The Essential Guide to Chart Patterns

Last Updated: October 2, 2020

By Rayner

Chart patterns are one of the most powerful tools you can use in your trading (only if you use it
correctly).
For example, it can help you:

 Read market conditions accurately so you know whether to buy or sell

 Get out of losing trades quickly and better manage your risk
 Find high probability trading opportunities
 And much more…
That’s why I’ve created this essential guide so you know how to trade chart patterns like
a professional trader.
But first, let’s destroy 3 myths about Forex chart patterns…
The myths about chart pattern (don’t fall for it)
Myth #1: Chart patterns can predict the future accurately
Many traders think chart patterns can predict the future (like some kind of magic crystal ball).
For example:
You see a Head & Shoulders chart pattern and think the market is about to head lower.
So, you go short.
Before you know it, the market reverses higher, and you got stopped out — ouch.

So here’s the deal…

Chart patterns can’t accurately predict the future, nothing or no one can.
But…
Chart patterns can help you assess market conditions and manage your risk.
(More on that later)
Myth #2: Chart patterns don’t work
Now…
After a few failed attempts at trading chart patterns, you’ll claim it doesn’t work.
Just look at the failed Head & Shoulders chart pattern earlier!
So here’s the secret…
Whenever you trade chart patterns (or any form of Technical Analysis), it has to be within the
context of the markets.
Let me explain using these 2 examples…
Example #1:
You spot a Bull Flag pattern in a downtrend.
Example #2:
You spot a Bull Flag pattern in an uptrend. And on the higher timeframe, the market had broken out
of resistance and is trading at 52-week highs.
Now let me ask you, which chart pattern would you trade, #1 or #2?
Next…
Myth #3: You must know every chart pattern if you want to trade
it profitably
Here’s the thing…
There are possibly hundreds of chart patterns out there.
Sure, you can try to memorize the shape and meaning of each pattern (and risk getting burned out).
Or, learn how to read the price action of the markets so you can understand any chart patterns that
comes your way — without memorizing a single one.
Which do you prefer?
Read the price action?
Then read on…
Chart patterns cheat sheet: If you know these 3
things, you NEVER need to memorize a single
chart pattern again…
This is important, so pay attention…
#1: Trending Move
You’re probably wondering:
“What is a Trending Move?”
A Trending Move is the “longer” leg of the trend.
If the candles are large (in an uptrend), it signals strength as the buyers are in control.
If the candles are small, it signals weakness as the buyers are exhausted.
An example of a Trending Move:
#2: Retracement Move
A Retracement Move is the “shorter” leg of the trend.
If the candles are large, it signals the counter-trend pressure is increasing.
If the candles are small, it’s a healthy pullback and the trend is likely to resume itself.
An example of a Retracement Move:

#3: Swing Points

Swing Points refer to swing highs and lows — obvious “points” on the chart where the price
reverses from.
Here’s an example:
This is important because it lets you know whether the market is in an uptrend, downtrend, or
range.
As a guideline:

 If the swing highs/lows move higher, then the market is in an uptrend

 If the swing highs/lows move lower, then the market is in a downtrend
 If the swing highs/lows are not moving higher or lower, then the market is in a range
You’re probably wondering:
“What has this got to do with reading chart pattern?”
Well, that’s what I’ll cover next.
Read on…

How to read and understand any reversal chart

patterns accurately
Now, let’s put what you’ve learned to use.
Reversal chart pattern #1
Look at the chart below…
#1 and #2: The market is in an uptrend as the price made new swing highs (and lows).
#3: The price failed to make a new swing high. And if you notice, the Trending Move is getting
weak as the range of the candles got smaller (compared to #1 and #2).
This doesn’t look good for the buyers. But if the swing low doesn’t break, the uptrend is still intact.
#4: The price broke below the swing low and the Retracement Move is getting stronger. Notice the
range of the candles getting larger?
Overall, the sellers are in control and the market is likely to move lower from here.
Pro Tip:
This is known as a Head & Shoulders chart pattern (and the opposite is called Inverse Head &
Shoulders).
Next…
Reversal chart pattern #2
Look at this…

