Many forex traders use chart patterns and formations to accurately predict the future direction of price. The most popular patterns occur across all timeframes and form a central part of technical analysis. These chart formations are considered reliable, not only because they have historically performed as anticipated when they have occurred, but also because of the number of traders who are watching for these patterns. Chart formations may take several hours, days or weeks to form but their outcome can be verified by looking at previous examples which have provided good trading opportunities. The two types of chart formation, reversal and continuation, are helpful to all traders learning how to read the forex markets.
The double top and bottom
This is one of the most highly recognisable and popular reversal chart formations. The double top and double bottom form when price attempts, twice, to push higher or lower. The result is that an M or W pattern forms and this represents the end of a trend. Traders normally wait for this pattern to be confirmed when price pushes up or down beyond the first pullback, showing that it is not simply a short-term correction but a complete reversal of the trend. Double bottom and double top chart formations can be seen on all timeframes and they are made even more reliable if the second top or bottom fails to reach the price level of the previous top or bottom.
Head and shoulder
This is another very recognisable and frequently-traded reversal chart formation. The pattern is formed when price rises before pulling back, creating the left “shoulder”, and then pushes higher to create the “head”. In the most obvious head and shoulders patterns the price will then fall to the level of the first neckline before trying once again to rise in order to create the right hand shoulder. Forex traders will wait for the right shoulder to complete before price is expected to fall aggressively beyond this. This is one of the favoured patterns for technical traders due to the high probability of success but also the speed at which price often falls off the right shoulder.
Flags and pennants
Flags and pennants form a good indication that price is going to continue in the direction of the trend after a consolidation period. These are particularly important for traders who use the trend to hold long and short positions as they provide reassurance that price will continue to move in their favour once the consolidation is complete. In order to be considered reliable, these chart formations should be found during a trend when a previously sharp rise or fall in price has occurred. These patterns are usually followed by a breakout beyond the resistance line formed by the pattern.
Channels are used by most technical traders to define the inner and outer boundaries of the current price trend. They can be found on price charts using both an upper and a lower trend line and these become support and resistance levels from which trades can be places. As a continuation pattern, channels can be either bullish or bearish, depending on their slops. Once the trend begins to falter, traders typically wait for the price to confirm a breakout of the channel before looking for reversal or corrective trades.
Breakout traders enjoy identifying rectangular chart patterns that represents price trapped within a range to form a rectangle. These patterns are particularly powerful on the 1 hour and higher timeframes as price tests the upper and lower support and resistance of the rectangle and eventually breaks out. Traders will typically wait for confirmation of the breakout and enter the trade with a high probability that the trend will continue in the direction of the breakout.
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