How to Read Forex Chart Patterns
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Forex (an abbreviation of foreign exchange) relates to the process of purchasing and selling different currencies within the foreign exchange market. Forex is sometimes referred to as ‘the currency market’ or ‘FX’.
In the international forex market, investors, shareholders and retailers influence the relative value for converting one currency into another by acquiring and trading currency pairs. Successful forex traders benefit from the changes in value between different international currencies by choosing two currencies and predicting which will go up in value compared with the other.
Forex charts can be used to provide an illustration of a currency’s behaviour or performance over time. Traders often use forex charts to help them to gain a better understanding of past performance; this information is then used to help them make informed trading decisions in the future.
Since forex charts can signal uptrends and downtrends in currency performance, they can be a helpful resource when it comes to planning your next trading move.
If you want to get started with forex trading, you will soon come to realise the importance of tracking currency movements. One of the most effective ways to achieve this is by using forex charting software.
There are many different options available, so it's important to look for one that will suit your skill level and trading style.
One of the most popular forex trading software solutions is TradingView. This software offers a free basic solution which can be used to trade any market. It is cloud-based, so you can access it from any device.
TradingView is designed to meet the needs of new and experienced traders alike. There are plenty of customisation options to ensure it meets your needs and you can set up alerts to prompt you when your favourite currency pairs begin to move.
If you would prefer to use an ad-free service, there are three different paid-for options which offer a range of additional benefits.
Forex charts can help traders to recognise patterns, gain an understanding of how many traders are trading in a market and identify areas of support and resistance.
Choosing a timeframe is one of the most important aspects of reading forex charts. To toggle between timeframes, zoom in and out of the chart. Time is represented on the ‘x’ axis and exchange rate pricing on the ‘y’ axis. To view historical data, move to the left of the chart.
In simple terms, a downtrend can be identified by looking for a line that moves downwards from left to right, whereas an uptrend is depicted by a line moving upwards from left to right.
The three main charts used in forex trading are:
1. Line Charts
These are the most straightforward type of forex chart to read so they are a good starting point for new traders. However, they don’t give as much information as some of the other chart types.
A line chart is simply a line between one closing price to the next. It can give traders an overall feel for how a currency pair has performed during a specific timeframe.
2. Bar Charts (sometimes called OHLC (Open, High, Low, Close) Charts)
A bar forex chart gives traders a little more information than a line chart. They show closing prices but, at the same time, they also give low and high indications of opening prices.
Within each bar, the lowest part of the vertical line represents the lowest traded price for the specified currency pair during a certain timeframe. Similarly, the highest part of the line shows the highest traded price during the same timeframe.
Each of the vertical lines meets with two shorter horizontal lines. The one on the left-hand side shows the opening price for the chosen currency pair at a specific time; the one on the right-hand side shows the closing price for the currency pair at that time.
3. Candlestick Charts
The candlestick chart has Japanese origins and is probably the most useful of the three main chart types.
When reading a candlestick chart, it is important to understand the basic candle structure. Each candlestick represents a timeframe – this could be anything from one minute to an entire week.
Irrespective of the timeframe, a candlestick symbolises the following values:
- Opening price at the start of the chosen timeframe
- Closing price at the end of the chosen timeframe
- Peak price within the chosen timeframe
- Lowest price within the chosen timeframe
According to the opening and closing price, the candlestick can be used to decide whether a session finished ‘bearish’ or ‘bullish’:
- Bullish – The closing price was greater than the opening price
- Bearish – The closing price was less than the opening price
When reading forex charts, it is important to be aware of some of the most popular forex chart patterns and trends you might observe and what they might indicate in terms of future prices. These signals include reversal and continuation trends:
During a reversal trend formation, you might spot one or more of the following patterns:
Look out for an ‘M’ shape with two ‘tops’ or peaks. Typically forming during an uptrend, a double top is a very bearish pattern which forms when the price reaches a particular level more than once but doesn’t go above it.
After this level has been reached, the price tends to dip slightly before returning back up to the top level again. If it bounces back down again, this is known as a double top. After reaching the second top, it is likely that the price will dip again.
Look out for a ‘W’ shape with two low points. This bullish forex chart pattern is usually seen following a downtrend – the price will drop down to a new low, increase slightly and then dip back down to the lowest point. After reaching the second low point, it is likely that the price will increase again.
Head and Shoulders:
In this relatively unusual bearish pattern, you’ll see an initial peak (shoulder), a slight dip followed by an even higher peak (head), another slight dip and, finally, one further peak (shoulder). The lowest points of the two troughs can be connected to form a ‘neckline’. After the second peak, it is likely that the price will fall.
Inverse Head and Shoulders:
In contrast to the standard head and shoulders pattern, the inverse version is bullish. Look out for an initial dip, a slight increase followed by an even lower dip, another slight increase and finally a further dip that is not as low as the middle one. After the second dip, it is likely that the price will rise again.
Sometimes called the ascending wedge, this bearish pattern often forms during an uptrend and can signify either a reversal or continuation trend. Look out for the price consolidating between rising sloping support and resistance lines. If this pattern shows just after an uptrend it usually indicates a reversal pattern, so you can expect the price to start dropping again.
During a continuation trend formation, you might spot one of the following patterns:
If you spot this forex chart pattern after a downtrend, it’s likely that the price will continue to drop.
Just like the rising wedge, the falling wedge can indicate either a reversal or continuation trend. If it forms at the end of a downtrend, this bullish pattern indicates that an uptrend can be predicted. If it forms during an uptrend, the price can be expected to continue increasing.
Rectangle patterns appear when the support and resistance levels of the price are parallel. You’ll notice the price ‘testing’ both the support and resistance levels a few times before finally breaking out. A bearish rectangle appears when the price increases for a period during a downtrend. If you spot this pattern, you can expect that the price will continue to fall.
A bullish rectangle appears following an uptrend. If you spot this pattern, you can expect the price to continue going up.
Following a significant upward or downward move in price, there is usually a short pause before further movement in the same direction. As a result, the price tends to consolidate. In a forex chart, this can be identified by a small symmetrical triangle shape called a pennant.
Bearish pennants form during vertical, steep downturns. Following a sudden drop in price, some traders will choose to close their positions whereas others opt to join the trend, meaning that the price consolidates for a short time.
Once enough sellers have moved into the trade, the price drops below the bottom point of the pennant and it can be expected to continue moving down.
Bullish pennant patterns are the opposite of bearish ones, so they appear after a sharp increase in price. This uptrend can be expected to continue after a brief period of consolidation.
When a triangle pattern appears, it can be more difficult to predict what will happen next. There are three different types of triangle chart formation to look out for:
- Symmetrical triangle: In this pattern, the incline of the price’s highs and the decline of the price’s lows come together to create a pattern resembling a triangle. It’s impossible to predict which direction the market will eventually break out in.
- Ascending triangle: In this pattern, there is a clear point of resistance, but the lows can be observed as increasing.
- Descending triangle: This pattern is the opposite of an ascending triangle – there is a support level line which the price doesn’t seem to be able to break and a series of lower highs creates the upper line of the triangle.
For any new trader, forex charts are likely to seem overwhelming when you first start looking at them. One of the best things you can do is set aside some time to gain a good understanding of how the price and time axis can be used to help gather historical data and learn how this can be used to predict what might happen next.
Many trading platforms offer the option to open a demo account which will allow you to trade risk-free before putting any of your money at risk. This is a good way to boost your overall trading knowledge and give yourself time to become familiar with forex charts, interpret patterns and act upon any trends that you identify.
WikiJob does not provide tax, investment or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.