Forex patterns are a critical tool in a forex traders arsenal for predicting movements in the forex market. These charts can signal entry or exit points for successful trading. This guide will show you the read forex patterns.
Updated: 07/04/2021
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If you want to learn how to read forex patterns the right way, the most important trading tool you’ll come across is a live forex chart. Forex trading without a chart can be a daunting task because the forex chart patterns allow seeing at first glance what the financial markets are doing and provide an effective way to time the market.
In other words, trading without forex charting software and forex patterns is like a blind man trying to cross the road. Forex traders can develop a complete trading strategy by simply using forex chart patterns.
While there are a variety of forex patterns, only a handful of them have a statistical edge and are reliable. The most commonly used forex chart patterns can help us know when is the right time to buy and sell. If this sounds interesting, you must learn the art of price action trading.
By the end of this price action trading guide you’ll learn:
The best way to track the price movements of your favourite currency pair is through live forex charts. There are many different alternatives to keep up with the most recent price moves in the forex market.
The best free forex charting software for analysing live charts are:
The majority of forex brokers will supply their clients with a free forex charting software that allows for the studying of FX charts. Most forex traders are using trading strategies that are based on price action trading, which inevitably requires them to use a trading platform equipped with forex charting software.
The MetaTrader 4 platform is the starting point for many retail traders as it’s free to download and has easily accessible trading charts.
Put it simply, a forex chart is a visual representation of the actual movement of prices over a given period of time. The prices of all currency pairs are displayed using the Cartesian coordinate system (x-y axis) where the horizontal axis displays the time while the vertical axis displays the price.
The forex charts are a great tool used to identify the general direction of the market, support and resistance levels and where to enter and exit the market among other things. Essentially, by using historical price data, forex traders can predict future price movement.
In technical analysis, there are 3 types of forex charts:
Each chart type is read in a different way. Ultimately, it comes down to your personal preferences which types of forex chart to use. However, the candlestick charts are regarded to offer a complete view of the price action, which is why it is among the most popular form of charting.
See below how to read different types of forex charts.
Through the line chart, the historical price data is represented by a continuous line. Usually, the line chart represents information about the average closing price. However, line charts can also use as input the open, high or low prices to give a visual representation of the exchange rate.
The main advantage of line charts is their simplicity, but the major drawback is the lack of information about the price action and the trading range over the defined time period.
The bar chart is also known as the OHLC price chart because it displays information about the opening, closing, highest and lowest prices. The bar charts can be visually recognised by a vertical line with two small dash lines to the left and right of the vertical line.
In a bar chart, the small horizontal dash line to the left represents the opening price, while the horizontal dash line to the right represents the closing price. At the same time, the bottom and top of the vertical line display the highest and lowest prices over the defined time period.
Candlestick charts are similar to line charts as they display the same price information (OHLC prices) but in a visually different way. Candlesticks charts display the price range between the opening and closing price with a rectangle.
The main advantage of candlestick charts is that it’s easy to spot forex chart patterns and very easy to interpret them. Candlestick charts are a good starting point for beginner traders to understand how forex chart analysis works.
Candlestick charts are constructed using four main prices:
These four prices put together can form different candle shapes over a set amount of time. The time frame used can vary from the 1-minute chart all the way up to the monthly chart depending on your chart settings. A new candlestick will be printed on the price chart as soon as the period of time is completed.
Each candlestick is made of a real body (the rectangle shape) and two thinner lines called wicks attached at the top and bottom of the real body. The wicks are also referred to as being shadows or tails.
In technical analysis, we can recognise two main types of candlesticks:
The bullish candlesticks are pointing upwards and show that the prices have risen over that period. In this case, the bottom of the real body displays the opening price and the top the closing price. The highest point and lowest point of the wicks represents the highest and lowest prices over that period of time.
Conversely, the bearish candlesticks are pointing downwards, and show that the prices have dropped over that period. In this case, the top of the real body shows the opening price, while the bottom the closing price.
Note* If the candlesticks are missing the wicks, that means that the highest and lowest prices are equal to the opening and closing prices. In technical analysis, these types of candlesticks are called Marubozu.
A bullish candlestick with a long body shows strong buying pressure whereas a bearish candlestick with a long real body shows strong selling pressure or that there are more sellers than buyers.
At the same time, candlesticks with long shadows above or below the body show price rejections and usually indicate strong levels of support and resistance. These types of candlestick patterns can signal a potential trend reversal.
By analysing the candlestick shape and the types of candles on a price chart, we can tap into the market sentiment and get a sense of market direction. The next section will elaborate more on this along with the most popular forex patterns in technical analysis.
