Forex traders use chart patterns to indicate a trend defined entry and stop levels in a trade. They provide entries, stops and profit targets in a pattern that is easily seen during trading. Chart patterns is a graphical presentation of price movement using a series of trend lines or curves.
Chart Patterns work by representing the markets supply and demand. However chart pattern movement is not guaranteed and should be used with other techniques of market analysis.
Technical Charting Patterns
Price action moves through phases and no movement in the market is ever random. The following patterns are the most frequently spotted on the charts, we will be going through how to interpret them and combine their specified rules alongside other aspect of technical analysis.
The Head and Shoulders Pattern:
This standard head and shoulder pattern that is displayed on the previous page is a price action signal indication that a currency pair is set to fall upon pattern completion and is usually formed at the peak of an upward trend. There is also a second version which is known as the head and shoulders bottom or inverse head and shoulders. The inverse head and shoulders pattern is simply the opposite and signals that a currency pair is set to rise and usually forms at the base of a down trend. In either case, the head and shoulders indicates an upcoming reversal, ultimately meaning the currency pair is likely to move against the prevailing trend.
Both of the head and shoulder patterns have a similar construction in that there are four main aspects which construct the head and shoulder pattern: two shoulders, a head and a neckline. The pattern is a confirmed trade setup upon the break of the neckline/trend-line (a level of support/ resistance), after the formation of the second shoulder. For example; An upward trend is seen as a period of successive rising peaks and dips (retracements) whilst the downward trend is seen as a period of successive falling peaks and pullbacks. The head and shoulders pattern illustrates a weakening in a trend where there is deterioration in the peaks and re- tracements.
Head and shoulders top:
This pattern has four main sequential steps for it to complete itself and signal the reversal.
The formation of the left shoulder is formed when the currency pair reaches a new high and then retraces slightly to a new low.
The formation of the head occurs when the currency pair reaches a higher high then falls back near the low that was formed as part of the left shoulder.
The formation of the right shoulder is formed with a high that is slightly lower than the high formed in the head but is again followed by a fall back to the lows of the left shoulder.
The price then breaks the neckline/ trend-line. In other words, price falls below support going on to break the level of the three lows created by the previous head and left shoulder.
Head and shoulders bottom (Inverse head and shoulders}:
The inverse head-and-shoulders pattern is the exact opposite of the head- and-shoulders top, because it indicates that the currency paid is set to make a move upwards.
The format ion of the left shoulder occurs when the price initially falls to a new low and then subsequently rallies to a new high.
The formation of the head occurs when the price moves to a low that is below the left shoulders low, followed a return to the previous high. This move back to the previous high creates the neckline for this chart pattern.
The formation of the right shoulder is typically a sell off that is less severe than the one from the previous head. This is followed by a return upwards to the neckline.
The currency pair then breaks above the neckline/ trend-line. The pattern is then completed when the price moves above the neckline created by the previous head and shoulder.
After the fourth step (when the neckline is broken), the currency pair should be heading in a new direction. It is at this point when most traders fol- lowing the pattern would enter into a position.
The head and shoulders chart pattern is formulated by three characteristics and can be spotted on the majority of timeframes, however the setup and execution performs best on the Daily and H4.