Introduction
If you’ve been trading forex for any length of time, it may feel like an endless study of geometry. As traders, we care about structure and repetition; patterns in forex trading offer us these qualities.
Charts always provide clues on the buying and selling pressure at any moment. All that is left is for traders to interpret them to make a profit. When the same story has repeated itself time and time again, well, Bob’s your uncle.
Here, we will look at the best forex chart patterns with diagrams and real-life examples of their appearances.
What are forex chart patterns?
Pattern trading refers to particular graphical structures on a chart that analysts use to forecast future price movements. These patterns offer a pictorial record of trading activity where we ascertain the strongest force between buyers and sellers.
The formation of any forex chart pattern is caused by numerous factors, one of which includes market or mass psychology. There are virtually endless reasons that make prices move up or down. Yet, you don’t need to know them all; it’s impossible.
Trading patterns are a branch of technical analysis, which also largely includes indicators and support and resistance. Technical analysts believe that the past repeats itself. Chaos theory suggests that we can find probabilistic order even in seemingly random behaviour.
Trading chart patterns easily describe the natural phenomenon of market movements. Most importantly, they tell a story of where the price will likely go next, which is what matters.
Over decades, these became a self-fulfilling prophecy. No one knows why a certain formation causes a directional change. But, in many cases, if more and more participants see it every time, it influences their actions to trade accordingly.
For all the wonders of forex market patterns, they aren’t foolproof. Everything in trading is about probabilities. So, no matter the likelihood, a pattern does fail here and there. Fortunately, we can always mitigate the risk, which is integral to long-lasting success and emotional control.
Types of forex chart patterns
We have three kinds: reversal patterns, continuation patterns and bilateral patterns. One advantage of all these formations is they have clear, proven entry, exit and stop-loss rules.
An essential tip is always entering once the candle closes above or below the breakout area with a full-bodied candle (check out our guide on candlestick patterns).
Reversal forex chart patterns
These set-ups suggest that the predominant trend is likely to change direction. The most common reversal set-ups are the following:
- Double top
- Double bottom
- Head and shoulders
- Inverse head and shoulders
- Rising wedge
- Falling wedge
Let’s explore these forex price patterns in better detail, along with real-world examples.
Double tops and double bottoms
Double tops and double bottoms are frequently-appearing formations.
The double bottom comprises two swing lows of relatively equal depth that fail to break a support area. This forex chart pattern is shaped like a W and occurs after a downtrend.
The double top has two swing highs of relatively equal height that decline to push past a resistance area. This forex chart pattern is shaped like an M and happens after an uptrend.
You should always enter double bottoms and double tops at the ‘neckline,’ a conservative point where traders expect the price to break out.
Another trick is to enter midway or at the 50% Fibonacci level between the neckline and support/resistance area. This technique applies to most forex chart patterns. The price doesn’t always break out forcefully.
Taking advantage of this event can offer a tighter stop loss, resulting in a greater reward. The stop is supposed to be placed below the lowest low (for a double bottom) or above the highest high (for a double top).
Lastly, the rule of thumb for profit targets is to aim for the distance from the highs/lows to the neckline. Yet, these patterns in forex can net a lot more pips. Let’s look at an example of this formation on the 4HR chart of XAU/EUR.
Here, we see a double bottom. We have pinpointed the entry and stop loss areas, along with the ‘midway’ entry technique.
Head and shoulders
The head and shoulders is another intriguing addition to the best forex chart patterns. It appears less frequently than the double top or double bottom, making it more reliable and rare.
This pattern consists of three consecutive peaks, where the middle one (the ‘head’) is higher than the two of adjacent height. The opposite is true for the inverse version of the pattern; three successive troughs, with one lower than the two of almost equal depth.
The last part of this formation is, of course, where chartists anticipate a breakout which solidifies the trend change. It is also where you should enter this forex trading pattern.
The image below demonstrates the stop loss and exit parameters. Traders aim for the distance from the head to the neckline as a profit target.
The example below is the head and shoulders on the EUR/GBP 4HR chart. We have marked the entries (including the alternative entry), stop loss and profit-taking areas.
Falling and rising wedges
Wedges are forex chart patterns that occur when the price contracts between slanted trend or support/resistance lines. In some cases, these formations can also signal continuations.
A falling wedge is a bullish formation where the lower highs appear faster than the lower lows. A rising wedge is a bearish pattern in forex where the higher lows form quicker than the higher highs.
In both scenarios, the two trend lines converge as the price gets cornered, leaving it no choice but to break out.
Make sure to connect at least three distinct swing highs and lows when plotting the trend lines. The picture shows this set-up in illustrative detail, along with where to enter and place your stop loss. For the target, traders aim for the height between the entry and the beginning of the wedge.
The example below is the rising wedge on the 1HR chart of GBP/USD. Similar to the previous patterns, you can also enter as the price retests the breakout zone, allowing for a tighter stop. We have also demonstrated this in the image.
Continuation forex chart patterns
As the term suggests, these forex trade patterns suggest the ongoing trend will continue. No matter how strong, any trend will always have a ‘breather’ or consolidate phase when the market is in a defined range.
As mentioned earlier, falling and rising wedges can also act as continuation forex chart patterns. The image below demonstrates how it looks in this situation.
The next two continuation set-ups are the pennants and rectangles.
Pennants
Below is a demonstration of the bullish and bearish pennant, along with the entry, stop and take-profit guidelines.
Pennants look quite similar to wedges, given their flagpole-like appearance. They consist of two slanted trend lines that contract the price to a triangular corner. The difference is the contraction is more pronounced compared to the wedge.
Let’s look at the bullish pennant on the 4HR chart of CHF/JPY.
Rectangles
Rectangle patterns display conventional range-bound situations where the price bounces off a horizontal zone. Of course, there is a bullish and bearish version of this set-up.
Let’s look at the bearish rectangle on the 1HR chart of AUD/NZD for better envisioning.
Bilateral forex chart patterns
We refer to these arrangements as bilateral because they can signal a reversal or continuation. You must use discretion and combine other confirmation factors to trade the most likely scenario.
Traders generally place an order at either side of the corner’s pattern to capitalise on both outcomes.
For this section, we have three types of triangles: ascending, descending and symmetrical.
For a realistic example, let’s look at a descending triangle forex pattern on the GBP/CHF daily chart.
Conclusion
So, there you have it – a look at the best forex chart patterns for your trading ‘arsenal’. Needless to say, there are many other chart formations out there, ranging from the cup and handle to the diamond.
As with anything related to technical analysis, stick to only a few things to prevent analysis paralysis. Once you’ve found your favorite forex chart patterns, master them. Finally, always ensure that the risk-to-reward is worthwhile enough each time.
