Price patterns project the future path of exchange rates. The patterns do so by observing the past price action of a pair and projecting the collective intentions of traders in the future.
Price patterns appear across all actively traded markets such as stocks, bonds, and commodities. Price patterns are especially prevalent in the forex market because it's so very liquid. In fact, one of the requirements of using price patterns is ample liquidity. Fortunately, the forex market is the most liquid in the world, making it the best market in which to apply price patterns.
The current sentiment of the market and the balance between buyers and sellers is all revealed by price patterns. Sometimes there is no existence of price patterns across currency pairs. Other times price patterns appear across most pairs.
Price patterns occur and are applicable in all timeframes, from intraday to yearly timeframes. The beauty of price patterns is that they are recurring. Best of all, there are only a handful of patterns to learn.
There are two categories of price patterns: continuation and reversal. There are mirror image patterns in these two categories.
Continuation patterns project the continuation of an existing trend. It's important to quantify trend when looking for continuation patterns. You can quantify a trend by using a moving average, a combination of moving averages, or simply looking at a pre-defined period of time in an exchange rate such as one month, six months, or one year. For example, you can conclude that a currency pair is in an upward trend if it is higher now than it was six months ago. Or, you can conclude that a currency pair is in a downward trend if it is lower now than it was one year ago.
Patterns emerge as trends unfold and continue in the prevailing direction. These patterns reveal increasing levels of demand for or supply of a currency. The patterns point to a continuation of the trend, offer price targets, and even suggest the time horizon in which the price target might be achieved. The four continuation patterns are: flags, pennants, triangles, and wedges. They occur in both bullish and bearish trends.
Reversal patterns predict the reversal of an existing trend and the beginning of a new trend in the opposite direction. Nevertheless, reversal patterns go against the grain of an existing trend. That makes reversal patterns a little more nuanced and delicate in application. It's incredibly important to carefully measure and manage your risk when trading reversal patterns.
Reversal patterns emerge as existing trends grow old, when the fundamental drivers of the trends have run their course. These patterns reveal equaling levels of demand for or supply of a currency. The patterns point to an end to one trend and the beginning of an opposite trend. The reversal patterns provide entry points, offer price targets, and even suggest the time horizon in which the price target might be achieved.
In addition to forecasting the direction of a currency pair, price patterns provide context to your trading. The price patterns offer targets, both in time and price. These objectives are extremely useful in helping you weigh the risk against the potential reward, and for setting time horizons.
Identifying continuation and reversal patterns in currency pairs will help you to organize price action into actionable categories. The price patterns repeat across all pairs and in all timeframes. Whether you're a very short-term day trader or long-term trend follower, you can use price patterns to gain an edge when trading the forex market.
The price patterns themselves are actionable. In fact, you can devise trading rules around price patterns such as entry points, exit points from profitable trades, and stop loss levels. Price patterns are even more effective, however, when combined with other forms of analysis such technical indicators or fundamental analysis.