Price has a tendency to repeat past patterns In the Forex market. Nobody really knows why; however it is a statement proved by time. Think of price as an animal. Animals have habits that they exhibit. For example, a man may have the habit of bending down and picking up coins. Will he pick up the coins every time? Maybe, and maybe not. But what if this man makes a notable motion before he picks up his dropped coin. Perhaps he wipes his nose every time after dropping a coin, then he bends down and pick it up. In this case, the act of him wiping his nose will be the pattern that leads to him doing an expectable “trend”. Same in trading – we first try to identify the patterns which lead to known outcomes (or trends).
Below, you’ll find chart patterns that are known to cause strong trends in the market.
- 1. Symmetrical Triangles
- 2. Descending Triangles
- 3. Ascending Triangles
- 4. Double Tops and Double Bottoms
- 5. Head and Shoulders
- 6. Reverse Head and Shoulders
- 7. Channel
- 8. Wedge
- 9. Flag/Pennants
There are three different types of triangles:
1) Symmetrical Triangle
A symmetrical triangle occurs when a trader begins to notice that a currency pairs’ high and lows are converging together at a specific point. This pattern occurs when the market is making lower highs and higher lows. When you use your drawing tool to trace down the lower highs and trace up the higher lows, you will notice the triangle form (seen below).
What is happening right now is the Buyers and Sellers are in a tug of war and neither one is showing any sign of winning. That is, until price “squeezes” its way out of the triangle, causing a new trend.
When the lower highs and higher lows converges at a point or when price breaks through one of the lines, a breakout may ensue in the direction in which the resistance or support was broken.
2) Descending Triangle
In a descending triangle, we notice a convergence from equal lows and lower highs. In other words, if you were to draw this pattern onto a chart, you would notice that the lower line was flat and the top line is slanting down and to the right.
This pattern could be an indication of a bearish signal, but traders should observe the break, as descending triangles may lead to a continuation pattern or a strong reversal signal.
In this example note the green line indicating the lower highs, while the blue line indicates the equal lows. After the lines converge, traders may expect a powerful trend to emerge.
3) Ascending Triangle
While the descending triangle is characterized by equal lows and lower high, the ascending triangle is characterized by equal highs and higher lows. When drawing an ascending triangle, you’ll notice that the top line is fairly flat and the bottom line will make its way up and to the right.
This may be considered a bullish signal, but this isn’t always the case. As with the other triangles, once a convergence is made, a powerful bullish or bearish trend may occur. Traders must keep an eye on the market to see which way this trend is going.
4) Double Top and Double Bottom
In the market place, double tops and double bottoms occur when the market tries to breakthrough a previous high or low, but doesn’t have the strength to do so.
An easy way to think of it would be if you imagined the currency candles on your chart as a person trying to swim upstream. They go as far as they can, get exhausted and are pulled back by the tide. They make one more valiant attempt to swim upstream and make it to the same spot as they did before. Now that they are really tired, there’s no place for them to go but to float downstream.
This is what happens in the market place.
In the picture above, we see a Double Top. Note the large M formation that price has made.
When you spot the Double Bottom, which resembles a large W, we have an indication of a bullish trend emerging. Adversely, a Double Top, which looks like a large M, may indicate a bearish trend.
5) Head and Shoulders
Named after its appearance, the Head and Shoulders looks much like its namesake. A trader can spot the Head and Shoulders formation when price has made three highs; two equal highs with one greater high occurring between the two equals. Much like the double top and double bottom patterns, price was rejected and a breakout was unable to occur. As a result, we have a strong reversal trend will ensue after the right price has moved past the resist point, known at the neck line (the line formed by the low points between the left shoulder and head and the head and right shoulder).
In the example above, you can see the neckline as the blue line. It can be estimated in this example that price has a good chance, but not necessarily, of moving below the neck line, therefore causing a bearish reversal trend.
6) Reverse Head and Shoulders
The Reverse Head and Shoulders pattern follows the same rules as the Head and Shoulders pattern, except the pattern signifies a bullish trend. In the Reverse Head and Shoulders pattern, we are looking for three instances where price has made new lows; one low followed by a greater low, followed by a low equal to the first low. This formation will create our “reversed” left shoulder, head and right shoulder.
After the formation is complete, a bullish trend may occur if price moves past the neckline (which is formed by tracing the two equal highs between left shoulder and head of right shoulder.)
In this example, the signal finding software estimates that there’s a 70% chance a bullish signal will emerge. In this case, the trend will emerge the moment that price moves up past the green neckline.
A channel forms when we’re able to trace a currency pair’s highs and lows and draw a parallel line from these highs and lows. A channel may indicate a relatively strong trend with price staying in the lines until a breakout occurs.
Wedges are very similar to the Triangles patterns that we have listed above. Both patterns are formed by tracing lows and highs to a certain convergence point. The difference between triangles and wedges is that support and resistance lines with wedges aren’t positive and negative slopes. In other words, a wedge is a convergence of highs and lows where the support and resistance lines are sloped in a similar direction.
If we take a look at the above example, we can see that this formation is similar to a triangle formation, but in this case both the resistance and support lines are sloped in a positive direction.
Flag and pennant patterns occur after the market has made a powerful up or down trend and is followed by a sideways market. To better visualize what is happening during a flag pattern, think of the powerful up or down trend as the flag’s “pole” and the sideways market as the flag or pennant’s “cloth”.
Flag patterns happen quite often in the market. Traders should take note of when price begins to level out after a powerful trend (flag). Depending on the flag’s slope, this may be an indication of a continuation pattern (which means that price will continue with the trend) or a reversal pattern (which means that a trend will occur in the opposite direction).
Given the small time frame, the shape of the flag is not completely evident. By looking on the left, we see three red candles, signifying the downtrend. Price is moving up, trying to find a new high. However, as we can see in the last two candles on the right (red candles), price can’t quite seem to find a footing and continuation of a downtrend seems imminent.