Patterns and trading theories in the Forex market

The Forex market represents a place where different currencies move against each other. The dashboard is made of currency pairs coupled together, and traders speculate on their movement.

In essence, Forex trading represents a bet against or in favor of an economy. An economy that performs better will have a stronger currency, while the currency weakens when an economy underperforms.

As such, traders speculate on the shape of different economies and then buy or sell a currency pair according to their analysis. If they are right and the pair moves in their direction, they’ll make a profit. If not, a loss occurs.

For example, if one bets on the excellent shape of the United Kingdom’s economy, it’ll buy the currency, the GBP. However, it needs to buy it against something else and therefore will choose the appropriate currency pair.

Technical trading

Traders that buy an sell based on a chart interpretation are technical traders. The bread and butter for their trading is technical analysis.

Various technical analysis techniques exist, like:

• Pattern recognition approaches. The most representative ones are:
  • Head and shoulders – a pattern that predicts a top or a bottom formed/is about to develop.
  • Wedges – rising and falling wedges also show bottoming or topping conditions
  • Double and triple tops and bottoms
  • Triangles – ascending or descending triangles act as continuation patterns, but triangles as a reversal pattern also exist
  • Pennants – they represent continuation pattern, similar to triangles. They appear when the market builds energy to break higher.
• Trading theories. Here are some of the critical trading theories part of the technical analysis:
  • Elliott Waves Theory – one of the most popular trading theories among retail traders, the Elliott Waves Theory tracks the chart of a currency pair using various patterns interpreted as waves. Traders understand the moves the market makes and label them as corrective or impulsive (three-wave or five-wave structures). At the end of a sophisticated top/down analysis, Elliott Waves traders place a trade based on the projected forecast. It is said the theory is one of the few that analyze human behavior in any market, the Forex market included.
  • Gann Theory. One of the most controversial traders, Gann believed everything moves for a reason. His legacy in the technical analysis field is enormous, and traders all over the world follow the Gann concepts. All trading platform offer Gann tools like the Gann lines, Gann square, etc.
  • Dow Theory. This is an approach to trading developed by Charles Dow. Together with Edward Jones, Charles is more famous for setting the pillars of the DJIA (Dow Jones Industrial Index) that tracks the movements of various companies in the United States. His trading theory is considered to be the one that inspired Ralph N. Elliott when he set the rules for the Elliott Waves Theory.
  • Gartley. The original idea of Gartley was somehow similar to the Dow Theory. However, Gartley took it to the next level, applying the action/reaction principle. In time, other technical traders like Pesavento and Carney applied various Fibonacci ratios to the original Gartley theory. As such, harmonic trading as we know it today appeared.

On top of the patterns and the trading theories listed here, technical traders use indicators and oscillators. They track the price movement and apply various filters to plot support and resistance levels or overbought and oversold levels on a currency chart.

Based on the result, traders buy or sell a currency pair, speculating on a bounce from a support level or rejection from a resistance one.

Conclusion

Technical analysis changed in time, with various factors influencing the way traders approach the market. Computers changed the way traders look at the market, and new technologies available altered the face of the Forex industry.

Look for this course of action to continue in time and for new technical analysis concepts to appear. As for the old ones, only the best will survive the test of time.