I only use a handful of Forex chart patterns.
In fact, I would say that 80% of the trades I take are based on channels.
The thing is, I like to keep things simple; really simple.
I’ve often said that you only need one pattern to become successful as a Forex trader.
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Read on to find out!
- 1. The Head and Shoulders (and Inverse)
- 2. The Wedge Chart Pattern
- 3. The Bull and Bear Flag Patterns
- Final Words
- Frequently Asked Questions
1. The Head and Shoulders (and Inverse)
This is not only my favorite reversal pattern, but it is also my favorite pattern, period.
That includes its inverse, which has similar characteristics.
For those who have followed me for a while now, you may recall that my favorite pattern to trade used to be the wedge.
However, the last year of trading has produced a new winner in my book.
The head and shoulders is the least common of the three formations we will discuss today. While there may be similar price structures that occur more frequently, a valid and therefore tradable head and shoulders reversal doesn’t come around very often.
Why I trade it
Put simply, it works. But more than that, it can be quite easy to spot and extremely profitable when you know what to look for and how to trade it.
The pattern can offer a precise entry given the fact that the neckline is generally based on several highs or lows. This fact alone takes a lot of the guesswork out of determining when the pattern has confirmed.
Another huge benefit, like the other two technical formations below, is that we have a measured objective from which to identify a possible target.
Staying out of trouble
This is something that you may not know (unless of course you’re one of my members). In order to be considered valid, the two shoulders of the pattern must overlap at some point.
Situations where the shoulders don’t overlap are most common when the pattern unfolds at a steep angle. While a break of the trend line (if one exists) may trigger a change in trend, it does not fit the criteria to be called, or traded as, a head and shoulders pattern.
Notice how no part of the first shoulder in the illustration above overlaps the second shoulder. This disqualifies the price structure from being traded as a head and shoulders pattern.
Another common mistake among Forex traders is to use a measured objective as a “one-stop shop”. In other words, they simply measure out the distance in pips and then set a pending order to book profits at that level.
While that may occasionally work out in your favor, a much better approach is to determine whether or not that objective lines up with a pre-existing key level. If it does, perfect, however a more common scenario is one where the market will come in contact with a key level prior to reaching the objective.
If this is the case, you’re far better off taking profit at the key level rather than hoping for an extended move to the objective. Remember that technical analysis is not a perfect science and there are no guarantees, so there’s no sense to risk losing an unrealized gain of 500 pips in order to make an extra 50 pips in profit.
Last but not least, the head and shoulders is best traded on the 4-hour chart or higher. However, I have found that the best price structures tend to form on the daily time frame. A formation on the 1-hour chart or lower should always be ignored, regardless of how well-defined the structure may be.
2. The Wedge Chart Pattern
As the name implies, the wedge is a technical pattern in which price moves into a narrowing formation, also called a triangle.
Unlike the head and shoulders we just discussed, the wedge is most often viewed as a continuation pattern. This means that once broken, price tends to move in the direction of the preceding trend.
That said, it’s important not to get caught up in trying to predict a future direction while the pattern is still intact. Only once support or resistance is broken should you begin to identify possible targets.
Why I trade it
The wedge was one of the first Forex chart patterns I began trading shortly after I entered the market in 2007. By 2010, I had not only become proficient in trading them, but I had also developed the intuition necessary to identify the most profitable formations – something that can only be had after years of practice.
The really great wedge patterns don’t come around all that often. By “really great”, I’m referring to the ones that form on the daily chart. While you can trade these on the 4-hour time frame, in my experience the most lucrative trade setups form on the daily time frame.
Wedges tend to play out relatively quickly compared to something like the head and shoulders pattern. However, they also allow for an advantageous risk to reward ratio, especially the larger structures that form on the daily chart.
This combination allows you to secure a nice profit in a relatively short period of time. So although they don’t come around all that often, wedges should certainly be something that you watch for during extended periods of consolidation.
Staying out of trouble
There are three common mistakes I see traders making when it comes to trading the wedge.
The first and perhaps most prevalent is trying to force support and resistance levels to fit. In fact, this is a common issue I see across all of trading, not just wedges.
