Forex and human fantasy
Being able to define the trend further direction is what every trader wants. One of the qualities singling out a Forex professional is the ability to interpret correctly signals produced by the price chart. It's for the sake of obtaining this quality that traders have developed the system of trend reversal patterns. Of course, they are just a fruit of human imagination. Since perception is subjective, not everyone can see one and the same figure in the same chart. Therefore, a question arises about whether or not we can trust trend reversal patterns when our own money is at stake.
Firstly, do not demand of the currency market what it can't provide you with. Forex is a living organism, a constantly changing system that requires constant adaptation. First and foremost, beginner traders need to realise and accept the fact, that risks are inherent in trading. Secondly, if the majority of market participants see trend reversal signs in these 6 patterns, the market situation can change in accordance with the expectations - that's how it works. Thirdly, traders always use several technical indicators to confirm their hypotheses. If you've noticed a trend reversal pattern, check it with a couple of other instruments. As they say, look before you leap!
Most popular trend reversal patterns
You have already understood that there are 6 most popular trend reversal patterns. They may be conventionally subdivided into 2 types: uptrend formation signals and downtrend formation signals. The first type includes "Inverse Head and Shoulders", "Double Bottom" and «Triple Bottom"; the second type includes "Head and Shoulders", "Double Top" and "Triple Top". The patterns included in the first group represent the patterns of the second group rotated 180 degrees, and vice versa. What do we need these patterns for? They warn us that a trend may reverse or a new trend may form in the shortest time, and they can even predict the range of upcoming price fluctuations. However, we should remember that it takes up some time for a pattern to be formed on the chart. It means, these patterns will be of no help to the traders using hourly or minute time-frames. But they may be quite useful on short-term or medium-term intraday time-frames.
Head and Shoulders pattern
Most readers will rather associate the "head and shoulders" name with the dandruff problem than financial markets. But this fact does not make this pattern less efficient.
As the saying goes, Head and Shoulders is a classic. Let's look at the chart, where we can see 3 extremums (price peaks.) The price fluctuation in the middle exceeds 2 side fluctuations and forms the "head" of the pattern. Two side extremums are the shoulders of the pattern. Look at the so-called neckline: it passes horizontally through 2 troughs of the middle wave ('"Head"). The price starts to fall sharply at the point where the neckline crosses the right shoulder. The price fall covers the same distance that separates the neckline from the top of the Head. Thus, we can define the best moment for closing a trade. Besides, there are 2 dotted lines on the chart. They allow us to predict to which extent the price will fall after the right shoulder has crossed the neckline. Remember that these breakouts must be always accompanied with an increase in volumes. That's why always check the volume histogram. The above-mentioned observations apply to the "Inverse Head and Shoulders" pattern the other way around.
Double Top pattern
The use of the "Double Top" pattern is also based on finding the neckline, but the search will be a little more difficult than in the previous example.
The neckline in the Double Top pattern passes only through 1 minimum. To draw it, we need to draw an auxiliary dotted line through the chart peaks (tops of the pattern.) Afterwards, we need to draw a parallel line through the minimum point - it's going to be the neckline. Another dotted line should be drawn below and oriented towards the neckline. The distance between the lower dotted line and the neckline must be equal to the distance between the neckline and the upper dotted line. All three lines must be parallel. When the price chart breaks out the neckline after the 2 tops, you will be able to make a forecast regarding the trend further movement. The price must fall to the level of the lower dotted line. The "Double bottom" pattern predicts an upward trend.
Triple Top pattern
Let's have a look at the "Triple Top" pattern using the example of the EUR/USD. We must say that the Triple Top pattern is very similar to the Head and Shoulders pattern due to its 3 extremums. There's still an important distinction: the middle extremum is not higher than 2 other tops and does not symbolize "the head", the 3 extremums are at the same level.
The Triple Top also points to an upcoming trend reversal. It should be used in the same way that other reversal patterns. First, we need to find the neckline. It passes through the troughs of the chart waves. The dotted lines are drawn in a peculiar manner here. The upper dotted line touches the price peaks, and the lower line is drawn symmetrically with respect to the neckline. Thus, the pattern predicts the extent to which the price will fall once the neckline is broken out. The "Triple Bottom" pattern is rotated 180 degrees and points to an upcoming price growth.
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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.