Chart patterns are on-chart price action patterns that have a higher than average follow-through probability in a given direction. These trading patterns offer significant clues to price action traders in their Forex trading decision process using technical chart analysis. Each pattern in the chart has the potential to push the price towards a new move. Forex traders thus tend to identify chart patterns to take advantage of the upcoming price fluctuations.
Forex trading patterns are divided into groups based on the potential price direction of the pattern. There are three main types of chart patterns classified in Forex technical charting.
The trend continuation chart pattern appears when the price is trending. If you spot a continuation chart pattern during a trend, this means the price is correcting. In this manner, continuation patterns indicate that a new move in the same direction is likely to occur. Some of the most popular continuation chart formations are pennants, rectangles, and corrective wedges.
The trend reversal chart patterns appear at the end of a trend. If you see a reversal chart formation when the price is trending, in most cases, the price move will reverse with the confirmation of the shape.
In other words, reversal chart patterns indicate that the current trend is about to end, and a new contrary move is on its way! The most popular reversal chart patterns are double (or triple) top/bottom, head, and shoulders, reversal wedges, ascending/ descending triangle.
Chart patterns have a defined formation and expectation of the potential future price behavior. This means that when a chart pattern forms, the subsequent price action determines whether it is a valid or invalid opportunity to trade or hold a position. There are defined rules for every chart pattern, and this helps in determining the risk/reward ratio beforehand. For instance, when a head and shoulders pattern forms in an uptrend, the initial target for the expected down movement is equivalent to the distance between the ‘neckline’ and the top of the ‘head.’ A stop-loss can be placed just above the ‘shoulders.’ With this information beforehand, traders can evaluate whether any trading opportunity that arises is worth trading.
Usually the price action is defined as the money footprint. Traders reading and interpreting raw price action and identifying trade opportunities as they occur. While still a form of technical analysis, the use of clean or ‘naked’ charts involves price action; no indicators to clutter the charts. Patterns are the highest form of analysis of price action, and help traders track trends as well as map definitive support and resistance zones. Unlike numerous technical analytical indicators that are inherently lagging in nature, chart patterns are in fact leading and allowing traders to effectively and efficiently create time market opportunities. This means traders can place orders on the market early enough and at optimum price points to buy and sell.
Conditional orders are orders that attach special parameters that must be met before they are executed in the market. Chart patterns are usually rule-based and have specific price targets when they form. This makes chart patterns the ideal analysis type for trading conditional orders, where specific price levels are targeted.
Trading with chart patterns means that traders track the raw price action of an asset. Chart patterns make it easy to determine or confirm when market conditions change unexpectedly. Identifying changes in market conditions early can help traders lock in their profits. It can also help traders to enter trade positions consistent with the new trend much earlier. Changes in market conditions are a natural source of market risk, but chart patterns ensure that they are a source of great opportunity.
By coloring and positioning the candlestick, you can see the direction the price moved during the candle’s time frame. If the candlestick is green, the price will be closed above where it opened, and that candle will be located above and to the right of the previous one, unless it is shorter and of a different color than the previous candle. The price closed below where it is when the candlestick is red. You can start looking for trading opportunities based on candlestick patterns, such as the three black crows and a hammer, once you understand what each candle is indicative.