Forex Chart Patterns that Print Money: Top Candlestick Setups

Have you ever looked at a forex chart and wondered if you could identify profitable trades just by recognizing certain patterns? Well, you’re not alone. Some of the most successful forex traders use candlestick patterns to determine when to enter and exit trades.

In this comprehensive guide, we’ll explain what forex chart patterns are, why they work, and reveal the most profitable candlestick setups for trading forex. Read on to become an expert in chart pattern analysis!

What Are Forex Chart Patterns?

Forex chart patterns are recurring formations on a price chart that help traders identify potential trade opportunities. These patterns reflect the psychology and behavior of market participants that consistently manifest in the market.

By recognizing these chart patterns, technical traders aim to enter trades just as new trends start to form. Chart patterns can be found on any timeframe, from one-minute charts up to monthly charts. The most popular timeframes for pattern trading are the 4-hour and daily charts.

Some of the advantages of using chart patterns in forex trading include:

• Chart patterns help identify market turning points and potential reversals early. This allows traders to get in at the start of new trends.
• Patterns provide trade entry/exit points. Traders know where to place stop losses to limit downside risk.
• Certain chart patterns have a statistical edge with high probability outcomes. Traders can swing the odds in their favor.
• Patterns work on all timeframes and currency pairs. This flexibility allows traders to operate multiple trading systems.

Now let’s take a look at the most profitable candlestick patterns for trading forex.

Top Candlestick Patterns for Trading Forex

Candlestick patterns are one of the most useful chart pattern types for forex traders. Candlesticks display the open, high, low, and close on a single price bar, giving traders valuable insight into market psychology and supply/demand dynamics.

Here are the top candlestick patterns every forex trader should know:

1. The Doji Candlestick Pattern

The doji is one of the simplest yet most powerful candlestick patterns for forex trading. It signals market indecision that typically leads to a reversal.

The doji candlestick forms when the open and close are virtually equal. This shows the tug-of-war between buyers and sellers lead to a stalemate and no meaningful change in market direction.

There are different types of doji candlesticks:

• Long-legged doji – This doji has long upper and lower wicks which shows that both buyers and sellers exerted force but eventually balanced each other out.
• Dragonfly doji – This doji has no lower wick. It signals buyers overpowered sellers and drove prices higher.
• Gravestone doji – This doji has no upper wick, showing sellers forced the price lower.

In general, the appearance of a doji candlestick after an extended move higher or lower signifies that a reversal may be in the cards. Traders typically look to enter a short position after seeing a doji form on an uptrend, and go long when a doji forms in a downtrend.

2. The Hammer and Inverted Hammer

The hammer and inverted hammer look identical but have different implications. Both signal potential trend reversals.

The hammer has a long lower wick and small real body near the top of the candle. It shows that sellers pushed the price lower during the session but buyers overpowered them to close near the high. This creates a bullish reversal signal after a downtrend.

The inverted hammer looks the same but forms after an uptrend. It shows buyers drove prices higher initially but sellers took over and pushed the price back down. This creates a bearish reversal signal as upside momentum stalls.

The key is to wait for confirmation on the next candle before acting on the reversal signal. Look for a bullish candle to close higher than the hammer for a long trade, and a bearish candle closing lower for a short trade.

3. Bullish and Bearish Engulfing Patterns

Engulfing patterns also signal potential trend reversals. The bullish pattern shows buyers overwhelming sellers, while the bearish pattern shows the reverse.

The bullish engulfing pattern forms after a decline. It consists of a small bearish candle followed by a large bullish candle that ‘engulfs’ the body of the first candle. This shows buyers have wrestled control from sellers.

The bearish engulfing pattern is the opposite, forming after an advance. The second bearish candle consumes the entire first bullish candle. This reflect bears taking charge from the bulls.

Traders typically wait for a confirmation candle before trading engulfing patterns. Go long after a bullish engulfing if the next candle closes above the pattern. Short sell if the third candle closes lower than the bearish engulfing formation.

