Chart patterns
Charts record every price movement of the trading instrument. Charts
reflect the traders’ sentiment in any given market scenario and depict
the underlying mindset of the buyers and sellers. Traders tend to behave
mostly in a similar pattern in identical situations. Since charts are a
result of the actions of traders, the trading charts reflect patterns. Forex
patterns and stock market patterns are similar to each other as the
trader’s sentiment mostly drives these markets.
A deep understanding of these patterns provides the trader with the best
entry and exit points and enables the trader to benefit from the entire
trend movement. Successful traders master these forex patterns since
they repeatedly occur and present multiple opportunities. The chart
patterns appear in all time frames and are suitable for all kinds of traders.
Both new traders and advanced traders can trade the patterns with great
succes.
Chart patterns are formations visually identifiable by the careful study of
charts. Completing chart patterns indicates the beginning of a new move,
a new leg of the price movement, or a reversal of the current trend
direction. Completion of a chart pattern enables the trader to identify the
best entry point in the market for swing trading as it indicates the
beginning of the next big swing move.
Chart patterns are classified as a continuation pattern and reversal
patterns based on the patterns’ ability to reflect the underlying asset’s
directional bias. The completion of continuation patterns indicates the
best possibility of the prices to continue the movement in the trend
direction. In contrast, the completion of a reversal pattern suggests the
market’s strong
tendency to reverse its current trend. Both continuation patterns and
reversal patterns provide a forex trader with the best trading
opportunities.
Continuation chart patterns
The following patterns indicate a strong possibility of
continuing the existing trend and are classified as continuation
patterns.
1. Pennants
2. Rising wedges
3. Falling wedges
Reversal chart patterns
The following patterns indicate a strong possibility of
continuing the existing trend and are classified as continuation
patterns
1. Head and shoulders
2. Inverted head and shoulders
3. Double top
4. Double bottom
5. Triple top
6. Triple bottom
7. Ascending triangle
8. Descending triangle
9. Rounded top
10. Rounded bottom
Bullish patterns
Based on the direction of the ability of the patterns to indicate the
potential price direction, the following can be classified as bullish
patterns
1. Ascending triangle
2. Rounded bottom
3. Penants
4. Rising wedges
5. Cup and handle
6. Double bottom
7. Triple bottom
8. Inverted head and shoulders
Bearish patterns
Based on the direction of the ability of the patterns to indicate the
potential price direction, the following can be classified as bullish
patterns
1. Falling wedges
2. Pennants
3. Descending triangle
4. Rounded top
5. Double top
6. Triple top
7. Head and shoulders
Patterns
Head and shoulders
The most important of the chart patterns is a head and shoulder pattern;
it is a bearish reversal pattern. This pattern provides an entry point and a
stop loss; the take pro t is calculated as a multiplier of stop loss. Its
distinctive left shoulder identi es the pattern and a head followed by the
right shoulder. The neckline is another critical component of the head and
shoulder pattern, neckline is drawn connecting the base of the shoulders
and the head. The pattern is completed once the left shoulder, head, and
right shoulder are formed, followed by the neckline break.
The neckline break by the price is considered the best entry point, the
stop loss can be placed on the high of the right shoulder, while the take
profit can be calculated at a 1:2 risk-reward ratio.
Inverted head and shoulders
Inverted head and shoulders is a bullish reversal pattern; the pattern has
similar components like head and shoulders and is the opposite. Most
new forex traders and experienced traders can successfully trade the
head and shoulders pattern and are often considered profitable traders.
Double top
This pattern is a bearish reversal pattern; the price makes a swing high at
Top A. The price retraces back and then moves higher again to Top B but
fails to create a new high, higher than the previous swing high. The price’s
failure to make a higher high makes the price fall back to the neckline.
The neckline is a horizontal line connecting the base of the lowest point
of retracement point between point Top A and Top B.
The formation of both the tops A and B and the break below the neckline
completes the pattern; a clear break of the neckline provides the best
entry point and indicates the current trend’s reversal. The stops are
placed
above the previous swing high; profits can be booked at a reward double
the risk.
