Lessons - Text + Video 8
Western Chart Patterns (Free Lesson)
The western chart patterns are a form of technical analysis that is performed through careful inspection of price data on a chart for identification of well-known patterns that emerge and re-emerge in the market. The patterns are named after the shapes they make, some of these common patterns are Triangle Pattern and Flag Patterns, which will be explained in this lesson. Each pattern has its own interpretation and a specific signal that can be used for trading. The chart patterns are not like the mathematical indicator tools but more of the psychological phenomena that occur between the buyers and the sellers in the market. The pattern formations do not form a trading system but rather indicate the future trend of the currency pairs as the price breaks psychological barriers in the form of support and resistance lines.
So what are the indications that chart patterns provide? Basically, they tell us about a market reaction, now whether the reaction will be upwards or downwards, that will depend on the type of chart pattern and the direction of a breakout or a reversal that takes place.
To begin with, let’s start with the triangle patterns.
Symmetrical Triangle Pattern
In a symmetrical triangle, the upper and the lower channels are in an equal proportion or equal angles. Both trend lines in the symmetrical formation can act as support and resistance and a breakout can take place in either direction. What actually happens is that the price patterns get narrow and both the angled trend lines come closer and closer to the current price indicating that a breakout is likely to take place. Finally, when the breakout takes place, the traders place their trades according to the direction of the breakout.
Ascending Triangle Pattern
In an ascending triangle pattern, one of the twos lines is horizontal and the other line is angled which comes up on the first line in the opposite direction. The ascending triangle patterns are usually more relevant in the trending market because the lower line in the triangle acts as support. So when in the up-trending market, when the price comes down, then the buyers push the price back up again. In another scenario, if the price breaks below the support line, traders could interpret that as a trend reversal. Conversely, when the price breaks the upper angled trend line, traders could interpret that as a breakout and place their trades accordingly.
Descending Triangle Pattern
In a descending triangle, the upper trend line is horizontal and the lower line is angled in a way that it comes down to the opposite of the upper horizontal line. This price pattern is more relevant in a downwards market. The upper horizontal line acts as the resistance line and whenever the price rallies back up, the bears pull price back down towards the angled trend line, symbolising that the downtrend is intact. But if price does go beyond these parameters, that is if it breaks the upper resistance line, it can be interpreted as a reversal or when it breaks the lower line it can be seen as a breakout in the direction of the downtrend and traders place their trades accordingly.
To understand the signal given by the triangle patterns, let’s take an example of the AUD/USD chart below. In the chart, a symmetrical triangle pattern is formed. The price moved within the triangle for some time and attempted to break above or below the triangle several times. However, at 0.6140 towards the end of the triangle, the long bearish (red) candlestick closed below the lower trend line of the triangle by quite a lot, confirming a bearish breakout. Following the breakout, the market further fell towards 0.5980 and continues to make lower highs and lower lows, confirming a downtrend.
Flag patterns are continuation patterns. In these patterns, the price briefly pauses or in other words goes into a sideways period before resuming the actual direction of the trend. Flag patterns are distinguished and easily recognizable, in these patterns you have a vertical movement followed by a sideways movement with a slope against the on-going trend. The vertical movement is called the pole while the sideways movement is called the flag.
Flag patterns are found in both bullish and bearish markets, in a bullish market, a long upwards movement is the pole, while the sideways movement is the flag on the pole. Conversely, in the bearish market, the flag is on the bottom of the pole, and the pole is represented by a long downwards movement. In both the case they indicate the continuity of the original trend.
To understand the flag patterns, let’s have a look at the below GBP/USD chart. The pair was falling and a strong downwards moment had happened that led to the formation of a pole, soon after the big move, the pair started a sideways movement that formed a flag at the bottom of the pole, confirming the bearish flag pattern. Following the pattern, the price broke out and resumed the ongoing downtrend.