Making money on the Forex (foreign exchange) market may seem tricky with the many trading screens colours and annotations. Still, it doesn’t mean it’s impossible. Thanks to technical analysis and chart patterns, Forex traders can predict price movements.
So, what are Forex Chart Patterns? They’re powerful tools that present historical behaviour between two Forex pairs and measure their movement throughout different time frames. They help traders look into the past and get an insight into what to do next.
If you’ve been doing Forex trading for quite some time, you will have heard how simple yet essential they are. Knowing what those patterns are and how they work will give you an advantage. That’s what we’re going to talk about right now here in Trade Wise. We’ll also give you a few tips along the way.
How Do Forex Chart Patterns Work?
These trading patterns offer noteworthy clues to traders using technical analysis. It highlights technical indicators found in historical data. Analysts can see if the pattern is repeating with the same outcome, then a trader can predict when it will happen again and what move to make. Each pattern has the potential to show if a trend is stalling, beginning, or ending.
You can spot these common patterns using simple methods called technical analysis. Whether retail or professional, all traders use technical analysis to determine a trade’s validity, but it can also be used differently.
By definition, “technical analysis is the study of historical price behaviour to identify patterns and determine probabilities of future movements in the market.”
The Main Types of Forex Chart Patterns
Forex patterns are divided and classified based on their signals or potential price directional cues. These are the common chart pattern types in Forex technical charting.
Continuation Chart Patterns
Also called Consolidation Patterns, Continuation Patterns are chart formations seen during an ongoing trend and signal that the dominant trend will resume. This means that trends move sideways and pause, then regain momentum to continue the prior trend.
Some of the most common continuation patterns are:
- Flags
- Triangles
- Pennants
- Rectangles
Reversal Chart Patterns
These patterns are chart formations that appear at the end of a trend, signalling a course change that’s about to happen to the ongoing trend. It means the current trend is about to end and a new move is on its way.
The Reversal Chart Pattern includes:
- Falling and rising wedges
- Triple top and triple bottoms
- Double top and double bottoms
- Reverse and straight head and shoulders patterns
** Please note that wedges can be considered continuation chart patterns or reversal chart patterns depending on the trend they form.
Bilateral Chart Patterns
Think again if you believe that Forex Chart Patterns can’t get even more complex. Bilateral Chart Patterns signal that the price can move either way. The price could break either to the downside or upside with triangles.
The best way to play these patterns is to consider both scenarios. Then, place one order on top of the formation and the other on the bottom. If one gets triggered, you can cancel the other order.
Setting your entry order too close to the bottom or top of the formation can make you catch a false break. This is the only problem with this type of chart pattern, so be cautious where you place your stops.
There are plenty of other Forex Chart Patterns out there. You may have heard of:
- Bar Charts
- Broadening Top
- Butterfly Pattern
- Engulfing Pattern
- A-Y Trading Patterns
- Neutral Chart Patterns
- Hammer Chart Patterns
- Rounding Bottom Patterns
- Candle Stick Chart Patterns
- Cup and Handle Chart Patterns (AKA Teacups)
How to Use Chart Patterns for Trading?
Chart patterns are a graphical representation of the real-time supply and demand in the market. They have a defined expectation and formation of the price’s potential behaviour. It evaluates the risk-reward ratio of the forming signal. So, when it forms, the subsequent price action will determine whether it’s an invalid or valid opportunity to hold or trade a position.
1: Determine the risk-reward ratio beforehand based on the defined rules for each chart pattern
For example, when a head and shoulders pattern is formed in an uptrend, the beginning target for the expected downward movement is a pip amount that’s equivalent to the distance between the top of the “head” and the “neckline.”
You can place the stop-loss above the “shoulders.” Traders can evaluate if it’s worth trading on an opportunity if they have this information beforehand.
2: Use price action as the basis for opening positions
Price actions are considered as the footprint of money. Price action traders read and interpret them to identify trading opportunities as they happen. It’s a form of technical analysis, but it has no indicators to clutter the Forex charts.
Forex Chart Patterns are the highest form of price action analysis. Other than tracking trends, it also helps traders map out definitive resistance and support zones. It leads and allows traders to time market opportunities efficiently and effectively.
3: Set price targets for conditional orders
Before they’re executed on the market, these special Forex order types with particular parameters must be met first. The most basic and common are stop-limit, limit, and stop orders. More advanced examples of conditional orders include OCO (once cancels the other), GTD (good till date), and GTC (good till cancelled).
