Forex Chart Patterns
As a Forex trader, one of your most invaluable tools will be the price chart. This is your basis for analyzing the trading history of a Forex pair and defining your own potential entry and exit points.
Today traders rely on powerful software packages to draw charts from real-time price data, updating with every tick in the market. Such tools, which also allow you to apply complex technical indicators to the price history, can require high subscription fees.
Why use trading charts?
A chart gives you the price history for a Forex pair over a given period of time. By viewing patterns in the price history you can predict future price movements, targeting future trading opportunities based on reversal or continuation of the pattern.
There are two essential elements to reading charts: identifying the trend and predicting deviation. First you need to establish if the price over your period of analysis is exhibiting an upward, a downward or a sideways trend. Then you need to find the future point at which the trend will change. Alternatively, if you can identify a point at which the trend will continue or strengthen you also have a basis for your future trades.
A wide understanding of the most common Forex chart patterns, such as the ‘head and shoulders’ pattern and the ‘double’ or ‘triple top’, is essential for any Forex trader employing trend-following strategies.
Types of charts
Three common styles of price chart are the line chart, the bar chart and the candlestick chart. The line chart is the most simple, plotting the closing price at each interval over the time period (each week, each day, each hour) connected by a simple line. Reading a line chart gives you a sense of the general price movement.
The bar chart seeks to add more data to this picture. Each interval is represented by a vertical bar running from the highest to the lowest price over this interval. And horizontal dashes on either side of the bar represent the opening price (to the left of the bar) and the closing price (to the right). In this way a bar chart conveys a fuller sense of the price dynamics over the period.
A candlestick chart illustrates the same data in a different way. A vertical bar runs from the opening price to the closing price over this interval. This is typically colored green if the closing price is higher than the opening price (i.e. the price has risen) or red if the closing price is lower than the opening price (i.e. the price has fallen). A vertical line extends above the bar to the highest price achieved over this interval, and below the bar to the lowest price achieved.
At a glance the candlestick chart gives you a clear visual indication of the strength of a trend or areas of market indecision, plus a set of typical patterns to suggest a change in the trend.
Applying technical indicators
You can apply technical indicators to your price chart to add information regarding market sentiment and potentially confirm your reading of the trend.
A technical indicator works by calculating a specific formula on the available price (and sometimes volume) data. The new data generated from the formula is then either plotted on top of the existing price chart or, in the case of oscillators, is plotted in a smaller chart beneath the main price chart, along the same timescale.
For example, a simple moving average is generated by calculating the average price over a given number of periods, e.g. the 10-day moving average calculates the average closing price over the last 10 days. At each interval on the price chart a moving average is plotted and these data points are connected by a simple line.
By contrast, an oscillator like the Relative Strength Index generates a value between 0 and 100 at each interval by comparing an average of recent gains to an average of recent losses. This is a momentum indicator in that it measures the rate of change of a price and tells you whether the asset is overbought or oversold.
Channels and breakouts
When you view price movements over a specific time period you’ll be able to plot support and resistance levels, the levels the price has not managed to break through over this period. The area between the support and resistance levels is a channel.
Reading chart patterns is all a matter of predicting continuation or deviation of the existing channel. A breakout trader will be looking to spot the points at which the price will break above the support level or below the resistance level, as this marks a decisive change in the trend and a potential trading opportunity.
Your chart analysis will ideally be providing entry and exit points for your forex trades. By reading patterns and applying simple and complex indicators you can generate clear trading signals as a basis for your forex trading strategy.