9 Patterns That Signal Forex Reversals

05/14/2014 9:00 am EST

Focus: FOREX

Richard Krivo of DailyFX.com identifies a host of candlestick chart patterns that can often give forex traders early warning signs about impending bullish or bearish price reversals.

First and foremost, a trader should determine the direction that the market has been taking the pair over time-the longer-term trend. Once that is determined, the trader can then look for entry signals in the direction of that trend, as that will be the direction that offers the greater likelihood of success.

As we look at the below four-hour chart for EUR/JPY, we can see that the pair is in an uptrend (has a bullish bias), as price is trading above the 200-period simple moving average (SMA), and at the time of this chart, the EUR was stronger than the JPY.

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So, if the pair is in an uptrend (bullish bias), we would want to look for candlesticks and candlestick patterns that demonstrate a potential for a bullish reversal. That would be a reversal by price action back in the direction of the trend.

On the chart above, we would be looking at the hammer candlesticks, doji, bullish engulfing patterns, and the morning star pattern for that bullish reversal signal. When we see these candlesticks and patterns forming at the end of a retracement (at a support level), this is a "tip" that the price action may very well reverse back in the direction of the overall trend.

Again, nothing in trading is a certainty, but these patterns can provide us with a trading edge, or the tip that we are looking for.

See related: How to Trade Engulfing Bar Patterns

What if the pair is in a downtrend?

On the chart above, I have also included some of the patterns that we would look for to indicate that price action may be reversing to the downside after a reversal (pullback) to a level of resistance. Those patterns would be the shooting star, bearish engulfing pattern, doji, evening star, and the spinning top.

While in most cases on this chart, price action did reverse to the downside after these patterns showed up, the higher-probability trade will still exist in the direction of the trend.

While it is not necessary to discard your indicator of choice in favor of candlestick patterns, using these patterns in conjunction with your indicator, be it MACD, Stochastics, RSI, etc., can provide an additional tip when it comes to looking for a pair to reverse its direction.

By Richard Krivo of DailyFX.com

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