What are Forex Graphic Patterns?
What are graphic patterns? What are the types of graphic patterns? How to find reversal patterns (double top, double bottom, head and shoulders, rising and falling wedge) and trend continuation patterns (flags, pennants, rectangles and triangles) on the chart?
Technical analysis using graphical patterns (or graphical models) is an effective way to analyze the Forex market. Graphical patterns can help you, as an intraday trader, identify reversals and trend continuations. In addition, these graphical models can help long-term investors get in and out at the right time. In this article you will learn everything you need to know about graphic patterns.
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What are graphic patterns?
Graphical analysis models show the state of the market and help traders assess whether the trend will continue or reverse.
Millions of players trade on the financial markets every day. These are professional traders, investment companies, retail traders and investors. Mark Douglas in the book "Trading in the zone" says that all people have behavioral patterns. A group of people who interact with each other (for example, on the stock exchange), together form collective behaviors.
In other words, people act on the basis of their past in a similar and predictable way in the future. History doesn't always repeat itself, but it often rhymes. That's why we have to think in broader patterns, because patterns repeat more easily than individual events.
You can also extend this philosophy to price charts, where transitions between uptrends and downtrends are often indicated by recognizable price movements. These price movements form graphical models that repeat with a certain regularity.
Forex charts provide us with the perfect environment to look for these patterns as charts are a visual representation of all buying and selling activity.
Types of graphic patterns
There are two types of graphic patterns:
- Reversal patterns. Reversal patterns report a possible change of an uptrend to a downtrend and vice versa.
- Trend continuation patterns. These models report a temporary pause in the trend and indicate that the previous direction of the price will remain. In other words, they offer traders the opportunity to join the market or expand an existing position for long-term investors.
It is important to note that some graphical patterns can signal both a continuation of the trend and a reversal, depending on the circumstances.
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Reversal patterns of graphical analysis
In this section, we will look at reversal patterns that you can use to determine the moment of a trend reversal and enter a trade at its very beginning.
1. Double Top
Let's start with the simplest, most common and one of the most effective patterns – the "Double Top", which occurs at the end of an uptrend.
This pattern is formed as follows:
- The price makes a new high, but faces resistance.
- We are returning to short-term support as traders take profits on their long positions below this resistance.
- Buyers are trying to re-enter the market, but they cannot break this resistance, as a result of which the price reaches new lows.
As soon as the price closes below this level, the pattern will end and become a signal to the end of the uptrend.
2. Double bottom
The "Double Bottom" pattern is the exact opposite of the "Double Top". It occurs at the end of a downtrend and signals a possible switch to an uptrend.
Stages of formation of the "Double bottom" pattern:
- The price makes a new low, but reaches the support level.
- Traders fear that the trend is coming to an end, and close their positions, causing the price to roll back to short-term resistance.
- The bears are making desperate attempts to break the support, but in the end the bulls take control. Instead of breaking the support, the price breaks through the maximum of the pullback.
As soon as the price closes above this level, the pattern will end and become a signal for the end of the downtrend.
3. Head and shoulders
This pattern can be found at the end of an uptrend. As soon as it forms, there is a high probability that a new downtrend will begin.
Why this graphic pattern is called "Head and Shoulders" is clearly seen in the picture below.
Here is an explanation of the "Head and shoulders" pattern:
- Due to the growing market, the price reaches its peak. After that, the rate drops slightly and the left shoulder is formed.
- From the minimum of the left shoulder, another bullish movement begins, clearly passing by the maximum of the left shoulder. This forms a head, after which the price falls again.
- Buyers make another upward movement from the bottom of the head to form the right shoulder. This vertex is lower than the head and approximately equal to the top of the left shoulder.
- From the top of the right shoulder, the price starts to fall again, and when the neck line is broken, the pattern ends. The neck line is the level of support that you can draw to connect the bases of the two shoulders.
4. Inverted head and shoulders
This graphic pattern is a bullish version of the "Head and Shoulders". You can find this pattern at the end of a downtrend, and it signals a possible trend reversal from bearish to bullish.
The "Inverted head and shoulders" pattern is formed as follows:
- During a bear market, the price reaches a temporary bottom, and then rises, forming a left shoulder.
- From the maximum of the left shoulder, the price falls far beyond the previous minimum, forming the head of the pattern, after which the price rises again.
- The downward movement from the top of the head gives rise to the right shoulder. This minimum is higher than the head and is approximately equal to the level of the left shoulder.
- From the minimum of the right shoulder, the price rises again, and when the neck line is broken, the figure on the chart is completed.
5. Rising wedge
The "Rising Wedge" pattern is formed when the price makes higher highs and higher lows within a narrowing range that moves up.
