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A reversal pattern is when a trend reverses course for a substantial amount of time. This is not the same thing as a retracement, because a retracement is a temporary reversal during an overall trend. For example, on a one day uptrend there can be several downtrending retracements. A reversal pattern will often be fairly symmetrical in both the direction of the original trend and that of its reversed trend.
The following are some examples of reversal patterns:
Head and Shoulders
A Head and Shoulders pattern is when a trend reverses itself six times and ultimately heads in the opposite direction of its original movementand is usually seen in uptrends. Uptrends are also when Head and Shoulders patterns are most reliable. In time, the market slows down and the forces of supply and demand become balanced. The left shoulder highs are when sellers come in, and the downside is probed at the beginning neckline. Buyers then return to the market and push through to new highs, marking the head. However, these new highs quickly turn back and the downside is tested once again, which forms the continuing trend. As tentative buying re-emerges and the market rallies again, a slight high returns to form the right shoulder but does not take out the previous high. At this point buying decreases and the market tests the downside again. Your trend line for this pattern should be drawn from the beginning neckline to the continuing neckline. The entire effect looks like a person shrugging.
Cup and Handle
A Cup and Handle trend is a pattern on bar charts resembling a cup with a handle. It begins with an uptrend, peaks and then begins to drop downwards. Bottoming out, the price begins to move upward to form a bowl and drifts downwards once again. The cup is in the shape of the letter "U" and the handle has a small downward drift.
Double Tops and Bottoms
One of the most common and reliable ways to identify a medium to long-term trend reversal is the Double Top or the Double Bottom. In a Double Top, an uptrend reverses itself for a time and then bottoms out. At this point, it returns to another peak of roughly the same level as the first and begins a more lasting downtrend. This trend can also be continued as a pattern called Triple Tops and Bottoms.
Reversal patterns are plentiful in the Forex market if you know where to look. While the shapes vary considerably, all of these patterns share an ultimate reversal in the price of a particular currency.