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Chart Patterns - Technical Analysis

Chart patterns are one of the most reliable, yet easy to use technical analysis tools. Just like in any endeavor in to financial chart analysis however, there comes a time to use your own discretion. Some patterns you come across are "textbook perfect", while for others... you may have to stretch your imagination to see them. Most are somewhere in the middle. If you spend too much time looking for patterns however, you will begin to see them everywhere - not only in your charts, but in your cereal bowl, in the sky and on TV. This is when things get dangerous. Because our brains come pre-loaded with excellent pattern recognition software, there is a chance for us to "overtune" it, and begin to see patterns even when there are none. Be careful about this, but don't let it keep you away from this powerful technical analysis tool. Just remind yourself to be objective, and go back and review the criteria for each chart pattern carefully every once in a while, and certainly before you make any trading decisions based on them.

Another thing to keep in mind is that chart patterns in the forex work a little differently than in equities for example. The difference stemming from the idea that equities have a "natural" upward bias, whereas currencies move relative to one another, so there is no upward or downward bias - an uptrend in USD/JPY is simply a downtrend in JPY/USD. Most of the known literature on chart patterns is not written specifically for the forex, so keep that in mind if applying any of that knowledge when trading currencies.

The chart patterns discussed in this section are meant for daily charts. They generally do not work well on shorter timeframes, and should not be used without further research.

Cup With Handle

Type: Continuation Pattern

Appearance: Looks like the cross section of a tea cup with small handle on the right side of the cup.

Typical Duration: 7 to 65 weeks (handle duration must be at least 1-2 weeks and can get to be quite long)

Cup With Handle continued ..

Pennant

Type: Continuation Pattern

Appearance: Price action bounded by converging trendlines. In most cases the price action inside the pennant is moving in the opposite direction of the trend, but this is not a requirement.

Typical Duration: up to 4 weeks (28 days).

Pennant continued ..

Flag

Type: Continuation Pattern

Appearance: Price action bounded by parallel trendlines. In most cases the slope of the trendlines is against the trend, although this is not a requirement.

Typical Duration: up to 4 weeks (28 days)

Flag continued ..

Hanging Man

Type: Reversal Pattern

Appearance: Opening price and closing prices are both at or very near the high price of the bar, with a much lower daily intra-candle low.

Typical Duration: 1 bar/candle

Hanging Man continued ..

Dead Cat Bounce

Type: Continuation Pattern

Appearance: An shallow upward bounce and declining price immediately following a steep decline.

Typical Duration: 2-4 days for the initial decline. From a few days up to 3 weeks for the bounce high to be reached. A few days to a few weeks for the drop below initial decline low. Up to 3 months for the final decline to play out.

Dead Cat Bounce continued ..

Engulfing Pattern

Type: Reversal Pattern

Appearance: The engulfing pattern is a major reversal signal composed of two candles with opposite color bodies. From this point on, we will consider "white candles" to be up and "black candles" to be down. A Bullish Engulfing Pattern occurs in a down-trend and consists of a white candle whose body completely engulfs the body of the previous down-candle. A Bearish Engulfing Pattern is the exact opposite: It occurs in an up-trend and consists of a down-candle whose body completely engulfs the body of the previous up-candle.

Typical Duration: 2 candles

Engulfing Pattern continued ..

Morning Star

Type: Bullish Reversal Pattern

Appearance: The morning star is a 3-candle bullish reversal formation characterized by a strong black candle (downward), followed by a small body white (upward) candle, followed by bigger white candle. The third candle does not need to breach the top of the first candle's body.

Typical Duration: 3 candles

Morning Star continued ..

Evening Star

Type: Bearish Reveral Pattern

Appearance: Following an up-trend, we see a large bodied white (up) candle, followed by a gap and a small bodied candle of either color. This is then followed by a large black (down) candle - although not larger than the first white candle in the pattern.

Typical Duration: 3 candles

Evening Star continued ..

Dark-Cloud Cover

Type: Bearish Reversal Pattern

Appearance:The dark-cloud cover pattern consists of a long body white (up) candle, followed by a black (down) candle which opens above the first candle's high. This means there is a gap between the first candle's close and second candle's open. The second candle then penetrates deep into the body of the first candle.

Typical Duration: 2 candles

Dark-Cloud Cover continued ..

Piercing Pattern

Type: Bullish Reversal Pattern

Appearance: The Piercing Pattern consists of a long body black (down) candle, followed by a white (up) candle which opens below the first candle's low. This means there is usually a gap between the first candle's close and second candle's open, although in forex this is not a necessary pre-condition. The second candle then penetrates deep into the body of the first candle, signaling a shift in market sentiment. The piercing pattern is the exact opposite of the dark-cloud cover pattern.

Typical Duration: 2 candles

Piercing Pattern continued ..

Please use the chart patterns described here only after doing your own due dilligence. No guarantees are made as to the success of your trading according the rules described here.

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