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Important Charting Patterns When Trading Forex

Important patterns exist within forex trading that offer traders cues as to when by or sell, and sometime as to what direction the market is about to move in.  The following is an explanation of some of the most important patterns to recognize. 

Many of these patterns are also self-reinforcing:  People believe they are going to happen, so that makes them happen in a fashion dramatic enough to be more noticeable. 

Many of the patterns have mirror opposites.  For instance, the “double bottom” simply behaves in the exact opposite way as the “double bottom.”  This makes learning about chart patterns easier.  Once you've learned what one indicates, you just reverse everything, and now you know what two different patterns mean. 

The first pattern to recognize is the symmetrical triangle.  This is what happens when you are looking at a chart of a currency pair, and the lows are getting higher and the highs are getting lower.  If you were to draw two trend lines of the lows and the highs, they would be converging, with the base of the triangle to the left and point to the right. 

It's often symptomatic of an important event approaching.  Traders are watching the waiting for something – say, an announcement from the Fed concerning interest rates – and as that event approaches, traders have settled into their positions, and are awaiting the results. 

A symmetrical triangle usually means that the market will break out in one direction or the other.  It doesn't indicate what direction the market is about to move, but it is a very strong indication that something is about to happen. 

To take advantage of this, place entry orders above and below the high and low slope lines, respectively.  That way, you can just “hitch a ride” in whatever direction the market moves. 

Ascending and descending triangles are two similar patterns.  In the case of the former, there is a flat slope line on top, and an ascending line on the bottom.  The lows are getting higher, but the highs can't seem to break a certain barrier.  This suggests the buyers are putting upwards pressure on a currency, but don't seem able surpass a barrier.  Sometimes, that barrier is psychological, like $100 a barrel for oil. 

Like in the case of the symmetrical triangle, the narrowing of the range suggests a break up will indeed occur.  More often than not, whether its the buyers with an ascending triangle or the sellers with a descending triangle, the group putting pressure on the barrier will win out, and the currency will break in their direction – up for buyers, down for sellers.

Of course, there's a big difference between “more often than not” and “always.”  The almost certainly will break out one way or the other, but it's only probable, not nearly certain, that it will move in the direction the ascending or descending triangle would suggest. 

These two triangles bring up an important side point:  Usually, currencies lose value faster than they gain it.  That is to say, a descending triangle suggests somewhat more future volatility than an ascending.

A “double top” happens when a currency twice tops out at about the same point.  Usually, it means that pressure from buyers has a pretty strong ceiling at that price, and the recognition of this fact tends to lead to sell orders. 

Go short below the valley between the two tops, and, if you've identified the trend correctly, you should be in a good position to do well. 

A “double bottom” is the exact reverse of a double top.

Then, there is the “head and shoulders.”  This happens when there is a small peak in price, then a large one, then a small one of similar size to the first small peak.  It operates like a descending triangle in this instance.  The first peak essentially reinforces the smaller descending triangle – which is how the chart would read if you took went from the highest peak, or head, to the last peak, or right shoulder.  The first head just makes the pattern that much more indicative of a looming break out in the direction of the sellers. 

The reverse head and shoulders is, obviously, the exact reverse of the head and shoulders.