As I always say, if a level is not extremely obvious, it should be ignored. The three points in the illustration above are clearly not inline with the upper and lower levels of consolidation, which invalidates the formation in terms of “tradability”.
The second mistake I see among traders is attempting to trade a wedge on a lower time frame. While these formations may occur more often, they won’t be nearly as reliable or effective as the price structures that form on the daily time frame.
Last but not least is the issue of timing. As you may well know, timing is a key factor if you wish to succeed in the world of Forex. And when it comes to wedge patterns, timing is everything.
More often than not, when this pattern breaks, the market will retest the broken level as new support or resistance. This retest offers the perfect opportunity for an entry, however it does take patience to achieve.
Be careful of entering on the first closed candle outside of the pattern as you will likely get a retrace of some sort. This will not only give you a more favorable entry, but it will also help you avoid making an emotional decision about exiting the position in the event you entered prematurely.
3. The Bull and Bear Flag Patterns
The bull or bear flag is another name for a channel. However, by adding “bull” or “bear” to the designation, we’re giving it a directional bias. So as you might expect, it is most often traded as a continuation pattern.
Like the head and shoulders, flags often form after an extended move up or down and represent a period of consolidation. It’s essentially an indecision point in the market, where the bulls and bears are battling to see who will win control.
Why I trade it
I feel confident in saying that you could literally trade nothing but bull and bear flags and make very good money in the Forex market. This, of course, assumes that you have become a proficient price action trader.
Why do I think so?
There are a few reasons, but mostly due to the fact that these formations occur quite often. This is true even if you are trading the higher time frames.
Of course when I say “quite often”, I’m referring to a few times per month, at most. That said, you only need one profitable trade each month to make good money as a Forex trader.
If that one good trade comes in the form of a bullish or bearish flag pattern, it is likely to have an extremely favorable risk to reward ratio attached to it. This is another reason why I love having this price structure included in my trading plan.
The measured objective in this case often allows for several hundred pips on most currency pairs. Combine that with a precise entry and a well-placed stop loss that is 50 to 100 pips away, and you have a recipe for a profit potential of 3R or better just about every time.
Staying out of trouble
Like the other patterns above, there are a few things you should watch out for when trading this formation.
The first is perhaps the most obvious – never cut off the highs or lows in order to make the channel fit. If it isn’t obvious before you even draw the channel tool on your chart, it isn’t likely something you’ll want to trade.
The illustration below shows price action that you would want to ignore completely.
Notice how the two points above don’t match up with support and resistance.
Calculating the measured objective also tends to give traders fits. Just remember that the measurement should include the consolidating price action.
The correct measurement in the illustration above covers the entire “flag pole”, not just the price action leading up to the consolidation.
Using chart patterns to trade the Forex market isn’t for everyone. However, if you enjoy using raw price action to identify opportunities, the three formations above would make a great addition to your trading plan.
You don’t have to know and trade every price structure available in order to make consistent gains as a Forex trader. Doing so will only slow the learning process and also send you chasing trades in every which direction.
Becoming a successful trader is about finding an approach to the markets that fits your style, defining your trading plan and then refining those rules as you gain experience.
So if you enjoy trading technical patterns, as I do, be sure to give some consideration to the three we just covered; they truly are all you need to become consistently profitable.
Frequently Asked Questions
What are Forex chart patterns?
As the name implies, Forex chart patterns are formations that occur on a price chart. They develop due to psychological triggers as other traders tend to focus on similar patterns in the market.
What are the most profitable Forex patterns to trade?
The head and shoulders, channels (bull and bear flags), and wedges (rising and falling) are three of my favorite patterns.
What time frame is best to identify these patterns?
In my experience, the higher time frames such as the daily and weekly are the best to identify and trade chart patterns. The 4-hour can be advantageous as well, but the daily and weekly should come first, in my opinion.
Now It’s Your Turn…
Are you ready to start using the chart patterns above?
If so, you definitely want to download the free Forex chart patterns PDF that I just created.
It contains all three price structures you studied above and includes the characteristics I look for as well as entry rules and stop loss strategies.
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