#1: A strong Trending Move higher as the price made a new high.
#2: A Retracement Move lower which forms a swing low.
#3: The market made another push higher but failed to break above the previous high (from #1).
This is a sign of weakness but the uptrend is still intact.
#4: The market re-tests the swing low (and consolidates for a while) before breaking lower.
Overall, the sellers are in control and the market is likely to move lower from here.
Pro Tip: This is known as a Double Top chart pattern (and the inverse is Double Bottom)
Continuation chart patterns, here’s what you
must know…
Let’s get started…
Trend continuation chart pattern #1
Look at the chart below and ask yourself:
“Is this a bullish or bearish chart pattern?”
#1, #2, and #3: The price made higher lows into Resistance. This is a sign of strength as it tells you
buyers are willing to buy at higher prices.
#4: This is an area of Resistance (the last line of defense for sellers). Also, there’s likely stop loss
orders above it from traders who are short.
Overall, the buyers are in control and if the price breaks out, the market is likely to move higher.
Pro Tip: This is known as an Ascending Triangle chart pattern (and the inverse is Descending
Triangle).
Also, it can be a reversal chart pattern if it forms after a downtrend.
Trend continuation chart pattern #2
Now, what about this chart pattern?

Let’s analyze it together…

#1: A strong Trending Move higher as the price re-tests the previous high.
#2: A weak Retracement Move with small-bodied candles. Sellers have difficulty pushing the price
lower.
Overall, the buyers are in control and if the price breaks out, the market is likely to move higher.
Pro Tip: This is known as Bull Flag chart pattern (and the inverse is Bear Flag).
There are other variations to it like Symmetrical Triangle and Pennant.

How to trade chart patterns like a professional

trader
Now…
You’ve learned how to understand any chart patterns and you’re itching to trade them.
You’re thinking:
“Time to look for a Head & Shoulders pattern and short the market.”
But wait!
Not so fast.
Why?
Because remember, not all chart patterns are created equal.
You can have two identical chart patterns but one has a higher probability of success.
So the question is, how do you tilt the odds in your favor?
Well, here are three things to look for…

 Trend
 Area of value
 Buildup
Let me explain…
The trend is your friend
Yes, I know you heard this a gazillion times, and it’s true (the trend is your friend).
So if you’re trading chart patterns, you’d want to be trading in the direction of the trend.
For example: Buying a Bull Flag in an uptrend

Or selling Bear Flag in a downtrend…

Next…
Area of value: How to buy low and sell high
Let me ask you:
When you go to the supermarket to buy Apples, what’s the price you’re willing to pay?
Probably anything below $2, right?
Now, what if an Apple cost you $10?
Well, you’d think it’s ridiculous and won’t even touch it.
And it’s the same for trading.
You want to buy when the price is at an area of value — when it’s “cheap”.
But how do you the area of value?
Simple.
You can use tools like Support and Resistance, Moving Average, Trend line, etc.
Here’s an example: Inverse Head and Shoulders pattern at Support

Now, you know Support is an area where potential buying pressure could come in.
And when you get an Inverse Head & Shoulders pattern, it means buyers are stepping in and could
push the price higher (if it breaks the Neckline).
Won’t this increase the odds of the trade working out?
Moving on…
Breakouts with buildup
Note: This mainly applies to chart patterns with horizontal boundaries (like Double Top/Bottom,
Head and Shoulders, etc.).
Now…
When you trade breakouts of a chart pattern (like Double Bottom), you don’t want to “blindly”
trade every breakout — especially when the price has made a big move prior to the breakout.
Why?
Because buyers would look to take profit at Resistance plus, sellers would step in to short the
markets.
And this leads to a low probability breakout trade.
Here’s what I mean…

