Price action is one of the most in-demand and popular approaches in trading. This method enables analysis and trading based solely on pure price movements, excluding technical indicators, although they can be used to enhance strategies. Price action is especially valuable in Forex and digital options markets, as it helps profit from price fluctuations without relying on indicators, using chart patterns and levels instead. In this comprehensive guide, we will cover 8 key patterns often used by professional traders to build effective strategies.
Support and Resistance Levels: The Foundation of Price Action
Before discussing specific patterns, it’s important to understand the role of support and resistance levels. These levels form the basis for any patterns and serve as a foundation on which trading decisions are built.
Support Level – A support level is a horizontal line connecting at least two price lows and marks an area where demand for an asset increases while sellers lose strength. This level signals that the price is unlikely to fall further, creating a buying opportunity.
Resistance Level – A resistance level is a horizontal line connecting at least two price highs, showing a zone where sellers dominate the market and prevent further price growth. Once this zone is reached, the price often starts to decline, creating a selling opportunity.
These levels help traders understand where buyers or sellers may gain control of the price. Properly identifying support and resistance is crucial for successful Price Action trading, as each pattern should factor in these levels.
1: Double Top and Double Bottom
The double top and double bottom are some of the most common and easily recognizable patterns on a chart.
Double Top – This pattern forms at a resistance level and consists of two peaks at the same price level. After forming the first peak, the price retraces, tests the local support level (neckline), and then returns to resistance to form the second peak. Breaking below the neckline indicates a potential sell signal.
Double Bottom – This pattern forms at a support level and features two price lows at the same level. After breaking above the neckline, traders can consider opening a buy position, as this pattern signals a potential reversal from a downtrend to an uptrend.
These patterns are classified as reversal patterns and signal a potential change in the prevailing trend.
2: Head and Shoulders
The head and shoulders pattern is more complex to identify and requires some trading experience. It consists of three peaks, where the middle peak (the head) is higher than the two surrounding peaks (the shoulders). This pattern usually forms after an uptrend and signals its reversal. Breaking below the neckline indicates a shift to a downtrend, providing a potential sell opportunity.
Inverted Head and Shoulders – This is a mirror pattern of the standard head and shoulders, indicating a reversal from a downtrend to an uptrend. Once the neckline breaks, it typically signals a buy opportunity.
3: Flags
Flags are continuation patterns that appear in the middle of a price move. They indicate a temporary correction before the trend resumes.
Bullish Flag – Appears after an upward price move and represents a downward correction. After breaking the upper boundary of the channel, traders may enter a buy position.
Bearish Flag – Occurs during a downtrend and signals a potential continuation of the decline following a correction. Breaking the lower boundary of the channel may offer a sell signal.
Flags help traders identify trend-following entry points after brief pullbacks.
4: Hammer
The hammer is a single candlestick pattern signaling a potential trend reversal. It forms at a support level and consists of a candle with a small body at the top and a long lower shadow. This pattern suggests that sellers are losing control while buyers gain strength. A buy position may be considered after the hammer closes or once the upper boundary of the pattern is broken.
5: Shooting Star
The shooting star is the opposite of the hammer and forms at the top of an uptrend. This candlestick has a small body at the bottom and a long upper shadow, indicating increased selling pressure. A sell position may be considered after the candle closes or when the lower boundary is broken.
6: Bearish Engulfing
The bearish engulfing pattern consists of two candlesticks: the first is bullish, and the second is a larger bearish candle that completely engulfs the body of the first. It forms at a resistance level and signals the start of a downtrend. A sell position may be considered after the second candle closes.
7: Bullish Engulfing
The bullish engulfing pattern is the opposite of the bearish engulfing pattern and forms at a support level during a downtrend. A larger bullish candle engulfs the preceding bearish candle, indicating a possible market reversal. A buy position may be considered after the bullish candle closes.
8: Rectangle
The rectangle pattern forms when the price consolidates between support and resistance levels, creating a horizontal channel. This pattern indicates a pause before a potential breakout. Breaking either the support or resistance level serves as a signal to open a trade.
Traders can also trade within the rectangle, selling at resistance and buying at support. These patterns help traders identify entry and exit points, minimize risks, and improve their chances of successful trades. Gradually mastering these patterns allows traders to build more informed strategies, understand market signals, and increase profitability. Learning and mastering these models is an essential step toward professional trading.