To be a price action trader means having a deep understanding of the various different price action patterns that form in the market. The problem with these patterns, is that because there are so many of them that form in the market, knowing which ones you should take the time out to learn and which you should leave can be quite challenging. To solve this problem, I thought that today I would give you a list of what I believe to be the most important price action patterns you need to learn as a Forex trader.
As some of you reading this will probably already know, there are three basic types of pattern that can form in the market:
- Price Action Reversal Patterns
- Price Action Continuation Patterns
- Price Action Candlestick Pattern
I’ll begin today’s article by first showing you what the most important price action reversal patterns are, followed by which continuation patterns you need to have knowledge on. Finally I’ll show you the two most important price action candlestick patterns you need to watch out for in the market.
I’ve also reformatted this article of important price action patterns into a PDF document, so if you would like to download it and read it at a later date you have the possibility to do so.
Price Action Reversal Patterns
- The Head And Shoulders Pattern
- The Double Bottom And Double Top Pattern
- The Rising And Falling Wedge Pattern
Reversal patterns are probably the most important set of price action patterns you need to really have a deep understanding of, as they can give you early clues about if a movement in the market is coming to an end. The six patterns I’m going to be showing you in this section are all multi-swing shape patterns, which means that each one of the patterns forms from more than one upswing and downswing taking place in the market, and they all look similar to common shapes upon their completion.
The Head And Shoulders Pattern
The first price action reversal pattern we’re going to look at is the head and shoulders pattern. Without doubt one of the most popular and well known price action patterns in the market, the head and shoulders formation is one which all price action traders need to memorize and understand if they want to become good at spotting reversals using price action. As you’ve probably already guessed, the head and shoulders pattern is a reversal pattern which has a swing structure very similar to that of person’s head and shoulders.
Here’s an image of a bearish head and shoulders pattern which formed on the 1hour chart of EUR/USD.
You can see from the image the structure of the pattern does bear a striking resemblance to somebody standing up with their head straight and their shoulders level with one another. Most head and shoulders patterns are supposed to look like the one you can see in the image above, but a large percentage of them will actually have features which are a little different from one another. For example, you might see a pattern form with one of the shoulders being a little bit higher than the other, or the distance of two shoulders from the head will be smaller or bigger than what you can see in the pattern above.
These small differences do not alter the pattern in any meaningful way. So long as the head is always found in the middle and the two shoulders are found to be either side, it’s a head and shoulder pattern. If the high of the right shoulder is found to be below the swing low of the move up which created the head, then it’s not a head and shoulders pattern and should not be treated as such.
The pattern itself comes in two variations. The one we just looked at in the image above is referred to as being a bearish head and shoulders pattern, which is a signal the market may reverse to the downside, whilst the one seen in the image below is a bullish head and shoulders pattern, but is often refereed to as being an inverse head and shoulders pattern due to the way the pattern is basically an upside down version of the bearish pattern.
Here’s what an inverted head and shoulders pattern looks like on a chart.
You can see that all the features of the pattern are the same as the bearish version, only the opposite way around. Instead of the head pointing upwards like it does with the bearish pattern it points down, as do the left and right shoulders. The only real difference between the two patterns is in what needs to happen in order for the pattern to become invalidated. With the bullish head and shoulders pattern if the right shoulder forms below the swing low of the move up which created the head, the pattern is not a head and shoulders and is instead some other formation. The bearish head and shoulders follows the same rule, only the right shoulder cannot form above the swing high of the move down which created the head, if it does it’s not a bearish head and shoulders pattern.
All in all the head and shoulders formation is usually quite a reliable signal the current movement is going to reverse. If you want to learn the best way to trade the head and shoulders pattern and get a more in-depth look at the way it should form on your charts, check out the article I’ve left below.
The Double Bottom And Double Top Patterns
The double bottom and double top formations are another couple of really important reversal patterns you need to be aware of forming in the market. They’re two patterns which get their name from the way the market will make two downswings with swing lows at similar prices to one another before reversing, (in the case of the double bottom pattern) or two upswings with swing highs forming at similar prices to one another before reversing, in the case of the double top pattern.
The image above shows an example of a double bottom pattern which formed on the 1hour chart of USD/JPY.
You can see the first part of the pattern forms after the market makes a downswing followed by an up-swing. The swing low that forms at the bottom of the swing higher is one of the two bottoms that forms during the pattern. The next swing low and bottom will always end up forming at a similar point to where this first swing low has formed, and the overall swing structure will usually resemble that of the letter W once the pattern has fully formed.
In this image we are looking at an example of the double top pattern.
The double top is of course the opposite to the double bottom, which means that it’s formation involves two upswings taking place with swing highs forming at similar prices to one another instead of two swing lows. Both patterns become invalidated if the second top or bottom in each respective pattern forms at a price which is far away from the price at which the first top or bottom has formed at. There isn’t any exact guidelines on how far away this should be, but I’d say that if you see two or three large candlesticks close below the first bottom or above the first top, then it’s probably not a double bottom or double top pattern.
Overall the double bottom and double top patterns are two decent reversal formations, although they can be quite difficult patterns to trade effectively, due to the way the swing seen after the second bottom or top has formed can easily turn into a retracement or consolidation soon after you would have entered a trade.
The Rising And Falling Wedge Pattern
The final two price action reversal patterns we’re going to look at, are the rising wedge and the falling wedge. The rising and falling wedges are two patterns which get their name from the way the market sometimes contracts before the end of an up-move or down-move. The contraction of the swings is what creates the wedge and gives the patterns their name.
Here’s an image of a large rising wedge pattern which occurred on the daily chart of EUR/USD.
You can see that at the beginning of the wedge the distance between the market hitting the upper wedge line and lower wedge line is quite large. As the pattern progresses though, the distance between the two lines becomes smaller and smaller until eventually the two lines are really close to one another, almost as if they were about to form the tip on an arrow head.
In this image we’re looking at an example of a falling wedge pattern.
The falling wedge is the bullish version of the wedge pattern and is always a signal the market may be about to reverse to the upside. It forms in much the same way as the rising wedge pattern, with the only difference being that the swings contract to the downside rather than the upside like they do during the formation of the rising wedge.
In closing, the rising and falling wedges are two patterns which are important for you to be able to recognize 0n a chart, but are not patterns which you should use to look for entries into trades, due to the way many false signals will appear as the swings contract and the pattern nears completion.
