read the signal of this pattern.
There are two major types of chart patterns. They are reversal and continuation. However, there is a third one that combines both types. It’s bilateral patterns. Let's learn how to identify all types on the price chart and what patterns each type contains.
There are two major types of chart patterns: reversal and continuation. However, there is a third one that combines both types. It’s bilateral patterns.
The name of the type explains the idea of the reversal patterns. These patterns predict the trend will turn in the opposite direction after their formation. If the price declines, a reversal chart pattern says the market will go up soon. Conversely, if the market rises, a reversal pattern sends you an alert that you should close a long trade and be ready as the market will decline soon.
Reversal chart patterns predict the trend will turn in the opposite direction soon.
Let's list the most effective and famous reversal chart patterns:
Although chart patterns look differently, we can highlight a key rule of reading their signals. To define a take profit level, measure the distance between support and resistance levels at the point where the pattern starts forming. It will be the distance between the entry point and the take profit level. The entry point is the place where the price breaks either support or resistance level depending on the trend.
As for the stop loss level, there is an idea of counting the distance between the support and resistance levels and dividing it by two. The concept suits the best risk/reward ratio of 1:2. However, we would advise you to evaluate the market conditions and use a trailing stop loss in case of an uncertain situation.
Continuation chart patterns appear when the current trend takes a pause. That's why sometimes they are called consolidation patterns. Trendlines serve as support and resistance levels. They occur on the chart when buyers and sellers can't beat each other, and the price consolidates for a while. Such patterns show the market will keep moving in the same direction.
Continuation chart patterns appear when the current trend takes a pause but keeps moving in the same direction later.
Look at the list of the most famous continuation chart patterns:
For most of the patterns, the idea of trading is similar. You should draw support and resistance lines and count the distance between them at the point where the pattern starts forming. This is the size of the area between the entry point and the take profit level.
Same as with reversal patterns, the entry point occurs when the price breaks either support or resistance level regarding the prevailing trend. The stop loss level differs. To define the size of the risk, you are ready to take, place the stop loss above the resistance for bearish patterns and below the support for bullish patterns.
A bilateral chart pattern is a pattern that doesn't predict a certain direction of the market. It sounds strange as the idea of the pattern is to predict the price direction. Still, the pattern will show you where the market will move. However, it will happen not during the formation of the pattern but after the break of either a support or resistance level.
Bilateral chart patterns don’t predict a certain direction of the market.
Ascending, descending, and symmetrical triangles are bilateral patterns. Although ascending and descending triangles usually signal a continuation of the trend, there is an odd price that will move in the opposite direction. Thus, you should always evaluate market conditions (for instance, whether the market is volatile) before opening a trade.
Above, we mentioned chart patterns. Of course, we can't leave you alone with all of them without explaining how they look and work.
A head-and-shoulders pattern is one of the easiest and most common patterns that is known even by newbies. It's a reversal bearish chart pattern that is formed at the end of the uptrend. Why is it head and shoulders? Because the pattern has three tops: the second is higher than the first one, but the third peak is lower than the second one. Thus, we have the highest peak, called the head, and two lower peaks which are called shoulders. The perfect pattern has two shoulders that are similar in height and width.
As we said above, the third top is lower than the second one, which signals a weakening of the current trend. Also, the pattern has a neckline. It's a line drawn through the lowest points of the two troughs that serves as a support level. The neckline can be drawn horizontally or moving down/up. The signal is stronger if the neckline declines. The pattern works when the price breaks below the neckline (support) after the formation of the second shoulder. You can open a short position at the breakout. The take profit order can be placed at a distance equal to the distance between the top of the head and the neckline.
Remember about the stop loss. You can always apply a 1:2 risk/reward ratio. So, the stop loss order will be half of the take profit distance and placed above the breakout.
Hint: we should warn you that the price can return to the neckline after the breakout. So, the neckline will turn into resistance.
An inverse head and shoulders or head and shoulders bottom is a reversal bullish chart pattern. The inverse head-and-shoulders pattern mirrors the standard one. It consists of three lows. The head has the lowest bottom, while the shoulders are almost the same size.
The pattern begins when the price forms two lower lows which signal a downtrend. However, the third low is higher, which means bears lose their strength, and there are odds of the uptrend. The reversal is confirmed when the price breaks above the neckline. Take profit and stop-loss orders are defined as in the standard pattern.
A double top is a bearish reversal pattern. It occurs at the end of the upward movement. This pattern is as famous as the head and shoulders one because it's easy and frequent. The name of the pattern explains its idea. If you find two consecutive tops of similar or almost similar height with a moderate trough between them, it's a double top pattern. The neckline should go throw the lowest point of the trough.
The pattern works when the price falls below the neckline after the second top is formed. A trader can open a sell trade after the breakout. To measure the take profit level, count the distance between the tops and the neckline and put it from the neckline down. Stop-loss level can be measured according to the risk/reward ratio. Divide the take profit distance by two and place this number of pips from the neckline up.
After the breakout, the neckline becomes a resistance. Like in the head and shoulders pattern, the price can turn back and test the neckline again.
As you might have guessed, the double bottom is a mirror pattern of the double top. It's also a reversal pattern, but it occurs at the end of the downtrend. The double bottom consists of two consecutive bottoms which have similar or almost similar length. Also, there is a high between them. The neckline is drawn through the highest point of the trough.
The pattern works if the price breaks above the neckline after the formation of the second bottom. Take profit and stop loss levels are measured as in the double top pattern. The price can retest the neckline after the breakout. However, it is anticipated to rise after the pattern's formation.
These patterns are rarer, but we should tell you about them, so you know they can appear on the price chart.