You’re probably wondering:

“So how should I trade breakout?”
Well, you look for a buildup to form at the horizontal boundaries (like Support and Resistance).
Here’s why…
#1: Favorable risk to reward
You have a logical place to set your stop loss (below the low of the build-up), and this offers a
more favorable risk to reward.
#2: A sign of strength
When the price forms a build-up at Resistance, it’s a sign of strength.
Because it tells you the buyers are willing to buy at higher prices (even in front of Resistance).
#3: Profit from losing traders
Imagine…
If the price is at Resistance, what would most traders do?
They’ll go short and have their stop loss above Resistance.
And the longer the price hovers at Resistance, the more traders will short and buy stop orders
would cluster above Resistance.
But what happens if the price breaks above Resistance?
This cluster of buy stop orders gets triggered which fuel more buying pressure (and this increases
the odds of a successful breakout).
Here’s what I mean…
An example of a build-up on GBP/CHF Daily:

Now:
You’ve learned how to trade chart patterns and identify high probability trading setups.
Next, you’ll discover how you can use it to manage your risk.
Read on…
How to use chart patterns and manage your risk
Here’s the trick…
You can use the structure of chart patterns to set your stop loss.
This means you set your stop loss at a level where if the price reaches it, it would “destroy” the
chart pattern.
Let me share with you a few examples…
Example #1
You know the Head & Shoulders is a bearish reversal chart pattern and traders might go short on
the break of the Neckline.
So, where’s a logical place to put your stop loss?
Well, you can set your stop loss above the highs of the right shoulder.
Because if the price were to reach the level, it would invalidate the Head & Shoulders chart pattern
(and you want to get out of the trade).
Here’s what I mean:
Make sense?
Example #2
The Bull Flag is a bullish continuation chart pattern and traders might go long on the break of the
highs.
And where would you set your stop loss?
Remember…
You want to place it at a level where if the price reaches it, it would “destroy” the chart pattern.
So, one way is to set your stop loss below the low of the Bull Flag pattern.
Here’s what I mean…

Now, you might be wondering…

“So, which are the most profitable chart
patterns?”
Well, the truth is…
It doesn’t exist because there’s no such thing as the most profitable chart patterns.
Why?
Because market conditions triumph any chart patterns you know of.
For example:
If the market is in a downtrend, then any bullish chart patterns won’t do well because the trend is
down.
And if the market is in an uptrend, then any bearish chart patterns won’t do well because the trend
is up.
Agree?
So the bottom line is this…
Forget trying to find the most profitable trader patterns — it doesn’t exist.
Instead, identify the current market condition and then trade the appropriate chart pattern — you’ll
do much better this way.
Frequently asked questions
#1: Do all these concepts work in the stock market as well or do they only work for Forex
market?
Yes, these concepts work in the stock market as well.
#2: Should I wait for a buildup to form before shorting the head & shoulders chart pattern in
a downtrend?
Ideally, you want to wait for a buildup to form as it tells you that there’s a volatility contraction at
that moment which could expand in your favour thereafter.
Sometimes if you don’t get a buildup, you can also reference the previous swing high to set your
stop loss if the risk-to-reward makes sense.
#3: Is there an easy way for me to know if the chart patterns work in the long run, or not?
No, there is no way to know for sure if something will work in the long run. That’s why you’ve got
to put in the hard work to validate your findings.
Ideally, when you’re trading chart patterns, you want to have sound logic behind those patterns.
Conclusion
So here’s what you’ve learned today:

 Chart patterns cannot accurately “predict” what the markets will do (nothing and no one can)
 You don’t need to know every chart patterns out there to trade it profitably
 If you want to understand any chart patterns, just analyze the Trending Move, Retracement
Move, and swing highs/lows — that’s all you need
 Chart patterns work best when you trade with the trend, trade from an area of value, and trade
breakouts with a buildup