Making money on the forex market—or any other exchange, for that matter—can certainly be tricky. But thanks to a number of chart patterns, you can learn to anticipate price movements and act accordingly. Making money doesn’t have to be impossible.
Unfortunately, with so many different patterns out there, it can be difficult to figure out which ones are best for determining where prices will go in the near future.
To make your job easier, we’ve outlined some of the more helpful continuation and reversal patterns below in a forex cheat sheet. Become familiar with each of them to make better trades.
1. Head and Shoulders
The head and shoulders pattern is one of the most common patterns on forex markets. As the name suggests, a head and shoulder pattern resembles human anatomy. It occurs when a financial instrument (e.g., a currency) reaches a high during an uptrend, finds resistance there and reverts to the trend line (i.e., the neckline), reaches yet another high before reverting back to the trend line, and finally reaches a third high before falling below the trend line.
The resulting pattern looks like two shoulders with a head in the middle. Those who are familiar with this pattern and trade it correctly can identify lots of potentially great trading opportunities.
There’s also an inverse head and shoulders pattern, which is a mirror reflection of the head and shoulders pattern. During a downtrend, the financial instrument will reach a low (the first shoulder), revert to the trend line, reach an even lower low (the head), revert to the trend line, reach a third low (the second shoulder), and then ultimately break out and close above the trend line.
2. Rising and Falling Wedges
Wedges, also known as triangles, are one of the most common patterns you’ll notice on forex charts. These patterns occur when price movements become constricted into an increasingly narrow range before finally breaking out.
Rising wedges are bearish patterns that generally precede downtrends. These occur when price consolidation trends upward. After a period of several higher highs and higher lows, consolidation is complete, and the price shoots below the trend line.
Falling wedges, on the other hand, are bullish patterns that generally precede uptrends. As price consolidation trends downward, a financial instrument reaches several lower highs and lower lows before ultimately breaking out above the trend line.
3. Double Tops and Bottoms
During an uptrend, a currency may reach the same high on two separate occasions but may be unable to break out above it. This is a pattern known as a double top. If the second top isn’t cracked, there’s a good chance that the price is going to start trending down.
Double bottoms, on the other hand, may signify that the price is about to trend upward. This pattern occurs during downtrends when the price finds resistance at the bottom and is unable to break down below it on two separate occasions. After the second bottom isn’t breached, the price may shoot upward.
4. Bull and Bear Flags
Bull and bear flags are continuation patterns that emerge when the market is indecisive. Let’s say a currency is trending upward (the flagpole). After a while, the price may stall or even tick down a bit, but for the most part, it remains more or less flat during a period of consolidation (the flag).
Once that period ends, the price generally continues on the previous trend, climbing higher and higher.
A bearish flag, on the other hand, occurs when the price is trending downward (the flagpole). During a period of consolidation, the price remains relatively flat or even trends upward a bit (the flag). After the price has consolidated, the instrument generally continues on the downtrend.
When you’re able to identify these patterns, you can make a lot of money because you’ll be able to predict with relative confidence when a price is about to shoot up or shoot down.
5. Engulfing Pattern
Engulfing patterns, which are incredibly easy to identify, occur when a candle’s real body completely engulfs the previous day’s.
Bullish engulfing occurs following a downtrend when an up candle engulfs the previous day’s real body. Bearish engulfing occurs following an uptrend when a down candle engulfs the previous day’s real body.
Engulfing patterns represent a complete reversal of the previous day’s movement, signifying a likely breakout in either a bullish or bearish direction, depending on which pattern emerges.
6. Butterfly Pattern
Although the butterfly pattern may look complicated, it’s actually fairly easy to identify. It features an ABCD pattern that starts with a swing high or low from the pattern’s originating point (X), followed by reversals between each point that correlate to Fibonacci extension ratios. The “B” point in the pattern is the linchpin between two triangles, or wings, that meet in the middle.
The butterfly pattern can also look like a capital “M” on a bullish pattern or a “W” when the trend is bearish.
When this pattern develops, it often serves as a strong sign of a price movement continuation in the trending direction.
7. Cup and Handle
The cup and handle pattern is an easy one to identify. It features a drop in price and a gradual rise up to the original value—typically over a period of 1-6 months—but the pattern’s development could be valid over periods ranging from weeks to years.
After the price rises back to the original value, forming the “cup” part of the pattern, a smaller drop and rise occurs to form the “handle.” This handle typically features a retracement of anywhere from 30% to 50%, although outliers are possible. This pattern is often viewed as a strong bullish indicator, especially when developing over a period of several months. When developing quickly or over a long period of time, the bullish indicator isn’t as reliable.
A pennant, which is one of the more basic patterns used in forex, typically develops after a flagpole and features a period of consolidation that can then lead to a breakout. This consolidation period creates the pennant pattern.
To capitalize on pennant patterns, use other indicators to forecast the direction of the breakout, and then place a stop-limit order on the other side of the breakout to limit your losses in case the breakout moves in the wrong direction.
9. Broadening Top
A broadening top is marked by five consecutive minor reversals, which then lead to a substantial decline. An important characteristic to note is that, at the point where the price changes course, the new high or low is more extreme than the high or low before it. This creates the broadening formation that, in most cases, suggests a bearish trend is developing.
This pattern can at first appear to be a butterfly pattern in development, but the fifth reversal and ascension beyond previous highs in the pattern shows a possible broadening top formation in progress. The breakout beyond the lower trend line set up by “B” and “D” will confirm this pattern.
The hammer is a useful, single candlestick pattern that can be used to identify a “bottom” in price action for a currency pair. The long wick at the bottom of this price can be indicative of an impending upswing in price, which some traders may use to open a position ahead of the action.
The rounding bottom can be an effective tool for identifying price movements that may lead to either a price reversal or a continuation. The best use of this pattern is in conjunction with other technical indicators that may help you determine which direction the price is most likely to move.
When opening a position after a rounding bottom is set up, it’s wise to set a stop-loss to protect yourself if your price movement expectation is wrong. You can also use trailing stop-losses to follow the price as it approaches a line of resistance, locking in profits as you watch to see if the pattern leads to either a reversal or a continuation.
On the other hand, an inversion of this single candlestick pattern—in which the peak of a price is marked by a long wick above the candle—can be referred to as a “zenith” and may be used by some traders to identify an impending drop in price.
Learning these 11 patterns and knowing them inside and out will almost certainly help you make better trades. But that doesn’t mean your education needs to stop here. To become an even more effective trader, read about these seven common indicators that can help you make better trading decisions.
The information provided herein is for general informational and educational purposes only. It is not intended and should not be construed to constitute advice. If such information is acted upon by you then this should be solely at your discretion and Valutrades will not be held accountable in any way.