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TECHNICAL ANALYSIS: Price Patterns
Traders vote with their money. If they believe a currency pair is going to move higher, they will buy it. If they believe a currency pair is heading lower, they will sell it. When money is on the line, traders will do whatever it takes to be profitable. Oftentimes the actions of these traders form price patterns on the chart.
Price patterns are chart formations that provide insight into what forex traders are thinking at various price levels. Learning to recognize various price patterns gives you an edge over traders who are only using fundamentals or technical indicators. Imagine having the ability to precisely identify trade entry points as a currency pair breaks out and the ability to accurately project how far a currency pair is going to move once it has broken out and starts to move. Price patterns helps you with this. Price patterns are divided into the following two categories: Continuation Patterns, Reversal Patterns.
Continuation Patterns
Forex traders frequently ask themselves, "how long will this trend continue?". Deciding whether to enter a new trade in the middle of a trend or whether to exit the trade you are in and lock in your profits is difficult. You can never know if a currency pair is going to reverse and start moving in the opposite direction or can you? Continuation patterns provides you with an early warning when a currency pair is likely to continue its trend after a brief consolidation period and how far the currency pair is likely to move in that direction. Obviously, continuation patterns are not perfect, but they do increase the odds of your success. We will look at some of the well-known price continuation patterns.
Pennants
Pennants are continuation patterns that form as the price of a currency pair moves into a tighter and tighter consolidation range. Pennants can be either bullish or bearish, depending on what the trend was before the pennant began to form. If a currency pair was in an uptrend before the pennant began to form, it is a bullish continuation pattern. If a currency pair was in a downtrend before the pennant began to form, it is a bearish continuation pattern. Pennants usually form over shorter periods of time. Pennants all have the following characteristics:
Resistance level (A) - down-trending level of resistance that is converging with the support level.
Support level (B) - up-trending level of support that is converging with the resistance level.
Flagpole (C) - the trend preceding the formation of the pennant. The flagpole spans the distance from the beginning of the trend to the highest point of the pennant (bullish pennant), or the flagpole spans the distance from the beginning of the trend to the lowest point of the pennant (bearish pennant).
Breakout point (D) - the point at which the currency pair breaks up above the down-trending level of resistance (bullish pennant), or the point at which the currency pair breaks down below the up-trending level of support (bearish pennant).
Price projection (E) - the price to which the currency pair will most likely fall after it has broken out of the pennant formation (bearish pennant), or the price to which the currency pair will most likely rise after it has broken out of the pennant formation (bullish pennant). The distance the currency pair is projected to move is equal to the height of the flagpole.
FLAGS
Flags are continuation patterns that form as the price of a currency pair pulls back from the predominant trend in a parallel channel. Flags can be either bullish or bearish, depending on what the trend was before the flag began to form. If a currency pair was in an uptrend before the flag began to form, it is a bullish continuation pattern. If a currency pair was in a downtrend before the flag began to form, it is a bearish continuation pattern. Flags usually form over shorter periods of time. Flags all have the following five characteristics:
Resistance level (A) - down-trending level of resistance that is parallel with the support level (bullish flag), or an up-trending level of resistance that is parallel with the support level (bearish flag).
Support level (B) - down-trending level of support that is parallel with the resistance level (bullish flag), or an up-trending level of support that is parallel with the resistance level (bearish flag).
Flagpole (C) - the trend preceding the formation of the flag. The flagpole spans the distance from the beginning of the trend to the highest point of the flag (bullish flag), or the flagpole spans the distance from the beginning of the trend to the lowest point of the flag (bearish flag).
Breakout point (D) - the point at which the currency pair breaks up above the down-trending level of resistance (bullish flag), or the point at which the currency pair breaks down below the up-trending level of support (bearish flag).
Price projection (E) - the price to which the currency pair will most likely fall after it has broken out of the flag formation (bearish flag), or the price to which the currency pair will most likely rise after it has broken out of the flag formation (bullish flag). The distance the currency pair is projected to move is equal to the height of the flagpole.
TRIANGLES
Triangles are continuation patterns that form as the price of a currency pair hits a flat level of support or resistance and begins moving into a tighter and tighter consolidation range. Triangles can be either bullish or bearish, depending on what the trend was before the wedge began to form. If a currency pair was in an uptrend before the triangle began to form, it is a bullish continuation pattern. If a currency pair was in a downtrend before the triangle began to form, it is a bearish continuation pattern. Triangles usually form over longer periods of time.
Triangles all have the following characteristics:
Resistance level (A) - horizontal level of resistance (bullish or ascending triangle), or a down-trending level of resistance that is converging with the support level (descending triangle).
Support level (B) - up-trending level of support that is converging with the resistance level (bullish or ascending triangle), or a horizontal level of support (bearish, or descending triangle).
Flagpole (C) - the trend preceding the formation of the triangle. The flag pole spans the distance from the beginning of the trend to the highest point of the triangle (bullish or ascending triangle), or the flag pole spans the distance from the beginning of the trend to the lowest point of the triangle (bearish or descending triangle).
