What are Reversal Patterns in Forex?

If you trade forex, you know what it means to look for patterns. In all kinds of trading, there are tell-tale patterns that investors use to catch part of the profit on a predicted upswing or downswing in price. The way it works, theoretically anyway, is that you use past price data to predict what the future holds. Knowing, or being able to make a good guess about, the future is the heart and soul of trading.

Three Kinds of Trends

There are hundreds, perhaps thousands of different trend-tracking methods that people come up with in the hopes of predicting future price levels. For foreign exchange markets, the same is true, but the vast majority of people in the forex markets look for one of three types of trends: reversals, continuations, and bilaterals. Continuations are aptly named because when you spot a setup, it can indicate that the current price movement, up or down, will continue, hence the term. 

Bilaterals are a bit different because they essentially signal chaos, or the unknown. If your automated chart identifier alerts you of a bilateral setup, it could be a smart time to pull out and simply do nothing. Take a break or go have lunch, because bilaterals mean the price line could either reverse or continue. Finally, there are reversal setups, namely those charts and price line configurations and shapes that tell us to look for a turnaround in the trend. If things have been slowly rising, for example, a reverse means they'll be heading downward in the near future. 

Have the Right Tools

Some of the better trading platforms, sites like this, for example, allow account holders to set automatic pattern recognition on charts. This is an especially helpful function for forex enthusiasts who operate in a fast-paced environment and often need to enter or exit positions rapidly. It's important to know the names and the basic math behind the six reverse patterns so that you can either program them into your platform's charting functionality or use your eyes to spot them when they appear in front of you. Fortunately, all six are relatively easy to identify, even for newcomers. Even if your trading platform does not include auto-identification of chart patterns, you should study the formations in the platform's educational section, library, or via any webinars or tutorial videos available from your broker.

The Six Key Formations

First, understand that there are really three basic reverse-patterns. We get six by inverting the three, namely turning them upside down in order to create reversals from downtrends to uptrends. You might have heard of some because they've been around for decades in the stock market and are popular among day traders, options enthusiasts, and people who dabble in the futures markets. The three are: double top, head and shoulders, and rising wedges. Each one can appear in an up-trending market, and when they do, they indicate that things are about to go south rather quickly. On the other side, there are double bottoms, inverted head and shoulders, and falling wedges. When you see these formations in a down market, it means there is a high probability for a rebound, or a coming upswing.