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Introduction to Technical Analysis

Price patterns

A chart for a currency pair will begin to form predictable patterns during trends. A pattern usually forms when a pair is in the process of changing: slowing down, reversing trend, etc. When that happens, it’s a signal to take a step back and evaluate what may happen.

Proper understanding of price patterns on a chart will help you better determine the probability of the currency pair continuing the trend it was in, or reversing to develop a new trend. This helps you determine whether to buy, sell or hold.

Price patterns are an underutilized and extremely valuable tool in your forex trading arsenal. It may take a little while to get comfortable dealing with the subtle nuances and occasional ambiguity that are a part of price pattern analysis, but once you get the basics figured out, you will be able to confidently make informed trading decisions.

It’s also important to understand that price patterns are visual representations of market psychology. They tell you when traders in the market are excited and moving, when they need to take a moment and catch their breath and regroup and when they are ready to get moving again.

All price patterns are made of the following four pieces:

Old trend: the trend that the currency pair is in as it starts to form the price pattern

Consolidation zone: a constrained area where the pair isn’t clearly continuing the trend or forming a new one

Breakout point: the point which the currency pair breaks the consolidation zone

New trend: the trend the currency pair enters coming out of the consolidation zone


Types of price patterns

Price patterns are divided into two major categories: Continuation Patterns and Reversal Patterns.

Continuation patterns tell you that once the pair “breaks out” of the consolidation pattern, it will continue in the same direction that the old trend was moving

Reversal patterns tell you that the new trend is going to reverse direction and move in the opposite direction that the old trend was moving

The only real difference between continuation patterns and reversal patterns is which direction the new trend is moving. Both types of patterns have an old trend, a consolidation zone, a breakout point and a new trend. The next two sections discuss these patterns.
 
Be sure to bookmark this page as a reference guide, as you'll want to refer to the chart pattern explanations below frequently in your analysis.

 
Continuation Patterns

Continuation patterns form in a few different shapes, but for the most part they look quite similar. The only real difference you will see is in the shape of the consolidation zone. The consolidation zones of some continuation patterns have support and resistance levels that converge as the pattern forms while others have support and resistance levels that remain parallel. Every other aspect of the price pattern is identical.
 
In an Uptrend
 
The following are the most common continuation patterns you will see during an uptrend:

Pennants: These form during an uptrend as the uptrending support level and the downtrending resistance level that encompass the consolidation zone converge.

Flags: Flags form during an uptrend as the horizontal or downtrending support level and the horizontal or downtrending resistance level that encompass the consolidation zone remain parallel.

Wedges: During an uptrend as the downtrending support level and the downtrending resistance level that encompass the consolidation zone converge, you see a wedge.

Ascending Triangles: Ascending triangles form during an uptrend as the uptrending support level and the horizontal resistance level that encompass the consolidation zone converge.
 
An example of an ascending triangle


 
In a Downtrend

The following are the most common continuation patterns you will see during a downtrend:

Pennant: They form during a downtrend as the up-trending support level and the down-trending resistance level that encompass the consolidation zone converge.

Flags: Flags form during a downtrend as the horizontal or up-trending support level and the horizontal or up-trending resistance level that encompass the consolidation zone remain parallel.

Wedges: Watch for wedges during a downtrend as the uptrending support level and the uptrending resistance level that encompass the consolidation zone converge.

Descending Triangles: Descending triangles form during a downtrend as the horizontal support level and the downtrending resistance level that encompass the consolidation zone converge.

Whether the consolidation patterns appear in a downtrend or uptrend these indicate that the trend is pausing and that on the breakout a continuation is likely. These can be helpful for timing a trade in the direction of the prior or "old" trend.
 

Reversal Patterns
 
Reversals during an uptrend

The following are the most common reversal patterns you will see during an uptrend:

Double tops: Double tops form during an uptrend as the uptrending currency pair hits the same resistance level twice in the consolidation zone.

Triple tops: Triple tops form during an uptrend as the uptrending currency pair hits the same resistance level three times in the consolidation zone.

Head-and-Shoulders tops: Head-and-shoulders tops form during an uptrend as the uptrending currency pair hits a lower resistance level, then hits a higher resistance level and then hits the lower resistance level a second time in the consolidation zone.
 
Head and shoulders top example

Reversals during a downtrend
 
The following are the most common reversal patterns you will see during a downtrend:

Double bottoms: Double bottoms form during a downtrend as the uptrending currency pair hits the same support level twice in the consolidation zone.

Triple bottoms: Triple bottoms form during a downtrend as the uptrending currency pair hits the same support level three times in the consolidation zone.

Head-and-Shoulders bottoms: Head-and-shoulders bottoms form during a downtrend as the uptrending currency pair hits a higher support level, then hits a lower support level and then hits the higher support level a second time in the consolidation zone
 
Like consolidation patterns, reversal patterns largely mean the same thing whether in a downtrend or uptrend. Prices have reached a point where the prior or "old trend" is likely to end and a new trend in the opposite direction is ready to start.

Provided by Learning Markets

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