For this graphical pattern, it is important that all the highs and lows are well aligned so that they can be connected to the trend line. It is clearly seen that the lower trend line is steeper than the upper one.
When the price breaks the bottom, it means the end of the uptrend and is a good sign of switching to a downtrend.
6. Falling wedge
A "Falling wedge" is an inverted pattern of an "Rising Wedge". Falling wedge formirit occurs when the price makes lower highs and lower lows within a narrowing range going down.
As the price falls into the "Falling Wedge", the trend lines get closer and closer until they touch. When the bears fail to set a new low, the downtrend ends and a new uptrend begins. At this time, traders may be looking for a good buying opportunity.
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Graphical patterns of trend continuation
In this section, we will consider the graphical patterns of trend continuation.
1. Bull flag
Flag models are very common and often cause explosive movements. In addition, they are easy to spot.
Explanation of the "Bull Flag" pattern:
- The flagpole is represented by a strong bullish movement.
- After this movement, the price consolidates in a phase that eventually forms a flag. It consists of two parallel trend lines pointing slightly downwards, which makes it a pullback to the previous movement.
- As soon as the price breaks through the upper part of the flag, the pattern ends.
2. Bear flag
The "Bear flag" pattern is the exact opposite of the "Bull Flag".
Explanation of the "Bear Flag" pattern:
- The flagpole is a strong downward movement.
- After this movement, a consolidation phase begins, forming a flag. In the picture, it is highlighted by two parallel trend lines, slightly rising up and formingand a rollback on the previous move.
- As soon as the price breaks through the lower part of the flag, the figure on the chart is completed and you can open a short position.
3. Bullish pennant
Pennant patterns are very similar in structure to flags. Some sites don't even distinguish between them. What is the difference between pennants and flags?
The consolidation phase, which we know as the flag, is less intense for the Bullish Pennant pattern. Bears have much more problems with containing the uptrend. This makes it impossible to get lower minimums, as with flags.
In other words, the Bullish Pennant pattern tells us that buyers are stronger than sellers during consolidation. The rules are similar to the rules of the "Flag" pattern.
4. Bearish Pennant
After a sharp downward movement that broke through the support, the price consolidates in a narrowing range resembling a triangular flag (pennant).
However, this is a relatively short period of consolidation before the price breaks the bottom. Thus, the Bearish Pennant pattern is completed, and you can look for an entry to continue the downtrend.
5. Ascending triangle
The ascending triangle pattern is usually bullish. You can find this pattern during a consolidation period during an uptrend.
The price makes higher lows, which we can connect with the trend line at the bottom, but buyers cannot break through the resistance above it.
You would say that the uptrend is probably over, but if you look closely, you will see that the price action is shrinking againit's crumpled. Buyers are gaining strength, and sellers are slowly running out of steam.
In the end, the price breaks through the top of the ascending triangle, which often causes a significant movement. A breakout completes the figure and signals the possibility of buying.
6. Descending triangle
The descending triangle is bearish, telling us that the downtrend is likely to continue.
This pattern can be recognized by the horizontal bottom, where the price has met strong support. At the top you can see a descending trend line connecting the lower highs.
This structure is created when strong bears continue to push the price down, and weaker bulls try to reverse the trend. Eventually, buyers are exhausted and sellers manage to push the price through the support.
The breakdown completes the "Descending Triangle" pattern, and at this moment we can look for an entry into a short position.
7. Bullish rectangle
Rectangles are the simplest shapes that can be found on the graph.
In fact, a "bullish rectangle" is nothing more than an uptrend range, which is usually formed on or just before a strong resistance. For a certain period of time, bulls and bears are equal.
This creates a range around which you can draw a rectangle. The lower part of the rectangle is the support, and the upper part is the resistance.
As soon as buyers take control, the price will break up, and we can open long positions.
8. Bearish rectangle
The "Bearish rectangle" pattern looks the same, but it takes place in a downtrende, so the effects are reversed.
Please note that rectangles are typical examples of graphical patterns that can work both for a reversal and for the continuation of a trend.
Fortunately, there are several periods of consolidation and only one reversal inside the trend, so rectangles are more often a continuation of the trend than reversals.
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The main disadvantage of graphical patterns is that they need to be searched on the chart. It's not very difficult, but you need practice. It is best to do this on history, then practice on a demo account, and only then switch to real trading. For some traders, when searching for graphical patterns, the transition from a candlestick to a linear chart helps.
Among the advantages, graphical patterns are a reliable signal for entering trades, they do not lag like indicators, and with their help you can easily determine the goals of take profit (for example, the height of the figure) and stop loss levels (the opposite level of the pattern).
Read also the article "Forex Candlestick Analysis".