Common Trading Patterns: Triangles, Price Channels and Head and Shoulders

In today’s trading environment, there are several patterns that can be helpful for short term traders.

Given the strength of the moves in the market, breakout patterns may be particularly fruitful on both a continuation and reversal basis.

Triangles

Triangle patterns usually develop in trending markets in the form of a consolidation area. The continuation pattern is formed when a series of candles place lower highs and higher lows developing a triangular shape. Confirmation of such a pattern should result in a breakout at about two-thirds of the triangle formation. We can see that in the 1-hour EUR/USD chart below:

Note: Confirmation of a triangle pattern should result in a breakout of about two-thirds of the triangle formation.

Price Channels

Price channels occur when the price action forms between two parallel trend lines. When a breakout occurs, prices will often retrace and use one of the trend lines as support/resistance. In reference to the chart on the right, typically, the more times these parallel trend lines are touched during the formation, the stronger the pattern becomes and the more powerful a breakout if any of the channel walls are broken.

Head and Shoulders

The head and shoulders pattern occurs at the end of a previous up/down trend and is usually considered to be a reversal pattern. It consists of a left shoulder, head, and right shoulder. The neck line is the base of this pattern and is the support/resistance level where the rallies from shoulder to head fail. Though the pattern can occur in either direction, we will describe the one occurring after an up-trend.

With the chart on the bottom, the left shoulder is part of the continuation from the previous trend which makes a small retracement and then continues higher. The head develops as price action creates a higher high, then retraces once again. The right shoulder develops when the retracement from the head is reversed but fails to form a higher high. Price action should soon break lower through the neckline to confirm the reversal pattern.

Material published courtesy of GFT