Double bottom
A double Bottom pattern is a bullish reversal pattern; it is the opposite of
the double top pattern and is often traded by new and advanced forex
traders. The confirmation of the pattern is the break of the neckline
after the formation of the double Bottom A and B. Stops can be placed at
the swing low of Bottom B and profits can be booked at double the risk.
The double top and double Bottom patterns are generally referred to
as “M” and “W” patterns.
Triple top
Triple tops and are an extension of the double top pattern and is a
bearish reversal pattern. The formation of three consecutive tops and
the price break below the neckline confirms the pattern completion.
The entry point is upon the neckline’s break, and the risk is calculated
towards the swing high C, and profits can be booked at a 1:2 risk and
reward ratio.
Triple bottom
Triple bottoms are the opposite of the triple top pattern and are a
bullish reversal pattern.
Rounded top
The rounded top pattern is a bearish reversal pattern. While in an
uptrend, the price fails to keep moving higher and stalls around the
highest highs, then retraces by making consecutive lower highs signaling
the uptrend’s weakness. Price also makes consecutive lower lows, and
prices start to move lower, visually creating a rounded top showing the
price reversal. The pattern completes once the price breaks the neckline.
Rounded bottom
The rounded Bottom pattern is a bullish reversal pattern and is opposite
of the rounded top pattern. It is traded once the neckline is broken and
the stop are placed at the lowest low of the curve, while take profits can be
placed at a reasonable risk and reward ratio
Ascending triangle
The ascending triangle is a bullish continuation pattern formed by
connecting two trend lines. The first is a flat trend line or a horizontal
trend line, while the second one is an ascending trend line or a rising
trend line. The intersection of both these trend lines forms a rising triangle.
The pattern is completed once the price breaks above the triangle. The
stop loss can be placed at the previous swing low within the triangle
and
take profit levels can be set with 1: 2 risk and reward ratio.
Descending triangle
Descending Triangle pattern is a bearish continuation pattern. Traders
expect the prices to continue the trend after a brief pause in the
movement. These patterns provide the best prices to book partial
profits and to add more positions in an existing trade.
Falling wedge
A falling wedge pattern is a bullish reversal pattern. The pattern consists
of 2 falling trend lines, with prices moving within the trend lines. The
trend lines converge each other but do not join to form a triangle at the
current market price scenario.
A break above the upper falling trend line A completes the pattern, and
the trend is validated by a close of the candle above the falling trend line
A. Stops can be placed below the previous low with profit targets with a 1:2
risk and reward ratio.
Rising wedge
A rising wedge pattern is a bearish reversal pattern. The pattern is
formed by two rising trendlines, converging in the end but not forming a
triangle.
Entry is confirmed once the prices break below the rising trend line B,
with stops above the previous high, the profits can be booked with a good
risk and reward ratio.
Rising pennant
Pennants are continuation patterns; depending on the formation within a
trend, they can be classified as bullish or bearish.
The above picture M shows a rising pennant pattern. The pattern is
formed
when prices while in a uptrend tend to stay within the trend lines and
show
consolidation due to traders’ partial profit booking. The consolidation
phase is marked by the price staying within the trend lines, forming a triangle
The pattern is validated once prices break above the pattern with a candle
close above the trend line. Prices tend to continue in the direction of the
previous trend after completion of the pattern.
Falling pennant
A falling pennant is a bearish continuation pattern formed during a
downtrend. The prices should be in a downtrend, and the pattern has to be
formed within the downtrend. The consolidation phase, once broken, will
lead to the continuation of the current trend.
Pennants are mostly formed during a trend and could be traded by new
and experienced traders. The pattern tends to form frequently and
provide
good additional entry points. Many traders add multiple positions to ride
the trend more profitably.
Limitations
Trading after the pattern’s completion is essential for successful trading;
however, traders tend to be impatient and enter the markets early. Mere
completion of the pattern does not warrant immediate price movement,
so traders need to look for additional confirmation of price action before
deciding to place the trades. Though patterns occur repeatedly, they may
not be successful every time; they need to be validated in the context of
price action as price movements are very dynamic
Our professional conclusion
Best technical traders always look for clues in the charts and use the
charts to make their trading decisions. Chart patterns provide the traders
with invaluable insight and assist the traders in spotting the best entry
points.