Depending on how the candlesticks are built and their location within the overall market trend, forex traders can recognise two main groups of chart patterns:
The multitude of combinations of different candlesticks shapes allow for the identification of countless forex chart patterns that can contain one, two, three or multiple candlesticks. Usually, some of the most recognisable candlestick patterns have self-explanatory names, which will be addressed below.
A reversal pattern is a price action formation that marks the end of the prevailing trend and the start of a new trend. In trend analysis, we can recognise two types of reversal chart patterns:
This transition phase from an uptrend to a downtrend and vice versa is what marks high and low points on candlestick charts.
At the most basic level, the reversal pattern helps us to measure the supply and demand imbalances and the shift in market sentiment. In other words, the reversal pattern tracks the buying and selling forces that are behind the movement of all prices and signals when the market trend losses momentum and is about to change direction.
Note* The most important characteristic of reversal chart patterns is that they must develop in a trending market (uptrend or downtrend) and they cannot be used in a ranging market or consolidation.
Below are listed the top 6 reversal candlestick patterns that every trader needs to know:
Head and Shoulders (H&S) are bearish reversal patterns that appear at the end of bullish trending markets. On a price chart, the Head and Shoulders price formation can be recognised by 3 successive peaks, where the middle peak is the highest point of this price formation followed by two outside peaks to the right (right shoulder) and left (left shoulder) of the middle peak. The outside two peaks are about the same height.
The middle peak resembles the head while the two peaks (left shoulder and right shoulder) on both sides of the head resemble two shoulders.
A trendline called the neckline can be drawn by connecting the two valleys (swing lows) below the head. The neckline can be with a flatter slope or pointing upwards or downwards. A breakout of the neckline can potentially signal a bullish-to-bearish trend reversal.
The most common entry strategy is to sell at the breakout of the neckline. Less common entry methods for the Head and Shoulders pattern are:
The strategy is to place the stop loss is above the head or above the right shoulder if you want to minimise the risk. At the same time, the Head and Shoulders profit target is calculated by measuring the price distance between the head and the two valleys and projecting the same price distance from the neckline breakout point.
We also have a bearish version of the H&S pattern called the inverse Head and Shoulders pattern.
The inverse Head and Shoulders pattern is a bullish reversal pattern that appears at the end of a downtrend. On a price chart, the inverse Head and Shoulders price formation can be recognised by 3 successive lows, where the low in the middle is the lowest point of this price formation followed by two outside lows to the right and left of the middle-low point. The outside two lows are about the same height.
As you might tell, the inverse Head and Shoulders pattern is the upside-down version of the Head and Shoulders pattern. In this regard, we can apply the same trading rules of the Head and Shoulder but in reverse.
In technical analysis, both the double top and the double bottom work on the same principles. The double top pattern develops at the end of an uptrend and can be found only in bullish markets. On a price chart, the double top can be recognised by two consecutive swing highs (peaks) that are roughly equal in price and indicates a strong resistance level.
Note* The double top resembles the letter “M.”
The double top entry is triggered once the valley (swing low) between the two tops is broken to the downside. The stop loss can be hidden above the two peaks respectively below the two valleys in the case of the double bottom.
The double bottom develops at the end of a downtrend and can be found only in bearish markets. On a price chart, the double bottom can be recognised by two consecutive swing lows (valleys) indicating support and is roughly equal in price.
The double bottom entry is triggered once the peak (swing high) between the two bottoms is broken to the upside.
Note* The double bottom resembles the letter “W.”
Another reversal pattern that resembles the double top/bottom is the triple top and triple bottom which has an additional peak (triple tops) respectively an additional valley (triple bottoms).
Understanding the rising wedge and falling wedge chart patterns is quite easy. Both forex chart patterns signal a trend reversal. The rising wedge signals a bearish reversal, while the falling wedge signals a bullish reversal.
The rising wedge is a price formation that can be identified by a series of higher lows followed by successive higher highs where the length of each subsequent price movement between the low and the high becomes smaller and smaller.
If we connect the rising highs with a trendline and the higher lows with another trendline, the two trendlines will converge towards what is known as the apex point.
Note* A key characteristic of the rising wedge is that the support line has a steeper slope compared to the resistance line, which leads to the wedge-like price formation.
The price compression between the two trendlines will eventually lead to a breakout. In this regard, a sell position is triggered by the breakout of the ascending trendline. The logical place to place the stop loss is on the opposite side of the rising wedge price formation, while a trailing stop loss can be used to lock in profits.
The falling wedge is a price formation that can be identified by a series of lower lows followed by successive lower highs where the length of each subsequent price movement between the low and the high becomes smaller and smaller.
Unlike the rising wedge, the falling wedge develops a resistance line with a steeper slope compared to the support line.