We mentioned that chart patterns are generally rule-based and have specific price targets when formed. This makes Forex Chart Patterns ideal for a conditional trading order, where price targets are defined.
4: Learn to adapt to the always-changing market conditions
Market conditions can unexpectedly change, making it a natural market risk source. If you trade with chart patterns, you can track a specific asset’s raw price action. These patterns can also make it easy to confirm or determine the changes, helping traders decide whether to limit their losses or lock in their profits.
Other than that, they can also help traders enter trade positions much earlier and more consistently with the new trend.
Do Forex Chart Patterns Work?
Using the Forex Chart Patterns alone will not give great results when predicting Forex Price Charts. Many traders fall into the common misconception that technical analysis and chart patterns are reliable on their own when predicting marketing moves.
Also, keep in mind that they use historical data to help anticipate future market moves. With that said, political and economic shifts or events shouldn’t be considered when using chart patterns.
Indicators such as interest rates, unemployment rates, home building, and other economic or political shifts affect the price of a currency in the present and future. This makes patterns unpredictable when it comes to technical analysis.
Disadvantages of Trading with Chart Patterns
The Forex Trading Chart Patterns come with pros and cons like other trading or investing strategies. Some of the disadvantages of chart patterns include:
Can deliver false signals
Patterns don’t work 100% of the time. What you consider a good chart pattern can also play out unexpectedly. That’s why it’s vital that traders only take advantage of risk-reward ratio opportunities that are compelling enough.
Can inspire subjectivity
Getting the feel of how the market goes is good, but it’s riskier when you’re more subjective than objective when it comes to trading chart patterns. Subjective biases may develop instead of following a rule-based system that characterizes objective trading.
What you may consider reversal patterns may be regarded as a continuation pattern for a fellow trader.
It can sometimes take too long to form
Investors should be patient, especially when trading with Forex Chart Patterns. Conclusively confirming high probability signals by patterns may take a while. This can be psychologically burdening while watching the price action play out. Eventually, it can make you feel like some profits are left on the table.
It can only be effective for the short term
This goes for most chart patterns because they give only valid signals for a certain period. It provides traders with a small window to take advantage of these signals. Also, even a slight delay can mean that an attractive risk-reward ratio is already gone.
Tips to Effectively Trade with Chart Patterns
We’ve established that Forex Chart Patterns help identify profitable trading opportunities by effectively tracking the price action. But here are a few tips so you can make the most of them:
- Switch to Line Charts when confirming a chart pattern formation – it will simplify and smoothen the price action to quickly identify the pattern earlier.
- Use Candlestick Patterns to confirm chart pattern signals – some signals are more qualified by Candlestick Patterns, which also helps analyze the market’s raw price movement. They only require one- to two-time periods to form so you can pick a high-quality trade early.
- Try combining technical indicators with chart patterns – Early price action signals can get pretty choppy. Merge it with patterns to confirm solid signals and take aggressive trade positions.
- Use Conditional Orders with chart patterns – Timing is everything, making Conditional Orders a great way to take advantage of chart-pattern-produced trading opportunities. It will ensure that you can ride the bull trend as soon as it resumes.
Frequently Asked Questions (FAQs)
What is the best chart for Forex?
If you’re wondering the best Forex Chart Pattern, we want to clarify that none of them has the upper hand. Each has its positives and negatives
Although, one of the favourite patterns out there is the Candlestick Charts. They’re a valuable tool for gauging price movements on all time frames and provide more information than other Forex charts.
Do chart patterns work for Forex?
Any chart pattern won’t work on its own. It has to be used with technical analysis to serve its purpose of predicting Forex market moves.
Make Forex Chart Patterns and Trends Your Friend
Chart patterns can be a reliable way to track the Forex market’s price and condition changes, as well as existing trends, key support, and resistance levels. It gives you an objective way to take advantage of any trading opportunities that arise.
As compelling as its advantages are, it’s best always to exercise strict risk management because you can’t completely count on chart patterns alone. Trading with chart patterns should be combined with other analysis techniques to enhance profit opportunities and limit risk exposure.
The bottom line is that patterns outweigh their liabilities. Traders have to seek, build, and improve their trading knowledge and skills to get better trading opportunities. Well understood Forex Chart Patterns have the potential of generating a steady stream of profitable trading in any market at any time.
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