November 28, 2020
Forex Price Action Patterns Every Trader Should Know
cropped chart patterns 1

Forex Price Action Patterns Every Trader Should Know

In this tutorial, we will discuss the most important Forex price action patterns, also called chart patterns, both names are equal. Although I find the price action patterns name more meaningful.

First we will introduce the main classic chart patterns, then the Fibonacci based chart patterns. Because we already discussed the most important continuation and reversal candlestick patterns earlier, we will not cover them again here.

Note: If you already read the Forex technical analysis tutorial, you can skip this tutorial as it has similar content.

Introduction to Price Action Patterns

While trending, the price usually creates chart patterns. This is simply why they are called price action patterns. The patterns can provide indications whether the trend will continue or reverse.

A price action pattern or formation is simply a configuration of the price action. Many of these configurations can be bounded by trend lines. 

For example, the triangle pattern in the chart below is bounded by two opposing trend lines. The falling trend line is constructed by connecting the swing highs and the rising trend line by connecting the swing lows.

triangle

Remember: All Forex price action patterns must be a preceded by either an advance or decline. I.e. if the triangle pattern shown above was not preceded by a directional trend, that would suggest it’s not a valid pattern.

 price action pattern- entry and exit

The entry to the pattern from the preceding trend is called the “Entry” of the pattern. All patterns have entries and exits. The entry is the direction before the pattern and the exit the direction of the breakout of the pattern.

Note:  We will be using the terms support and resistance, upper and lower bound, and upward and downward trend lines interchangeably in this section. So don’t be confused, they all have the same meaning.

 price action pattern - invalid pattern

Classic Forex Price Action Patterns

Double Top and Double Bottom

The simplest of the price action patterns are the double top and bottom patterns.

double top and double bottom - forex price action pattern

The double top pattern consists of two peaks separated by a trough. Both peaks must happen roughly near the same price (less than 5% percent difference).

The double top pattern must be preceded by an advance or an uptrend. Otherwise it is not a double top, it is just a sideways market.

The pattern completes on a breakout below the middle trough.  And suggest a trend reversal or at least a deep retracement of the prior trend.

A downside potential target of the breakout is identified by measuring the distance from the highest peak to the trough between the two peaks. Then projecting this distance from the point of breakout (This is called the Measured Rule). A safer target would be 75% of the this distance.

double top example

The double bottom pattern is the exact opposite of the double top.

double bottom example

Triple Top and Bottom

Triple top is like a double top, but it consists of three peaks instead of two. And two troughs instead of one.

triple top and triple bottom

Like the double top, the triple top peaks must be within the same price range with a maximum of 5 percent difference.

The pattern completes on a break below the trend line that connects the first trough with the second trough. And suggests a trend reversal or at least a deep retracement of the prior trend.

The downside potential target of the breakout is identified by projecting the the distance from the highest peak to the trough from the point of breakout.

Chart examples:

triple top example
triple bottom example

Rectangle

A Rectangle is simply a sideways movement that consists of multiple peaks and throughs, that is contained above a horizontal support and below a horizontal resistance. Each peak must touch the resistance level at least twice and each trough must touch the support twice.

In other words, connecting the swing highs we will get a horizontal line and connecting the swing lows we will get a horizontal line. Both lines are parallel.

Unlike double and triple top/bottom patterns, the price may fail to reach the resistance or support area, it may fail short ahead of it. And this might be an indication of the direction of the eventual breakout. 

rectangle pattern - forex price action pattern

The target of a breakout of a rectangle whether up or down, is identified by measuring the distance between the resistance and support lines, then projecting this distance from the point of breakout.

Remember: The rectangle can be a reversal or a continuation pattern depending on the direction of the entry (prior trend) and the exit(breakout).

i.e. if the price was in an uptrend then paused and formed a rectangle formation, then a breakout completed to the upside, that would suggest the continuation of the uptrend.

Oppositely, if a downside breakout of the rectangle occurs, that suggests the uptrend might be reversing.

Charts example:

rectangle example

Triangles

The rectangle pattern is bound by two parallel trend lines forming a rectangle shape. What if the trend lines are not parallel?

Symmetrical Triangle

If the result of connecting the swing highs is a downward sloping trend line. And the result of connecting the lows is an upward sloping trend line. The formation constructed will be a symmetrical triangle.

symmetrical triangle

The triangle’s upper bound is a downward slopping trend line, and the lower bound is upward sloping trend line. The two trend lines are opposing.

Both trend lines must have the similar (or close) angle. The price must touch each trend line at least twice and the area within the triangle must be covered with the price action.

Remember: The point where the two trend lines meet is called the apex. The price must breakout before reaching the apex. Otherwise, the triangle will be no longer valid. The optimal breakout area is within the last quarter of the triangle.

symmetrical triangle apex

The target for the triangle is identified by measuring the distance between the first trough and the first peak of the triangle, then projected from the breakout point.

