Forex Price Action Basics - Lesson 8: Reversal Patterns
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This lesson will cover reversal patterns. Many Forex traders that use price action analysis, aim to identify specific patterns created by price. Usually these patterns signal a price reversal (trend reversal) or predict when markets are going to rally. In this lesson, we will teach reversal patterns. In the next lesson we will go through consolidation patterns. Both patterns are regularly evident in the Forex market and other financially traded markets.
Forex Reversal Patterns
Most reversal patterns are based around the principle that when price trends, there are a series of swing highs and swing lows. If you need a reminder about the characteristics of trending markets, please see our Forex price action lesson on Trending Markets. In the illustration below, you will notice that price is up-trending and that we have a series of higher swing highs and higher swing lows. When price creates a lower swing low, this is a possible signal that trend direction may be changing. Forex reversal patterns help Forex traders to identify possible changes of trend direction. Each pattern in this lesson is based on the principle of higher highs and higher lows, and lower lows and lower highs.
Do you notice that price has moved lower than the previous low? This can signal that the uptrend has now finished and that price may now downtrend. Most reversal patterns in Forex trading are based on this principle - the 'break' of swing highs and swing lows.
Head & Shoulder Patterns
A head & shoulder pattern is a common reversal pattern used by many Forex traders that use technical analysis. It consists of a similar or lower low on an uptrend, followed by a failed higher high. The reason for the name of this pattern is due to head-and-shoulders-like pattern that price creates.
Below is a real Forex price chart. It is a daily chart of the USDCAD. I have marked the swing lows as 'SL' and the swing highs as 'SH'. Do you notice how price has formed a lower swing low and a lower swing high?
To help you understand and identify this pattern better, please study the images below...
Here is another true-life example of a head and shoulders pattern in the Forex market. The screenshot has been taken from the EURAUD daily chart.
If you would like more examples of head and shoulder patterns and some more direction, watch the video for this lesson.
Head and shoulder patterns can also appear at the bottom of downtrends and can signal up-trends. These head and shoulder patterns are referred to as inverted head and shoulder patterns. Below is an example of an inverted head and shoulder pattern in the Forex market.
Double Top & Double Bottom Patterns
Double bottom and double top price patterns can also signal the reversal of trends. Double tops can be formed at the top of up-trends and double bottoms can be formed at the bottom of downtrends. The patterns are similar to head and shoulders patterns but price forms a double push rather than a "head" and 2 "shoulders".
Below is an example of a double top. Do you notice that price fails to create a higher swing high? Price then reverses and could potentially start down-trending.
Below is an example of a double bottom. Do you notice that price fails to create a lower low? Price then reverses and starts forming higher highs and higher lows (up-trending).