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In general, useful chart patterns tend to fall into the basic categories of continuation and consolidation patterns and reversal patterns. The classification of a chart pattern depends on how the subsequent forex rate action usually proceeds once the pattern completes itself.
Triangles present something of an exception because they can break out in either direction, and so can be either continuation or reversal patterns. These categories and some of the useful chart patterns within them are described further below:
Continuation and Consolidation Patterns
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Triangles – These patterns come in symmetrical, ascending and descending types. The market typically trades in a gradually narrower range between converging trend lines before breaking out on increased volume and continuing in that direction.
Although certainly a consolidation pattern, as noted earlier, a triangle can be either a continuation or a reversal pattern, depending on which side its breakout occurs on. Triangles generally consist of five increasingly smaller internal movements, and they must break out before reaching their apex. A breakout sets up measuring objective equal to the width between the converging trend lines that define the pattern at the initial high or low.
- Flags - Preceded by a sharp move, often called the “flag-pole”, the market consolidates between parallel trend lines that often slant counter-trend, before resuming sharply in its original direction, and to a similar extent to the original move.
- Pennants – Also preceded by a sharp “flag-pole” move, the market consolidates between converging trend lines, usually resembling a small symmetrical triangle, before resuming sharply in its original direction and to a similar extent to the original move.
- Wedges – Consists of two converging trend lines. A falling wedge interrupts an up trend, and its breakout is bullish, while a rising wedge interrupts a down trend and its breakout is bearish.
- Rectangles – A trading range bordered by roughly horizontal lines drawn among the major highs on the top and among the major lows on the bottom. A breakout in either direction sets up a measured move equal to the width of the rectangle.
Reversal Patterns
- Head and Shoulders Top or Bottom – One shoulder forms, then a head forms a major top or bottom, then another shoulder appears at a similar level to the first. The dips or rallies between the head and the shoulders define a neckline. When the neckline breaks, look for a move equal to the distance between the neckline and the head.
- Double Top or Bottom – Forms when two tests of a roughly similar level occur, with an intervening dip or rally. The dip/rally defines the neckline and a break of that level sets up a measured move equal to the distance between the neckline and the double peak/trough.
- Triple Top or Bottom – Like the double top, but with three peaks or troughs instead of two.
- Triangles – See the previous entry under continuation patterns for triangles which become reversal patterns when their breakout comes in the opposite direction to the preceding trend.
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