Chart example:

symmetrical triangle example

The triangle can be a reversal or a continuation pattern, depending on the direction of the entry(prior trend) and the exit(breakout).

Ascending and Descending Triangles

The ascending triangle consists of a horizontal trend line resistance and an upward sloping trend line support.

For all triangles, the price must breakout before reaching the apex. Otherwise, the triangle is no longer valid. The optimal breakout area is within the last quarter of the triangle.

ascending triangle

The target for the triangle is identified by measuring the distance between the first trough and the first peak of the triangle, then projected from the breakout point.

ascending triangle example

The ascending triangle is mostly a bullish continuation pattern. But it can be a reversal or a continuation pattern depending on the direction of the entry(prior trend) and the exit(breakout).

The descending triangle consists of a horizontal trend line support and a downward sloping trend line.

The point where the two trend lines meet is called the apex. The price must breakout before reaching the apex. Otherwise, the triangle is no longer valid. The optimal breakout area is within the last quarter of the triangle.

descending triangle

The target for the triangle is identified by measuring the distance between the first trough and the first peak of the triangle, then projected from the breakout point.

descending triangle example - forex price action patterns

The descending triangle is mostly a bearish continuation pattern. But it can be a reversal or a continuation pattern depending on the direction of the entry (prior trend) and the exit(breakout).

Flag and Pennant

A flag pattern is very similar to a channel, but it has a smaller size and it forms in short period of time. Also, the pennant is similar to a symmetrical triangle, but smaller in size and shorter in time. Both patterns are continuation patterns.

Both patterns are small corrective moves within a strong trend.

Both patterns can be bullish or bearish. Bullish flag and pennant form in the context of an uptrend. While bearish flag and pennant form in the context of a down trend.

bullish and bearish flags

Remember: Usually, trends pause for corrections that take the shape of flag or pennant. If you spot one, expect the price to resume the trend after a breakout of the flag or pennant.

bullish and bearish pennants

The target of the breakout is identified by measuring the distance between the the start of the wave preceded the pattern to the first high of the pattern. Then, projecting this distance from the breakout point.

Wedges

A wedge is a form of a triangle pattern, where the two-trend line are heading in the same direction but with different slopes.

Remember: A breakout of the all wedge formations usually signals a trend reversal or at least a deep correction.

Wedges come in several shapes, here are the main wedge patterns.

Rising Wedge

The rising wedge forms when both trend lines are upwards, and the lower bound trend line is steeper the upper bound trend line.

rising wedge

The breakout in rising wedge usually occurs to the downside but sometimes the price can break to the upside.

A break out of a rising wedge to the upside is a signal of unhealthy acceleration of the uptrend.

rising wedge example

Falling Wedge

In a falling wedge, both trend lines are downward. And the upper bound trend line is steeper the upper lower bound trend line.

falling wedge

The breakout in falling wedge is usually to the upside, but in some occasions it breaks to the downside.

falling wedge example

Rising Broadening Wedges

A rising broadening wedge has two trend line pointing upwards. The lower bound trend line has a smaller slope than the upper bound trend line.

The breakout in rising broadening wedge usually occurs to the downside but sometimes the price can break to the upside.

rising broadening wedge example

Falling Broadening Wedges

A falling broadening wedge has the two trend lines point downward. The lower bound trend line has a larger slope than the upper bound trend line.

The breakout in falling broadening wedge is usually to the upside, but sometimes it breaks to the downside.

falling broadening wedge

There is no specific rule for measuring targets for wedges patterns.  Other technical analysis techniques should be used to forecast price target.

Head and Shoulders Patterns

The pattern is considered a reversal pattern, it can be bullish reversal (head and shoulders top) or bearish reversal (head and shoulders bottom).

Head and shoulder top pattern consists of three swing highs. The middle(second) high is higher than the first one, and the third high is lower than the second one and near the price of the first peak.

The first and third peaks are called shoulders, while the middle peak is the head.

head and shoulders top and bottom - price action pattern

The pattern completes when the price breakout of the trend line that connects the swing lows between the peaks. This line is called the neckline of the pattern.

Remember: The neckline can be horizontal, upward or downward sloping.

The target of the pattern is measured by projecting the distance between the neckline and the head of the pattern, from the point of breakout of the neckline.

head and shoulders top example

A head and shoulders bottom is a bullish reversal pattern. It is the exact opposite of head and shoulders top.

head and shoulders bottom example

In both top and bottom head and shoulder patterns, if the pattern has a symmetry in both side of the head, the pattern is considered more reliable.

