Chart patterns provide one of the best ways to trade the forex market with a good win rate. You can build a whole strategy around them if you are able to trade the patterns the right way. Sometimes the term chart patterns is interchanged with market structure or consolidations. If this is a new concept to your trading go through this first
Formation of chart patterns.
There are two main directions in which the forex market moves in order for traders to make money; that is either up or down. As imperfect as the trading world is, it is not always so; there are times and this is quite frequent, where the market will get stuck.
When the forex market is stuck, it means the buyers are not strong enough to move it up or the sellers are not strong enough to move it down. This causes a struggle between the buyers and sellers which contributes towards messy and tight up and down moves.
When the quite frequent scenario above occurs, we say that the market is ranging or it is in a range. Ranging markets are the best places to look for chart patterns since ranges provides a lot of them.
Why chart patterns form.
This has been described by many a traders as human psychology having a direct influence on the market movements. If you have been around any tradable market for a while, you certainly know that the market does not move in a straight line.
After a huge up or down move, the market takes a breather. This breather comes in the form of a consolidation or a retracement and sometimes a total reversal of the initial trend. The breather is the reason why chart patterns form.
You can look at it this way; in a bullish move, buyers will rest for a while before continuing with the up move. With the resting of the buyers, the sellers can also take over and reverse the whole bullish move. The “resting” mood is where chart patterns occur.
A different way to look at them.
Generally, we classify chart patterns as either bullish or bearish. Over the years, I have realized that it is a stubborn way to classify them. In my revised view, all chart patterns are neutral until the imminent breakout occurs.
Textbook chart pattern trading criteria states that ascending triangles break to the upside whereas descending triangles break to the downside. These however are the “most likely” scenarios and they are not cast in stone.
I have seen ascending triangles breaking to the downside and descending triangles breaking to the upside and you might have probably observed that as well if you have been in this game for quite a while.
Holding the view that consolidations are bullish or bearish could cause you to act before the appropriate time. For instance, if you know very well that ascending channels break to the upside; you would be tempted to buy before the actual breakout.
In a situation where this particular one breaks to the downside, you would have ended up with a very avoidable loss if you held no initial bias. A simple knowledge about the traditional bullish or bearish consolidations is enough but always stay cautious.
In my revised view, there are no bullish or bearish chart patterns, only the direction of the breakout can tell the type that has occurred. Hold on to this view and your trading account would thank you later. This will prevent you from jumping the gun always.
Consolidations come in many forms.
The market has countless ways of ranging and sense can be made out of only a few. Some consolidations are super choppy and no viable patterns can be drawn out of them. The market can range horizontally, diagonally or converging.
Horizontal ranges come in the forms of head and shoulders, double tops, double bottoms and rectangles.
Diagonal ranges are wedges and flags; these type of formations are slanted and they mostly occur as retracements. Head and shoulders and double tops and bottoms could be diagonal as well. Double tops and bottoms are otherwise known as M & W formations.
All triangles are converging chart patterns since the trendlines used in connecting them meet at a point.
How to spot chart patterns.
It doesn’t matter the type of timeframe you are in, chart patterns occur in all timeframes. It is however worthy to note that, the higher the timeframe the more reliable; preferably 1H and above.
To spot chart patterns, ignore parts on the charts where the market trended smoothly or moved in a straight line in one direction. Focus heavily on the areas where the market ranged or consolidated; that is in the choppy areas.
Although trading platforms have various tools built in to plot some specific chart patterns, it is okay to use trendlines to plot them since they give the accuracy.
After spotting the consolidation in question look at the highs and lows and try connecting two or three points of each level. You are highly likely to find a valid market structure that way. It may not be easy at first but the patterns will jump at you with enough practice.
It is prudent to also say that, if you do not find any textbook pattern after going through the criteria above, do not force it. The best chart patterns for you will be found with just an adequate amount of effort.
Helpful tips on consolidations.
Support and resistance bind chart patterns. Support and resistance levels are areas of value where the market breaks out or reverses. Market structures like triangles, rectangles, wedges and flags make use of support and resistance levels in its formation. The trendlines that are used to connect them act as those key levels.
Do not trade within them. Trading within the formational area of a chart pattern is never ideal. You will be caught in a range where neither buyers or sellers are ready to move; no trader loves it in a choppy range. An exception is if the pattern is wide enough to accommodate significant moves.
Be patient and wait for the eventual breakout. Always have the patience to wait for the breakout of the patterns’ support or resistance level before taking a position. This will prevent you from getting stuck in markets that are directionless.
Chart patterns fail too. Just as these patterns are formed with support and resistance levels whose idea is to wait for breakouts, false breaks are not ruled out. To limit falling victim to false breaks, you can always wait for the break and retest to be sure that you’re making a good decision.
Is this stuff new to you and are you willing to learn more? Go through this module to learn the many traditional type of market structures there are.
If chart patterns are already a part of your trading strategy then you already know how powerful they are. If they are not then make sure to incorporate them into your strategy if it garners your interest. Let me know about what you think in the comment box below.