Chart patterns play an integral part in technical analysis and help traders to determine when and where to enter and exit positions.
They provide a way for you to decide whether the assets’ price is likely to continue in the same direction of the existing trend, change direction, or stay in a narrow range. It is, therefore, the reason why chart patterns are categorized into three main categories – continuation patterns, reversal patterns, and bilateral chart patterns.
From the perspective of an individual trader, if you learn how to use these repetitive price patterns correctly, forex trading can be much easier and more effective. And while every chart pattern is valuable to read and interpret market price action, reversal patterns are arguably the most effective and accurate of all other chart pattern categories.
So, in this article, we’ll help you to get familiar with 4 of the most popular and reliable reversal chart patterns in technical analysis.
Top 4 Reversal Chart Patterns You Should Know
Here are the four most valuable and common reversal patterns in technical analysis that will help you in finding trading opportunities:
Doji Candlestick Pattern
The Doji candle pattern is one of the most commonly used chart patterns in trading. This single candlestick chart pattern, which is characterized by a small body with similar opening and closing prices, usually indicates indecision between buyers and sellers. Therefore, when the Doji candle appears, it usually means that the existing trend is very likely to change.
Keep in mind that the Doji candlestick can also be interpreted as a continuation chart pattern. Also, there are many variations of the Doji candlestick pattern, each with a different meaning. Those include the standard Doji, long-legged Doji, gravestone Doji, and the dragonfly Doji.
The interpretation of the Doji candle depends on the market conditions. However, when the Doji candle appears at the end of an uptrend or a downward trend, it usually indicates the clash between buyers and sellers; therefore, it signals that buyers or sellers cannot push prices above or below a certain level.
That said, when you identify the Doji candle price pattern, it’s always better to wait for the following candlestick to close above or below the highest or lowest level of price levels the Doji candlestick.
Double Top and Double Bottom Reversal Patterns
Typically, reversal patterns are more effective when the price cannot break a specific level several times. When this happens, traders realize that the market has reached a support or resistance level, and the price is likely to reverse. And if there’s a chart pattern that signifies this scenario is the double top and bottom patterns.
Simply put, when a double top or double bottom chart pattern appears on a price chart, investors realize that the price has reached a peak or a bottom price. Therefore, the market is likely to reverse in this market scenario.
Best of all, when you use the double top and bottom patterns, you should know exactly where to place a stop loss order. Like the head and shoulders pattern, this chart formation is based on a strong support or resistance level. Therefore, a trader will place the stop loss order slightly above the support or resistance level, which is a great method to utilize a risk-reward ratio.
The Three Drives Pattern
The 3 drives pattern is another effective and powerful trend reversal chart pattern. This reversal harmonic chart pattern consists of three consecutive symmetrical price movements, creating higher highs and lower lows.
Following the three price movements, the asset’s price is expected to move in the opposite direction of the previous trend. Once the price ends the third and last price swing and meets the pattern’s Fibonacci requirements, a trend reversal signal is given.
Above all, the three drives pattern is such an effective chart pattern because it offers a trader a precise stop loss level and a take-profit target at any of the previous price swings key levels.
Furthermore, it is known as one of the most accurate and reliable reversal chart patterns in technical analysis. Finally, note that the three drives pattern can be either a bearish or bullish chart pattern.
Head and Shoulders
The head and shoulders is a popular chart pattern used by technical analysis traders to identify price reversals. The pattern is considered a bearish trend reversal pattern, although it has an opposite version known as the inverted head and shoulders pattern, which is a bullish reversal pattern. In general, the head and shoulders pattern is known as one of the most accurate and reliable trend reversal chart patterns.
In terms of structure, the head and shoulders pattern has the shape of… head and shoulders. It consists of a first peak (the first shoulder), a higher peak (the head), and a lower peak (the second shoulder) at around the same price level as the first shoulder. Once the price falls below the support level, which is the price level of the two shoulders (also known as the head and shoulders bottom), a trend reversal is likely to occur.
The Bottom Line
To summarize, trend reversal chart patterns can help you understand the market context and find trading opportunities. Of course, you can use many other reversal patterns (as well as common continuation patterns) to determine when to enter or exit a trade.
But, in my opinion, the chart patterns we have listed above are some of the most common and easy-to-interpret chart formations you’ll find on a price chart. Every day you can find these chart patterns on trading charts, which means that if you learn how to trade them correctly, you can potentially build a successful trading strategy around these chart patterns.