The patterns resemble double top/bottom patterns and work similarly. The only difference is that triple bottom/top works after the third peak/low is formed.
There are three variations of triangles. A triangle pattern is easily recognized. To define it on the price chart, you should draw support and resistance levels. The idea of triangle trading is to open a trade on the breakout. It's risky to trade within the triangle.
Triangles are traded on the breakout. It's risky to trade within the triangle.
The take profit order for any type of triangle can be defined by measuring the distance of the widest part of the pattern. This distance should be counted from the entry point. To define the stop loss order, use the 1:2 risk/reward ratio. The symmetrical triangle is neither bullish nor bearish. The signal depends on the direction of the breakout.
The support and resistance levels move towards one point. Support is going upwards, and the resistance sloping down, so they meet at one point and form one angle. Trading the symmetrical triangle, you can use two different approaches. You can wait until the price breaks either a support or a resistance line and open a trade after the breakout. Another way is to place One-Cancels-the-Other Order. So, when one order works, the other will be canceled automatically.
A descending triangle is considered a continuation pattern that signals the downtrend will continue. Still, it is tricky and can be called a bilateral pattern as the price may turn in the opposite direction to the prevailing trend. In common concept, the descending triangle shows that bears are strong enough to pull the price further down.
In the descending triangle, the resistance line slopes down, while the support is almost horizontal. The price is expected to break the support level and keep falling. So, as soon as the breakout occurs, you can open a short position. We don't recommend opening trade before the breakout as the price may break the resistance, and the trend will change.
An ascending triangle is also a bilateral chart pattern. Still, the main idea of the ascending triangle is a trend continuation. The pattern depicts the strength of bulls, so they are ready to push the price further up.
Opposite to the descending triangle, the resistance of the ascending triangle is relatively flat, while the support level slopes up. Although the price can break both support and resistance, the more common case is that the upward trend continues, so the price breaks above the resistance.
You should wait for the breakout to open a trade as any bilateral pattern includes risks.
A pennant is a continuation chart pattern. This pattern occurs after a strong move. The pennant reflects a pause in the strong market direction no matter if it's up or downtrend. There are two types of pennants: bearish and bullish. As the market moves in the same direction forming almost a vertical trend, it needs a pause. This short-term pause when the price consolidates is called a pennant.
Traders enter the market on the breakout in the trend's direction. The take profit level can equal the distance of the move ahead of the pennant formation. The stop loss order should be placed above/below the beginning of the pattern.
Pennants and triangles look similar. Still, the pennant is a short-term pattern that happens when the market moves strongly up or down. The triangle is a medium- or long-term pattern which occurs independently to the previous trend.
Now you can be confused as pennants and triangles look similar. The difference is timeframes. The pennant is a short-term pattern. It happens when the market moves strongly up or down. The triangle is a medium- or long-term pattern. It occurs independently of the previous trend.
Flags are considered more reliable than triangles or wedges as they are less frequent. There are two types of flag patterns. They are bull and bear. Although the price may break in any direction, in most cases, the flags are continuation patterns.
The flag pattern resembles a flag and looks like a small channel after a strong movement. The flag moves in the opposite direction to the prior trend. After an upward movement, it slopes down. After a downward movement, it has an upward slope. Traders should enter the market after the breakout. Take profit order should equal the size of the flagpole (the distance of the movement before the flag's formation). Stop loss can be placed above/below the beginning of the flag.
A wedge is a chart pattern that predicts a trend continuation. There are two types of wedge patterns: rising and falling.
Support and resistance levels of the pattern move in one direction, so the channel narrows until the price breaks any of the levels. During the ascending (rising) wedge, support and resistance lines move up. However, the rising wedge is a bearish pattern that signals the price will keep moving down. In the descending (falling) wedge, support and resistance decline.
When the price breaks below the support level, a trader can enter the market. To measure the take profit level, calculate the distance of the widest area of the pattern. A stop-loss order can be placed above the resistance in the rising wedge and below the support in the falling wedge.
A rectangle is a continuation chart pattern that occurs due to the pause in the trend. There are bearish and bullish rectangles. The pattern consists of flat support and resistance lines. The price tests them several times before the breakout.
The signal of the rectangle depends on the trend. If the rectangle happens during the uptrend, it signals the price will keep rising. If the rectangle occurs during the downtrend, there are odds the market will fall. To enter the market, wait for the price to break either support or resistance. The take profit should equal a distance between the support and resistance lines. Stop loss can be placed above the resistance in the downtrend and below the support in the uptrend.
Follow these steps to read FX chart patterns:
We have prepared a few simple rules that will make your trading more effective:
Why do traders use chart patterns? Is it not complicated to remember all the shapes and signals they provide? If you still think like this, you should practice more looking for chart patterns on the real market.
However, we don't recommend training on the real account as a wrong reading of chart patterns can lead to losses. Use a Libertex demo account that allows practicing on real market conditions and a wide range of trading instruments, including currencies and CFDs.
To round up, check the answers to the following questions.
Forex chart patterns work for sure. Otherwise, traders all around the world would not use them. Still, you should remember that there is no perfect chart pattern, and each signal should be confirmed.
You can find chart patterns on any timeframe and for any trading instrument.
Chart patterns are useful trading tools as they provide entry, take profit, and stop loss levels. All you need to do is draw support and resistance lines that will tell you where to place all the levels.
A forex chart consists of chart and candlestick patterns. To read the chart and catch the trading signals, you need to have comprehensive knowledge about the patterns.
Fortunately, all types of chart patterns have common rules for reading their signals. Learn the main concept and practice on a Libertex demo account to strengthen your knowledge.
There is no most bullish or bearish chart pattern. Such factors as market volatility, timeframe, market conditions affect the strength of the chart pattern.
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