Head and shoulders pattern symmetry

There is a variation of the head and shoulders patterns, where more than two shoulders are formed. This is called a complex head and shoulders pattern. It has the same implications of the normal head and shoulders pattern.

complex head and shoulders bottom

Cup and Handle Top and Bottom

A cup and handle pattern is rounding patterns that is formed when the price reverses direction gradually and in a slow manner. The reversal forms a curve like shape. The price then enters a small and short pullback, before resuming the upward reversal.

cup and handle pattern

The high of the retracement is called a lip. The lip is the key breakout level to watch. As the pattern is confirmed when the price breaks back above the lip.

cup and handle pattern example - forex price action pattern

Target of the pattern is identified by measuring the distance between the lowest low in the pattern towards the lip level. Then projected from the breakout level (lip level).

Fibonacci Based Forex Price Action Patterns

There several Fibonacci based patterns. However, according to my personal experience their reliability is minimal. Only two patterns have passed my reliability requirement. The ABCD and the Three-Drive patterns.

If you are not familiar with Fibonacci levels, please review the Fibonacci retracements and extensions.

The ABCD Pattern

The ABCD is a three wave pattern. Two main waves and one corrective wave.

The ABCD pattern can be bearish ABCD or Bullish ABCD.

ABCD pattern -price action pattern

The bearish ABCD consists of an up wave AB followed by an down correction BC, and finally a upward wave CD that extends above the high of AB wave(point B). When the price reaches point D traders look to sell the price as it is expected to reverse to the downside.

In a bearish ABCD

  • The correction wave BC must end at the 61.8% or 78.6% of AB.
  • Then CD should end at the 127.1% or 161.8% extensions of BC.
  • A reversal to the downside or a pullback should start at one of these these extension levels 127.1-161.8. And this is called the potential reversal zone of the pattern.
ABCD pattern
  • Ideally, if BC ends at 61.5% then expect the potential reversal zone to be at 161.8% of BC.
  • If BC ends at 78.6%, then expect the potential reversal zone to be at 127.1% extension level.
  • The ideal case is not necessarily needed in my personal experience.
ABCD pattern
68.1% – 168.1% ABCD
ABCD pattern
78.6% – 127.1% ABCD

Remember: Never count on ABCD patterns solely. Use other technical analysis tools to confirm a reversal.

– A bullish ABCD pattern is more effective if it forms within the context of an overall bullish trend. The opposite is true for Bearish ABCD within an overall downtrend.

– If a bullish ABCD pattern forms in a downtrend, the result is usually a correction not a major reversal. The opposite is true for bearish ABCD in a an uptrend.

Chart examples:

This is an ideal bearish ABCD with BC retracing 61.8 percent of AB, then CD extending to 161.8.

ABCD pattern example

The is an example of bullish ABCD with BC retracing 78.6 percent of AB, then CD extending to 127.1 percent.

ABCD pattern example

This one is a non-ideal ABCD, where the BC corrects 61.8% of AB, and the price extends only to 127.1 to reverse direction. Therefore, do not assume that the price will always reach 161% level. Keep your eye on the 127 level for signs of bearish reversal.

ABCD pattern example

The following chart is a an example of two bearish ABCD patterns that formed within the context of the longer term trend. Two ABCD patterns formed within the context of a longer term bearish trend had a powerful bearish outcome.

ABCD pattern examples

Note: Talking about retracement and extension levels, don’t be too precise with numbers. i.e. if the price reaches near a retracement or extension level, but fails to touch it with few pips difference. That should not invalidate the pattern.

This note is valid only on time horizons above the one-hour chart. If you are trading very short term time intervals , few pips should count.

The Three-Drive Pattern

The three-drive pattern is on of my personal favorite price action patterns.

It is a 5-wave pattern. Three main waves and two corrections.

The three-drive pattern is very similar to the ABCD. The only difference is that there is a third main wave that extends above point D.

three drive pattern - price action pattern

Same rules of ABCD apply to the three drives pattern. Expect reversal at point F.

Point F should be either the 127.1% or the 161.8% extension of DE corrective wave.

Don’t give too much weight to whether the pattern complies with the ideal case. The most important factors are:

  • Corrections should stop NEAR either 68.1% or 78.6% levels of the prior main wave.
  • Extension should stop at either the 127.1% or 161.8% of latest corrective wave.

Here is an chart example:

three drives pattern example

What do you think? According to the ideal rules, the price reversal should happen at the 161.8% extension. Because the latest correction(DE) was stopped at the 61.8% level.

Fast forwards, here is the answer:

three drive pattern example 2

The reversal happened at the 127.1. If you waited for the price to reach the 161.8 level you would have missed the trade.

Some more chart examples of the three drives pattern:

three drive pattern example 3

Conclusion

To see some examples of real-life applications of these price patterns, you can check my Forex trend following strategy and how to spot a trend reversal in Forex.

The above price action patterns are of the most popular and reliable. However, there are dozens of other chart patterns, which I personally do not use. If you are interested in knowing more, Bulkowski’s has written a complete encyclopedia of chart patterns book, as he tested these patterns on thousands of charts. You can review the patterns and their reliability index.

Remember, it’s always necessary to use other technical analysis tools in conjunction with these patterns to increase your trade probability of success.

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