Important Note* The wedge patterns (rising and falling) can also be considered as continuation patterns. For example, if the rising wedge appears at the bottom of the downtrend, it could signal the continuation of the bearish trend. On the other hand, the falling wedge can be considered a continuation pattern if it appears at the top of an uptrend because it is seen as a simple pause within the trend.
The continuation chart patterns are price action formations that usually appear in the middle of the trend, and as the name suggests, signals a pause in the trend before the prevailing trend resumes. On the price action chart, reversal patterns are recognised by a period of temporary consolidation of different durations.
In trend analysis, we can recognise two types of continuation chart patterns:
Below are listed the top 7 continuation patterns that every trader needs to know:
In technical analysis, the triangle pattern is one of the most popular continuation chart patterns. The ideal market environment for the triangle pattern to emerge is when the forex market is entering an ongoing consolidation period.
In the study of technical analysis, there are 3 types of triangle patterns:
The symmetrical triangle is a price action formation formed of consecutive higher lows and lower highs. If we connect the series of higher lows with a downward sloping trendline and the series of lower highs with an upward sloping trendline, at some point these two trendlines will converge where it looks like a triangle.
The price contraction between the two trendlines shows a fierce battle between the buyers and sellers. But, as soon as these two trendlines get closer to each other it signals that a breakout is imminent.
As a general rule, the breakout will happen in the direction of the prevailing trend. In this regard, if the symmetrical triangle develops within a bullish trend, it will break higher. Conversely, if the symmetrical triangle develops within a bearish trend, it will break lower.
The ascending triangle pattern is a price formation that can be identified by its flat top and an upward sloping support trendline that connects a series of higher lows. At some point, these two lines will converge where it looks like an ascending triangle.
As a general rule, the ascending triangle is a bullish continuation price action that appears in the middle of an uptrend. A breakout of the resistance levels will be the trigger for the trend to resume.
The rising higher lows and the multiple retests of the top of the triangle keep putting pressure on the horizontal resistance levels and as a result, a breakout is bound to happen.
The descending triangle pattern is a price action formation that can be identified by its flat bottom and a downward slopping trendline that connects a series of lower highs.
As a general rule, the descending triangle is a bearish continuation price action that appears in the middle of a downtrend.
In the case of the descending triangle pattern, the battle between the buyers and the sellers is won by the sellers and subsequently, the price breaks the flat support line.
The bullish pennant is a price action formation that appears within an uptrend and signals a trend continuation. The ideal pennant pattern would appear after strong price moves, which are often referred to as the flagpole which is then followed by a tiny ranging zone that often takes the shape of a small-scale symmetrical triangle, which is called a pennant.
As a general rule, the breakouts in the direction of the flagpole are considered to yield better results.
The bearish pennant is a price action formation that appears within a downtrend and signals a trend continuation. As a general rule, the downside breakouts are considered to yield better results for the bearish pennant.
There are 2 key characteristics of the bullish and bearish pennants:
The rectangle pattern is a price action formation that can be recognised by prices being confined by two horizontal support and resistance levels. The rectangle unveils a pause in the overall trend where prices are consolidating.
In technical analysis we can recognise two types of rectangle patterns:
To draw a rectangle pattern, we only need two tops and two bottoms with the tops acting as a resistance level and the bottom acting as a support level.
Forex chart patterns are great to identify potential entry and exit points, establish profit targets and stop losses which are the basic elements of a trading strategy.
The price action cheat sheet below will help you remember all the forex chart patterns learned through this trading guide and what they signal. We’ve listed the most popular forex patterns, along with what type of trends they work, the signals they generate and if they are forecasting upwards or downwards prices.
Forex patterns are a great tool to forecast future price movements however, it’s important to use other forms of technical (Fibonacci retracement, pivot points, moving average, etc.) and fundamental analysis (USD economic calendar) alongside forex chart patterns to increase the probability of your trading edge.
Risk Disclaimer: Forex trading carries a high level of risk due to the high use of leverage and may not be suitable for all forex traders. In this regard, it’s recommended to start trading first on a demo account until you master the art or reading forex price charts. Nowadays, most forex brokers offer risk-free demo accounts that you can try to hone up your trading skills.
Justin Grossbard has been investing for the past 20 years and writing for the past 10. He co-founded Compare Forex Brokers in 2014 after working with the foreign exchange trading industry for several years. He also founded a number of FinTech and digital startups including Innovate Online and SMS Comparison. Justin holds a Masters Degree and an Honours in Commerce from Monash University. He and his wife Paula live in Melbourne, Australia with his son and Siberian cat. In his spare time, he watches Australian Rules Football and invests on global markets.
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