4. The Piercing and Dark Cloud Cover Patterns

The piercing pattern and dark cloud cover are another set of bullish and bearish reversal patterns common in forex trading.

In a piercing pattern, the first candle is a long bearish candle that continues the downtrend. The second candle gaps down but rallies to close above the midpoint of the first candle. This shows the bears are losing steam and buyers could be asserting control.

The dark cloud cover starts with a strong bullish candle that extends the uptrend. The next bearish candle gaps up but closes below the midpoint of the first candle. This signals the bullish momentum is waning as sellers fight back.

To trade these patterns, go long on a piercing pattern if the third candle moves above the second candle’s close. Look to sell the dark cloud cover if the following candle closes decisively below the second candle’s close.

5. The Morning and Evening Star Patterns

The morning and evening star candlestick patterns incorporate the doji to predict trend turning points. These patterns tend to lead to strong breakouts.

The bullish morning star forms after a downtrend, with the first candle extending the move lower. The middle candle is a doji that gaps down from the first candle, showing indecision. Finally, the third bullish candle moves up to close near its midpoint.

The bearish evening star occurs after an uptrend. The first candle continues the advance higher. The doji middle candle gaps up but its small real body shows weakening momentum. The third bearish candle moves lower to close below the midpoint of the first candle, reflecting the sellers have taken over.

These patterns are best traded on the higher timeframes like the daily or 4-hour charts. The morning and evening star signal convincingly that the prior trend is ending and a reversal is ahead.

Now that you’re familiar with the best candlestick patterns, let’s explore other powerful chart pattern configurations.

Advanced Forex Chart Patterns

The candlestick patterns above are excellent for novice traders to get started with chart pattern analysis. Once you become more experienced, there are a number of advanced forex chart patterns to watch for:

Head and Shoulders

The head and shoulders is a reversal pattern that signals an uptrend is about to reverse into a downtrend. It has three swing highs: left shoulder, head, and right shoulder. The pattern reflects growing supply overwhelming demand.

Traders watch for a break of the neckline support to trigger the head and shoulders pattern. The ideal entry is on the retest of the neckline after the initial break. The take profit target is the height of the pattern extrapolated lower from the breakout.

Inverse Head and Shoulders

The inverse head and shoulders flips the pattern on its head, signaling the end of a downtrend. The left shoulder, head, and right shoulder mark three swing lows that reflect demand overcoming supply.

Upside breakouts are triggered when price pushes above the neckline resistance. Look to buy the retest of the neckline after the breakout. Set the price target by measuring the height of the pattern upwards from the breakout point.

Double Tops and Bottoms

Double tops and bottoms indicate key support and resistance levels in the market. These patterns signal indecision and stagnation, often leading to breakouts.

The double top shows two failed attempts to push the price higher. Sellers gain control after the second peak, forcing the market down. Breaks below support confirm the pattern.

The double bottom sees two spike lows form without new lows. This shows buyers defending support and generates upside breakouts when resistance gives way.

These patterns often lead to fast moves after breakouts as traders anticipate the start of a new trend. Use the height of the pattern to set price targets.

Ascending Triangles

Ascending triangles have a flat upper resistance line and an uptrending support line that converges. This coiling reflects building upside momentum ahead of a breakout.

Look to buy ascending triangle breakouts above resistance, with a price target equal to the height of the pattern extrapolated upwards from the breakout point. Stop losses go below the pattern support trendline.

Descending Triangles

Descending triangles have flat support and trending downwards resistance that squeezes as the pattern matures. This signals bearish momentum building before downside breakouts.

Trade descending triangles by short selling breakouts below support. Measure the height of the triangle to set your downside profit target. Place stop loss orders above the downward resistance trendline.

Flags and Pennants

Flags and pennants show shallow chart patterns signaling a continuation of the prior trend. These temporary pauses offer low-risk entries in the direction of the trend.

Bull flags have a rectangular shape showing consolidation after an uptrend. Trade these by buying the upside breakout with a profit target equal to the previous advance.

