Nobody can foresee exactly how the markets are going to move – that would be far too simple. However, there are certain patterns you can look out for to improve your chances of success when trading. Learn about 12 common foreign exchange trading patterns and test your knowledge to see if you can accurately predict how each pattern plays out.
Double tops often form towards the top of a move up during an uptrend. The price peaks at a certain level before dipping down slightly - this alone is known as a ‘top’. As the name suggests though, the price can do something quite different after hitting the neckline…
In a double top, the price will go back up to form a second ‘top’. Generally this will go no higher than the first ‘top’ before falling again, indicating an imminent reversal as the buying pressure is about to end – however some traders opt to add 1x ATR range around the last top as an allowable range for a double top to form. Can you see any double top patterns in the USD/JPY currency pairing?
Double bottom formations usually appear towards the lower end of the given move and follow an opposite trend to the double top. Initially the price will hit a low point, before rising again.
A double bottom pattern is defined by price making two consecutive lows at or near equal levels. The rise after the second ‘bottom’ is seen as a bullish development and suggests that prices may continue higher. The second ‘bottom’ will rarely go lower than the first low, as the selling pressure will have been exhausted, however similar to a double top, some traders will add a 1x ATR range around the last bottom as an allowable range for a double bottom to form. Keep an eye out for double bottom trends after a strong downturn in price. See if you can spot a situation where a double bottom might occur in the AUD/USD currency pairing.
A head and shoulders is an interesting chart pattern which is given its name due to two peaks (shoulders) sandwiching a larger peak (head). A break below the support trendline connecting the two troughs, referred to as the neckline, constitutes a break of the formation with such a scenario shifting the focus lower in price.
The distinctive pattern shows how the currency price can have two troughs and another increase before finally dropping. Notice how the shoulders, while not always identical in height, never exceed the height of the head. Traders will often look for a level of symmetry between the two shoulders, meaning the time between the first shoulder and the head can be similar to the time between the head and the second shoulder, however this is not a firm rule. Necklines tend to form a polarity point in markets where necklines that previously acted as support in an uptrend turn into resistance in the reversal. After the second should has been reached, it’s a good signal that the price will then fall. Can you identify any emerging head and shoulders patterns in the USD/CAD currency pairing?
As the name would suggest, the inverse head and shoulders follows a similar path to the head and shoulders pattern, only upside down. This pattern will often manifest towards the bottom of a given move and is defined by three consecutive troughs, of which the middle point shows a more significant low.
A ‘neckline’ - the point where both high points level out - forms, and if you are to measure the distance between the lowest point (the inverse ‘head) and this neckline you can judge the approximate distance the price will increase after it breaks the neckline on its way back up. Traders will often look for a level of symmetry between the two shoulders, meaning the time between the first shoulder and the head can be similar to the time between the head and the second shoulder, however this is not a firm rule. Necklines also tend to form a polarity point in markets where necklines that previously acted as resistance in a downtrend turn into support in the reversal. See if you can identify any emerging inverse head and shoulders patterns in the GBP/JPY currency pairing.
A rising wedge (uptrend) will usually be found in an up trend when the price is beginning to consolidate itself, indicating that higher lows are being formed faster than the higher highs.
Buyers will often show more enthusiasm in response to the lows rather than what is happening at the highs, however a rising wedge should warn buyers about the dangers of chasing a trend near the end of a move. Does this trend appear to be emerging in the EUR/JPY currency pairing?
A rising wedge (downtrend) will often show around longer-term bullish reversals, as traders become more enthusiastic at the lows and ignore what shows at the highs, which can often indicate a shifting sentiment in the backdrop of a particular market.
This leads to the price, coming from a downtrend , consolidating and experiencing higher highs and higher lows. In this situation the price can often break and the downtrend will continue. See if you can spot this trend in the NZD/USD currency pairing.
A falling wedge (uptrend) pattern may be showing reversal potential, as sellers are getting more aggressive at lower-high resistance and slowing the approach at or around support of prior lows.
This can be looked at as a slow-motion fill of longer-term resistance in what could turn out to be a bearish reversal of the prior up-trend. When a falling wedge forms on an upward trend, there’s a good chance the trend will continue later on.
See if you can spot these trends in the USD/ZAR currency pairing.
A falling wedge after a downtrend could signify that the downtrend is getting a bit dated, increasing the potential for a pullback in the price. Traders can respond to resistance when witnesses the enthusiasm that drove the original downtrend, however a less aggressive trend-line at the lows can indicate a slowing motivation from sellers when they retest the lows
The ‘rectangle’ is formed as both buyers and sellers test the price, but neither trend is yet able to take over. The price is bounded by two key price levels – one of these will break, dictating how the pattern continues.
A bearish rectangle tends to take place after two distinct scenarios; either a sharp drop in price when traders fear that the price has moved too low too fast beyond potential fair value, or when there is short covering as sellers take their profits on a short trade after a sharp drop in price.
The ‘rectangle’ is formed as both buyers and sellers test the price, but neither trend is yet able to take over. The price is bounded by two key price levels – one of these will break, dictating how the pattern continues.
A bullish rectangle forms under similar circumstances as the bearish rectangle, however instead it usually appears after a sharp jump in price when traders fear the price has moved too high too fast beyond potential fair value. This can also occur when traders take some money off the table on the profitable trade after a sharp jump in price.
Trend reversals are quite rare and tend to require a fundamental shift of the supporting factors that led to the trend in the first place as well as market sentiment around the asset. Therefore it is likely that, following the rectangle, the price will go up again.
A bearish pennant is formed after a strong and relentless bearish trend, as the market begins to consolidate sideways. The consolidation tends to be relatively small compared to the depth of the downtrend. As the consolidation drags sideways, it forms lower highs and higher lows taking the shape of a triangle or pennant – hence the name.
This pattern typically leads to a breakout, often in the direction of the previous trend. In this scenario traders should look for a break lower through support. Take note though: If the pennant was particularly shallow in depth compared to the previous downtrend, then a large continued sell-off is also possible.
A bullish pennant usually appears when, after a strong and relentless bullish trend, the market begins to consolidate sideways. The consolidation tends to be relatively shallow compared to the length of the uptrend.
As the consolidation drags sideways, it forms lower highs and higher lows taking the shape of a triangle or pennant. This pattern typically leads to a breakout, oftentimes in the direction of the previous trend.
