Pattern recognition is at the core of technical analysis and provides a disciplined approach to trading. Over time, investors have noticed that the market forms distinct patterns before continuing or reversing a trend. Starting with early stock market trading in the United States, classic technical analysis patterns were documented by investors and speculators of all kinds. Some stood the test of time; some didn’t.
The technical analyses that still exist today, are widely used in all markets, including Forex. This lesson aims to list and briefly explain the most relevant and inspire investors to find out more about these elegant patterns that can either show continuation or reversal conditions.
Head and Shoulders
A complex and time-consuming pattern, the head and shoulders pattern appears when a trend is reversing. Therefore, it appears at the end of either a bullish or bearish trend and has:
- two shoulders (left and right),
- a head,
- a neckline,
- an even measured move.
The name comes from the shape of the human body, and the pattern in the FX market looks like this:
There are two types of wedges: falling and rising. A saying among investors is that rising wedges fall (meaning they are bearish) while falling wedges rise (they are bullish patterns). A wedge shows the price’s inability to continue any lower or higher, making only marginal highs before reversing.
Ascending and Descending Triangles
Triangles are one of the oldest technical analysis concepts and are simply consolidation patterns. Typically, they can represent the market taking a breather before breaking in the direction of the original trend. Most of the time they form before critical economic releases, or, during illiquid trading sessions, like the Asian session.
Double and Triple Tops
Double and triple tops typically reverse trends, therefore they usually appear at the top or bottom of a trend. Double tops and bottoms appear more often than triple tops and bottoms. A double top resembles the letter ‘M’ while a double bottom resembles the letter ‘W’. As for triple patterns, they are often confused with ascending or descending triangle patterns, except that they break in the opposite direction of the previous trend.
Bullish and Bearish Flags
Bullish and bearish flags are variations of ascending and descending triangles and are consolidations in the middle of a trend. They are tricky patterns, as it isn’t mandatory for the flag to form horizontally, and it may end up taking quite some time before the trend resumes.
Classic technical analysis approach also includes other patterns like pennants, rounding tops and bottoms, cup and handle. These patterns, also known as the Western contribution to technical analysis, complement the Japanese candlesticks, and together they form a big chunk of today’s technical analysis field.
- Bullish and bearish flags are tricky as they can take a lot of time to consolidate.
- Head and shoulders patterns are always reversal patterns.
- A rising wedge is “falling” and a falling wedge is “rising”.
- Double tops resemble the letter M, double bottoms resemble the letter W.