Breakout point (D) - the point at which the currency pair breaks up above the horizontal level of resistance (bullish, or ascending triangle), or the point at which the currency pair breaks down below the horizontal level of support (bearish, or descending triangle).
Price projection (E) - the price to which the currency pair will most likely fall after it has broken out of the triangle formation (bearish or descending triangle), or the price to which the currency pair will most likely rise after it has broken out of the triangle formation (bullish or ascending triangle). The distance the currency pair is projected to move is equal to the height of the flagpole.
REVERSAL PATTERNS
As we already covered, forex traders often ask themselves the question, "how long will the trend continue?". Deciding whether a trend is over and if it is time to trade against the previous trend is difficult. You never know 100% if a currency pair is going to reverse and move in the opposite direction. Reversal patterns give you an early tip of when a currency pair is likely to turn around and begin a new trend and how far the currency pair is likely to move in the opposite direction. Let us review the following price reversal patterns:
Double Tops and Bottoms
Double tops and bottoms are reversal patterns that form as the price of a currency pair hits a support or resistance level twice before the pair pivots and moves in the opposite direction. Double tops are bearish reversal patterns and double bottoms are bullish reversal patterns. If a currency pair is in an uptrend, it will form a double top. If a currency pair is in a downtrend, it will form a double bottom. Double tops and bottoms usually form over longer periods of time. Double tops and bottoms have the following characteristics:
Resistance level (A) - horizontal level of resistance.
Support level (B) - horizontal level of support.
Breakout point (C) - the point at which the currency pair breaks up above the horizontal level of resistance (double bottom), or the point at which the currency pair breaks down below the horizontal level of support (double top).
Price projection (D) - the price to which the currency pair will most likely fall after it has broken out of the double-top formation, or the price to which the currency pair will most likely rise after it has broken out of the double-bottom formation.
TRIPLE TOPS AND BOTTOMS
Triple tops and bottoms are reversal patterns that form as the price of a currency pair hits a support or resistance level three times before the currency pair turns around and moves in the opposite direction. Triple tops are bearish reversal patterns and triple bottoms are bullish reversal patterns. If a currency pair is in an uptrend, it will form a triple top. If a currency pair is in a downtrend, it will form a triple bottom. Triple tops and bottoms typically form over longer periods of time.
Triple tops and bottoms all have the following characteristics:
Resistance level (A) - horizontal, or slightly angled, level of resistance.
Support level (B) - horizontal, or slightly angled, level of support.
Breakout point (C) - the point at which the currency pair breaks up above the horizontal level of resistance (triple bottom), or the point at which the currency pair breaks down below the horizontal level of support (triple top).
Price projection (D) - the price to which the currency pair will most likely fall after it has broken out of the triple-top formation, or the price to which the currency pair will most likely rise after it has broken out of the triple-bottom formation.
HEAD AND SHOULDERS Tops/Bottoms
Head and shoulders tops are reversal patterns that form as the price of a currency pair hits a resistance level (forming the first shoulder), then breaks through the first resistance level and hits a higher resistance level (forming the head) and then hits the first resistance level again (forming the second shoulder).
Head and shoulders bottoms are reversal patterns that form as the price of a currency pair hits a support level (forming the first shoulder), then breaks through the first support level and hits a lower support level (forming the head) and then hits the first support level again (forming the second shoulder).
Head and shoulders tops are bearish reversal patterns and head and shoulders bottoms are bullish reversal patterns. If a currency pair is in an uptrend, it will form a head and shoulders top. If a currency pair is in a downtrend, it will form a head and shoulders bottom. Head and shoulders tops or bottoms usually form over long periods of time. Head and shoulders tops or bottoms all have the following five characteristics:
Left shoulder (A) - horizontal, level of resistance (head and shoulders top), or a horizontal, or slightly angled, level of support (head and shoulders bottom).
Head (B) - higher horizontal level of resistance (head and shoulders top), or a lower horizontal, or slightly angled, level of support (head and shoulders bottom).
Right shoulder (C) - horizontal, or slightly angled, level of resistance that is in line with the left shoulder (head and shoulders top), or a horizontal level of support that is in line with the left shoulder (head and shoulders bottom).
Neckline (D) - horizontal, or slightly angled, level of support (head-and-shoulders top), or a horizontal, or slightly angled, level of resistance (head-and-shoulders bottom).
Breakout point (E) - the point at which the currency pair breaks up above the neckline (head-and-shoulders bottom), or the point at which the currency pair breaks down below the neckline (head and shoulders top).
Price projection (F) - the price to which the currency pair will most likely fall after it has broken out of the head and shoulders top formation, or the price to which the currency pair will most likely rise after it has broken out of the head-and-shoulders bottom formation. The distance the currency pair is projected to move is equal to the distance between the head and the neckline.
