Analysing chart patterns are part of technical analysis that most traders don’t immediately master. It takes some time and experience in the watching and trading the markets to understand. You can, however, use chart pattern recognition software to show you where chart patterns develop as this will step up your learning curve much faster. With experience, you’ll be able to identify them in real time by yourself and give you quicker access to good trading opportunities.
A chart pattern is a graphed configuration of price movement that tends to reoccur every once and a while. In other words, chart patterns, or price patterns, are a pictorial representation of the buying and selling pressure that goes on the market. The shape of the candlesticks is what differentiates one pattern from another.
The action of trading based on price patterns is what we refer to trading patterns.
The chart patterns give the chart a voice and behind every single chart pattern, there is a story of what is actually happening. For example, if we see a long upper wick at the top of an uptrend with some high volume, we know there is a lot of profit-taking, and we can anticipate that the bears are going to start to show up.
Trading based on chart patterns should not be done in isolation without consideration of what the rest of the market is doing. You need to have other supporting factors that validate the trade signals; otherwise, you will not have consistency in the long run.
Types of Chart Patterns
We can distinguish two different types of chart patterns:
- Reversal patterns, which as the name suggests signals a change in the direction of the prevailing trend.
- Continuation patterns, which as the name suggests signals that the trend will continue to stay in motion.
Due to the fractal nature of the markets, the same chart pattern can work in different time frames, and it can perform both as a continuation and a reversal pattern. It all depends on the location of the pattern relative to the trend direction.
The most popular continuation patterns include:
- Inside bars
The most popular reversal patterns include:
- Head and Shoulders
- Double Tops and Double Bottoms
- Bearish and Bullish Outside bars
Trading Chart Patterns
According to the chart theory, we can go one step further and make the distinction between trending patterns such as channels, and non-trading patterns like triangles. The support and resistance levels that form the channel are parallel, effectively creating a mini-trend, while in a triangle the price gets squeezed into a tighter and tighter range.
Trading based on chart patterns has its limitation because it doesn’t tell you the trend, and how the market has moved over a particular period of time. For example, the pin bar, which is the most basic reversal pattern, is only the action of a single bar.
In order to trade successfully in the Forex market, you need to keep the chart pattern in a much broader context. You need to read the whole story behind the chart pattern and ask questions like where it’s located in relation to the trend, support and resistance levels, previous swing high/low, momentum readings, overbought and oversold conditions and more.
Trading based on chart patterns is simply a technique, or a tool, that you can use in your trading to help you make better trading decisions and to better time the market.
Chart patterns give you a way to read the charts and can help you identify profitable trading opportunities. It’s important to focus and master one chart pattern at a time. Take it slow and make sure you’re absorbing all the information that the chart pattern is trying to tell you before committing to the trade.