Pattern trading is the art of identifying recurring patterns within the charts of currency pairs. Learning and making use of these patterns can make an astronomical difference in a technical analyst’s analysis and help plot s/l’s, t/p’s, and entry’s.
In this article, I will cover a few of the most commonly occurring, useful and simple patterns in technical analysis as well as instructions on how to trade them.
3 things a pattern can indicate
* Continuation, this signifies the current trend will be continuing
* Reversal, when the pattern signifies a change in trend
* Bilateral, when the direction of the market can go either way.
Triangle patterns are the most commonly seen pattern in trading especially on short term charts, they can be symmetric, ascending or descending. They are also the easiest pattern to identify and once a trader is accustomed to them, the trader will see them often.
In figure 1 we see a descending triangle pattern indicating a reversal, I could easily identify this pattern using Dukascopy’s ‘’pattern analysis widget’’.
Fig 1. Descending triangle pattern on EUR/USD 5-minute chart.
Once we have identified the descending triangle pattern we can use it to determine our s/l, our t/p and our entry point. See figure 2.
Fig 2. Descending triangle pattern on EUR/USD 5-minute chart, with S/L T/P and entry point indicated.
The s/l is the top of the triangle, the entry is where the pattern is breached and the t/p is the entry minus the height of the triangle, which in this case is 36.3 Pips. Vice versa if this was an ascending triangle pattern the t/p would be the entry plus the height of the triangle and the s/l would be the bottom of the triangle.Channels
Channel patterns are about as common as triangle patterns. Just like triangles they can be ascending or descending, but they can also be horizontal for a trendless market.
Fig 3. Ascending channel on EUR/USD 5-minute chart.
The bottom line of an ascending channel is a ‘’buy zone’’ while the top line is a ‘’sell zone’’. I personally use CCI and Stochastic indicators to confirm overbought or oversold conditions, much like a Bollinger Band reversal strategy only using a channel instead of Bollinger Bands.
Fig 4. Channel on EUR/USD 5-minute chart, with buy/sell indications circled.
As we can see in figure 4 the reversal strategy is just as effective with a channel as it with Bollinger Bands. The black circles highlight buy/sell points that line up on all 3 indicators, while the red circles highlight where the CCI/Stoch was not below the -100 line at the time of the candle approaching the buy zone and thus indicating the end of the channel.Engulfing Pattern
Once a trader gets accustomed with these patterns they all become easy to spot, however right from the start the easiest to identify is the engulfing candlestick pattern. Engulfing patterns come in bullish and bearish forms and they signify a strong and immediate reversal because the previous candle has already been reversed.
Fig 5. A bearish engulfing pattern indicating a reversal on the EUR/USD 5-minute chart.
This pattern also gives us our s/l, which would be the top of the previous candle, however the t/p is not defined with this, I would use a trailing stop or simply keep a strong eye on this trade.
Head and Shoulders pattern (H&S)
The H&S pattern usually signifies a reversal. A H&S pattern that would signify a bullish reversal would consist of a price low, followed by retracement, a lower price low, retracement and then a higher low then a ‘’neckline’’/trendline that connects the two highs, thus forming the head and shoulders and vice versa for a bullish reversal.
Fig 6. A H&S pattern on the EUR/USD 5-minute chart signifying a bullish reversal.
Using the H&S pattern, much like the triangle pattern, we can accurately plot our entry, s/l and t/p. The entry is where the neckline is broken, the s/l can be placed below the right shoulder, or below the head, the t/p is calculated the same as the triangle pattern, we take the height of the pattern in pips (from head to neckline) and add it to the breakout point. In this case, the height was 12.8 pips and the entry point was 1.08517, so we place our t/p at 1.0864.5. Conclusion
In this article, we have covered some basic trading patterns and how to use them, we also coupled channel patterns with a reversal strategy which proved effective. Patterns are valuable tools in Technical Analysis, they provide entry’s, s/l’s and t/p’s right off the bat and can be used on their own or in conjunction with other indicators. They are easy to learn and Dukascopy has brilliant tools for utilising them quickly and easy.
However, there are many more complex patterns out there and even indicators that collect pattern data, this was very much a beginner’s introduction, but if you would like to know more feel free to comment and simply ask for more in future articles.