One of the most important skills involved in interpreting forex charts is detecting chart patterns. These patterns signal the direction in which an exchange rate is likely to move once it has been completed. There are two major types of chart patterns. Reversals signal that a price trend will reverse once the pattern has been completed. Continuations, on the other hand, indicate that the trend will continue when the pattern is done. Here is a brief overview of some of the most commonly encountered patterns in forex charts.
- Head and Shoulders: In this pattern, the currency price reaches two lows (which represent the ‘shoulders’) with retracements in between and the lower low as the head. A trend line is drawn in between the two retracements and the pattern is deemed completed once the price breaches this line. This pattern offers the trader not just an entry level, but also a stop loss level and a profit goal. The trader enters when the ‘neck’ of the pattern is broken and places the stop loss under the right shoulder or the head, depending on the trader’s risk appetite.
- Triangles: These patterns are generally formed on forex charts with short-term time frames when the highest and lowest prices gradually narrow into a tighter price area. The entry point for a trade is when the price penetrates the perimeter of the triangle and the stop loss is placed at the lowest end of the pattern. To find the profit target, find out the height of the triangle in pips by subtracting the lowest point from the highest point, and then add this figure to the entry point.
- Engulfing patterns: These forex charts patterns are found on candlestick charts and represent outstanding trading opportunities since they can easily be spotted and indicate that a price reversal is imminent. If the reversal is downwards, an up candle will engulf completely the past real body of the down candle, while the opposite happens in an uptrend. The entry point is the opening price of the first bar once the pattern has been formed, while the stop loss is placed just below the lowest point of the pattern.
- Ichimoku Clouds: This chart pattern defines support and resistance levels of a currency as well as identifies its price direction. It consists of a series of ‘clouds’ that are formed between moving averages. The price trend is upward when the prices are charting above the clouds, downward when they are below and neutral when they are inside the clouds. The Ichimoku is generally used when the currency price is trending in order to allow the trader to capture profits by taking advantage of the trend. The entry point for a trade is when the price breaks through the cloud and moves below or above it. The ‘clouds’ are also given different colors depending on what trend it is experiencing. Momentum is indicated in these forex charts patterns when the Conversion Line crosses the Base Line and a bullish or bearish signal is created if the Conversion Line moves above or below the Base Line.