How to Identify Reversal Chart Patterns and Trade Profitably
The Forex market is cyclical and incredibly interconnected. Therefore, every major movement on the market generally has some precursor movements that lead up to it - and with time you can learn these movements. That is the basis behind the Forex Technical Analysis - a rather reliable way of predicting the movements on the Forex trading instruments.
What Are the Reversal Chart Patterns
The best way to express the Forex market movements is chart patterns - a visualization of the market prices using “candlesticks”. And the most interesting - and potentially profitable - of them are the reversal patterns.
Reversal chart pattern means that the currency pair (or any other financial instrument) is already at its peak, followed by a reversal. In the future, the price will move in the opposite direction which makes reversal patterns a great moment to get into the market.
There are quite a lot of these patterns. We are going to review the most common and useful ones.
Head and Shoulders
This ascending chart pattern is characterized by a series of three peaks with the middle one being the highest. These peaks are called Left Shoulder, Head, and Right Shoulder - with Head being slightly higher (at both the bottom and top points) than the other two. Once the price rolls off the Right Shoulder, it enters a prolonged reversal.
Despite the fact that this pattern is rather common, it often gets mistaken for a different one or applied incorrectly. To make sure that you are definitely looking at the Head and Shoulders pattern, consider if it corresponds to these features:
- There is a strongly marked uptrend before the formation of the pattern;
- The quotes gain a local maximum when forming the Left Shoulder;
- Once the price rolls off the Left Shoulder, it falls below the support level before climbing back up again;
- The base level for the peaks is almost horizontal or has very little incline;
There is also an Inverted Head and Shoulders pattern that forms on descending charts.
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Multiple Top/Multiple Bottom
The trend doesn’t reverse by itself - it bounces off the resistance or support line. However, the traders are rarely unanimous in their decisions and the trend might take a couple of “bumps” - a sharp ascends and descends - at the line before everyone gets the message. On the charts, it generally looks like a Multiple (Double, Triple) Top/Bottom pattern.
At some point all traders come out of the outdated trend and enter the new one, which accelerates the reversal.
WARNING : You may attempt to trade during the development pattern — sell at the tops and buy at the bottoms. However, it is considerably more risky, and if you want a safer strategy — wait for the final bounce off before entering the market.
Wedge happens when the quotes are moving while the trading range of the currency pair - the difference between its highest and lowest local points - is becoming smaller. Wedges can be both upward and downward.
A lot of beginner traders see the wedge and immediately start trading in its direction, but they don’t know that it’s a reversal pattern. And eventually, the wedge turns around and starts moving in the other direction - even further than its starting point. However, a much better option would be to wait until the price break and entering the newly formed market.
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Reversal Chart Patterns Cheat Sheet
- Use higher timeframes (H4-D1) when looking for the reversal chart patterns. The smaller timeframes are rather imprecise and often straight up useless.
- Use lower timeframes to search for confirmations of the patterns.
- Use technical indicators like oscillators to confirm your suspicions further. MACD Divergence indicator is especially useful when dealing with wedges.