What are graphic patterns?
Price changes are usually shown in charts using Japanese candlesticks. Since the price is constantly changing, so-called graphic patterns (figures) form in the trading chart from time to time. They show the history of the price movement of the selected asset. In this article, we will figure out what Forex graphic patterns are, what types of patterns exist, and how to use patterns for technical analysis.
What are graphic patterns?
Graphic patterns are sets of items, mostly Japanese candlesticks, that form shapes such as triangles, wedges, flags, double tops, and many others. They form in trading charts and are an essential part of technical analysis.
The patterns form due to price fluctuations and provide some information about the price of the underlying asset. Forex traders use patterns to profit from expected price movements.
What are the types of graphic patterns? How to trade using the patterns?
Forex graphic patterns are divided into 3 groups:
- Trend continuation patterns
- Trend reversal patterns
- Bilateral patterns
Groups are based on the types of market trends: uptrend, downtrend, and sideways movement (flat). You can find out more information about market trends by reading the article “What is a trend on the Forex market?”
Trend continuation patterns
Trend continuation patterns are patterns that indicate to the trader that the current price trend will continue, triggering new momentum in the same direction. For example, if the price is in an uptrend and the chart creates a trend continuation pattern, there is a good chance that the uptrend will continue. Each of these patterns can create new momentum in the direction of the current trend.
These patterns are characterized by a pronounced upward or downward price movement preceding the formation of the pattern. In the case of the Pennant pattern, the price fluctuates in a horizontal range that decreases before the breakout. Traders expect the price to continue in the direction of the trend after breaking through the channel.
The best moment to open a trade is when the pattern border is broken in the direction of the current trend.
A wedge pattern is a kind of combination of flags and pennants with an upward or downward price movement in the channel range before price breaks through the channel line and continues with its original direction.
Note that in different situations an upward and downward wedge can act as both reversal and continuation patterns. It depends on the previous trend. An upward wedge always has the potential to start a downtrend, and a downward wedge has the potential to start an uptrend.
You can make short-term trades within the wedge pattern at wedge highs and lows. To open long-term trades, it is best to use the breakout moment of the pattern.
A rectangle forms in the chart when the market zigzags between horizontal support and resistance levels. At the moment of a breakout of one of the levels, the momentum of the newly formed trend is likely to be no less than the size of the rectangle. Rectangles can be bearish or bullish depending on the direction of the trend.
The best strategy for trading with all rectangle patterns is to open short-term trades within the pattern. Place a buy order once the market reaches the lower support line of the triangle. As soon as the market reaches the upper resistance level, it is a good time to open a sell trade.
Trend reversal patterns
Reversal patterns usually signal a change in the current price trend, triggering a new movement in the opposite direction.
Suppose you have an uptrend and the price movement creates a reversal pattern. In this case, there is a high probability that the previous uptrend will reverse and create a new downtrend in the chart.
Head and Shoulders pattern
Head and Shoulders is one of the most indicative patterns in all of technical analysis. There is both a bullish Head and Shoulders pattern for an uptrend and a bearish one for a downtrend. Traders expect a trend reversal if these patterns form in the chart. To figure out the optimal time to enter the market, traders add a neckline to the chart.
The neckline is the support or resistance level that is used in a head and shoulders pattern. It is used by traders to determine the right moment to open trades. A breakout of the neckline signals a trend reversal.
If you see a head and shoulders pattern in the chart, wait for confirmation in the form of the neckline breakout before opening trades.
Double Top and Double Bottom patterns
Double top is an uptrend reversal pattern where the market creates two tops exactly at the same price level. Double bottom is a downtrend reversal pattern where a change in the price of an asset creates two bottoms exactly at the same price level. Traders add a neckline to the chart to indicate the optimal time to enter the market.
If you see the double top or double bottom patterns in the chart, wait for confirmation – the breakout of the neckline – before opening trades.
Wedge pattern reversal
Wedge is also a trend reversal pattern.
You can make short-term trades within a wedge pattern at wedge highs and lows. To open long-term trades, it is best to use the breakout moment of the pattern.
These are patterns that signal price movement, but the direction of the future trend is unknown. Bilateral patterns signal market consolidation. Traders expect the market to roll back and form a new trend or continue the previous one.
Ascending Triangle pattern
An ascending triangle has higher lows and equal highs. An ascending triangle forms during an uptrend or a correction in a downtrend.
Descending Triangle pattern
A descending triangle has lower highs and equal lows. A descending triangle forms during a downtrend or a correction in an uptrend.
Symmetrical Triangle pattern
A symmetrical triangle has lower highs and higher lows. In these triangles, both sides have approximately the same size and angle. This ensures the neutral character of the pattern and speaks of an uncertain market sentiment.
The best strategy for trading with all triangle patterns is to open short-term trades within the pattern. Once the market reaches the lower support line of the triangle, it is a good time to make a buy trade. As soon as the market reaches the upper resistance level, it is a good time to open a sell trade.
What are the disadvantages of using graphic patterns?
As with any other trading strategy, despite the obvious advantages of using chart patterns in technical analysis, it is essential that you know how to use them correctly. When used inappropriately, such tools can do more harm than good.
Chart patterns can give false signals, especially such patterns as wedges. There is no hundred percent reliable signal, as it is impossible to fully predict the movement of the market. The trader should be aware that there is always some level of risk involved when using graphic patterns.
Graphic pattern analysis is subjective. Each trader can interpret the pattern in their own way, depending on the experience, the chosen timeframe, and trading strategy.
Some patterns may take much longer to form than the trader expects.
Using too many patterns in one chart creates even more confusion. You can easily find several patterns with opposite signals at the same interval in the price history.
To become a professional trader, you need to be able to identify and use chart patterns in your trading. Technical analysis has become easier with the use of graphic patterns that help you to identify potential price movements.
The main challenge when using graphic patterns is to correctly identify the type of pattern in question.
Having determined the type of pattern, traders can open short-term trades in the trend channel zone. At the same time, the moment when the channel line is broken signals a new momentum in the trend and is a good moment to make long-term trades.
Article last updated: 2022-05-11