3 Main Groups of Chart Patterns | LiteFinance (2024)

Trading based on price patterns can boost profits when done right. This guide explores the three major groups of chart patterns — reversals, continuations, and bilateral formations – and explains how to identify and use them properly. Whether you spot a head-and-shoulders-top reversal, ascending triangle breakout, or rectangular trading range, knowing pattern psychology is crucial to timing trades correctly.

From projecting targets to managing risk, we’ll cover all the essentials you need to take your technical analysis to the next level. By the end, you’ll have expert knowledge to capitalize on these high-probability chart signals as you navigate the forex markets.

Reversal Chart Patterns

Reversal chart patterns signal a potential change or reversal in the prevailing trend. If a reversal pattern emerges during an uptrend, it hints that upside momentum is waning and the existing rally may soon end. The price is likely to turn down after pattern completion. Conversely, reversal patterns forming in downtrends suggest bullish sentiment is building, and an upside bounce could occur.

There are many types of reputable reversal patterns, like

• double tops;

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• double bottoms;

• head and shoulders;

• inverse head and shoulders.

These signals see upside or downside exhaustion. As buyers/sellers temporarily run out of steam, the price consolidates into these formations before reversing.

To trade reversal chart patterns:

1. Enter orders toward the expected trend change beyond the neckline or pattern breakout point.

2. Set potential profit targets based on the pattern's height projected from the breakout level.

3. Place stop losses at the other end of the formation to control downside risk.

For example, with a double bottom, go long on a break above the neckline for a target equal to the height from the bottom to the neckline.

Continuation Chart Patterns

Continuation patterns are formations that signal an ongoing trend is likely to resume after a period of sideways consolidation. These patterns emerge mid-trend as a pause or pullback before the prior up or downtrend continues.

Classic continuation chart patterns include

• symmetrical triangles;

• flags and pennants.

The triangle forms when the price oscillates between two converging trendlines. Flags and pennants take on a downward-sloping channel shape for uptrends or upward-sloping in downtrends. These patterns indicate the current directional momentum is taking a breather. However, the original trend often continues once the symmetrical triangle, flag, or pennant is completed. The theory is that consolidation builds energy for the next impulsive wave.

To trade continuation signals:

1. Wait for a breakout in the direction of the previous trend and enter a retest of the pattern breakout level for confirmation.

2. Set a profit target based on the height of the chart pattern projected upwards or downwards from the breakout point.

3. Consider placing a protective stop loss on the other side of the formation.

Bilateral Chart Patterns

Bilateral chart patterns signal that a price breakout could occur upwards or downwards. These patterns consolidate within a range or channel, offering clues of a potential move but no clear direction bias.

Bilateral formations include rectangles and triangle patterns like symmetrical triangles. As these patterns evolve, the price bounces between parallel or converging support and resistance lines.

Eventually, the price must "choose a direction" and break out of the formation. However, it needs to be clarified whether the break will be bullish or bearish.

To trade bilateral signals, consider placing pending buy and sell orders above and below the chart pattern boundaries to catch either scenario. Just allow some space so you don't get faked out by false breaks. Alternatively, wait for the actual breakout and trade the retest in the same direction.

Mastering the identification of any of the chart patterns can lead to profitable turnaround plays. Remember to use stop losses and look for volume confirmation before trading any formation.

Conclusion

Knowing how to trade chart patterns can lead to more profitable technical analysis. Identifying and interpreting the three main groups of reversal, continuation, and bilateral formations provides savvy traders an edge. Combining chart pattern analysis with volume and momentum indicators lets you pinpoint high-probability setups. Whether trading breakouts, pullbacks, or ongoing trend reversals, utilizing formations like head and shoulders, triangles, and double tops/bottoms offers a strategic market timing tool.

Mastering chart patterns delivers a reliable method to enhance entries, exits, and risk management across any instrument or timeframe. However, remember to remain patient for confirmation signals and always employ appropriate stop losses when trading.

The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. 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.