Bear pennants have a small symmetrical triangle shape after a downtrend. Short sell the breakdown from the pennant to ride the next bearish leg lower.

Use recent swing highs or lows as stop loss levels for flags and pennants to limit risk on these trades with larger position sizes.

How to Trade Chart Patterns in Forex

Now that you know the major forex chart patterns to look for, let’s discuss how to actually trade them:

• Pick a time frame – Use the 4-hour or daily charts to start, as these provide the cleanest patterns. More intraday charts can be noisy.
• Identify the pattern – Look for a clearly formed chart pattern meeting the specifications outlined above. Pay attention to highs, lows, closes, and trend direction.
• Confirm the breakout – Never blindly trade the first break. Wait for confirmation, such as a retest or follow-through candle in the breakout direction.
• Place a stop loss – Use swing high/lows, or pattern supports/resistances as logical areas to place stops to limit downside.
• Set a profit target – Measure the height or length of the full pattern and project this distance for the minimum target.
• Manage the trade – Consider taking partial profits at the minimum target. Move stops to breakeven once the pattern reaches the halfway point.

Here are some final tips for effectively trading chart patterns in forex:

• Trade with the trend for the best odds of success. Patterns signaling reversals have lower win rates.
• Combine patterns with indicators like the RSI for confirmation.
• Focus on clean, well-defined patterns. Ambiguous or choppy patterns are riskier.
• Catalog every pattern you trade and review performance regularly to improve.

Chart patterns provide a visual way to analyze price action and identify trading opportunities from key levels. Mastering the most common and reliable patterns will dramatically improve your forex trading strategy. But always remember to use tight stops and manage risk on every trade!

Frequently Asked Questions About Forex Chart Patterns

Are chart patterns more effective than technical indicators?

Chart patterns can often be more effective than indicators because they incorporate multiple factors like peaks, troughs, breakouts, and trends. Indicators mainly rely on past prices and limited computation. Patterns provide a more holistic analysis of market behavior.

What time frame is best for trading chart patterns?

The daily or 4-hour timeframes tend to provide the cleanest patterns and highest probability setups. One-minute and lower timeframes are often too choppy. The weekly and monthly charts don’t form as many tradable patterns. Start on the 4-hour or daily and branch out from there.

How do I confirm a chart pattern breakout?

Always wait for confirmation before trading breakouts from chart patterns. Look for a retest of the broken level that holds, signalling the new trend has begun. Alternatively, watch for a follow-through candle closing far outside the pattern in the breakout direction for confirmation.

Should I trade the breakout or wait for the pullback?

Trading pullbacks and retests after breakouts tends to offer better risk/reward ratios. Breakout trades are riskier and face the prospect of sharp reversals. Waiting for confirmation also improves the odds of a successful trade.

Which chart patterns have the highest probability outcomes?

Some of the best patterns with high win rates include ascending/descending triangles, flags, head and shoulders patterns, channels, and well-defined double tops/bottoms. Some patterns like broadening formations are random and unpredictable. Focus on those with clear statistics and defined entry/exit rules.

How do I set my profit target when trading chart patterns?

Use the height or width of the full pattern to estimate a minimum price target. For example, if a triangle is $2 tall, project that distance from the breakout point. You can extend targets further using multiples of the pattern dimension (2x or 3x height). Move stops to breakeven once the initial target is reached.

Should I trade chart patterns during news events or high volatility?

It’s best to avoid trading around major news announcements and events with heightened volatility. The additional whipsaws and erratic price action makes chart pattern analysis less reliable. Focus on trading when volatility is lower for better pattern recognition.

How can I improve my chart pattern trading results?

Catalog a trading journal and review both your winning and losing trades. Look for any mistakes trading specific patterns. Also track your profit factor and win rate for each pattern over a large sample size. Master the high probability patterns one by one until your metrics improve.

Chart patterns are invaluable for timing entries and exits, gauging price targets, managing risk, and increasing overall trading performance. Take your forex chart analysis to the next level by mastering the definitive guide to chart patterns provided above. You’ll be confidently spotting profitable setups in no time!