Chart patterns and forex trading
Like many things in life, practice makes perfect. By understanding chart patterns, you’ll identify what type of market movement is likely to follow. This gives you an edge over traders who are just looking at the numbers and graphs without considering how prices are moving based on previous days’ activity.
The three main types of charts used for forex trading are line charts, bar charts and candlestick charts. Each presents information slightly differently, but all can tell you something about the direction that a currency pair may take next.
Some traders prefer using one type of chart more than others, but it’s best to become familiar with all three as you never know which one will be providing the most helpful information at any given time. The following is a brief overview of each type of chart and how they can be used in forex trading.
A line chart connects the closing prices of two successive periods. The most commonly used timeframes are the 5-minute, 15-minute, 30-minute, 1-hour, 4-hour and daily charts.
The line chart shows overall trends but can be misleading when trying to identify shorter-term price movements.
A bar chart shows the open, high, low and close for a given period on the vertical axis with time on the horizontal axis.
This type of chart is better for identifying short-term price movements and support and resistance levels.
A candlestick chart is very similar to a bar chart, but it shows the body of the candle, which is made up of the open and close prices and the wicks, which offer high and low prices.
Candlestick charts are viral among traders as they provide a lot of information in a compact space. They are also suitable for identifying reversal patterns.
Once you have a basic understanding of how each type of chart works, you can apply them to your trading.
The following are some common chart patterns you may encounter while trading forex.
Head and Shoulders
The head and shoulders pattern is one of the most reliable reversal patterns, and traders often use it to predict future price movements. The design starts with a steep rise in prices, leading to a quick downward spike.
Another slightly steep climb follows this before the currency pair drops again. If you are using candlestick charts, this pattern will look like two small candles clustered inside the body of the first candle, which is referred to as the right shoulder.
A break below the low of this second candle indicates that it may be time to sell, while a break above shows more bullish behaviour and suggests that it may be time to buy.
The double top occurs when prices move up and down through an area of resistance twice without breaking through it, thus indicating a likely reversal.
This pattern is the opposite of the head and shoulders pattern in that it shows bullish behaviour followed by what could be a bearish movement.
This reversal pattern is the inverse of the double top because prices fall through an area of support twice without breaking through.
The triple top also forms when prices come up to an area of resistance three times but cannot break through, which suggests that this might be where long positions should be closed.
A triple bottom would indicate an upturn in price movements, while a move below the low of anyone’s candle suggests a downward trend.
A tunnel occurs when there’s a period where price consolidates between two parallel trend lines, usually at or near resistance or support levels. The space in the middle is referred to as the “tunnel”, and it often shows where the price will go next.
Trends are one of the most reliable chart patterns because they tend to repeat themselves repeatedly, which makes them easy to identify.
Directions can be up, down or sideways (ranging), but most traders know that when you see an uptrend, that’s usually a good time to buy, while downtrends point toward selling opportunities.
There are several ways to draw trendlines on charts—two examples are connecting swing highs on a bar chart or placing parallel lines along with congestion areas on either side of a candlestick chart.