Technical Analysis: Chart Patterns
A chart pattern is a different pattern on a stock chart that makes a trading signal, or a mark of future trend movements. Chartists employ these patterns to make out current trends, trend reversals and to execute buy and sell orders.
The idea is that positive patterns are seen repeatedly and that these patterns indicate a certain high prospect movement in a stock. Based on the historic trend of a chart pattern setting up a solid price action, chartists wish for these patterns to find out trading opportunities.
As there are common ideas and formations to every chart pattern, there is no chart pattern that will show you with 100% sureness where a security is headed. This makes some margin and dispute as to what a good pattern seems like, and is a major reason why charting is often seen as more of an art than a science.
There are two sorts of patterns within this level of technical analysis, continuation and reversal. A reversal pattern indicates that a previous trend will turn around upon completion of the pattern. A continuation pattern, on the other hand, indicates that a trend will continue as soon as the pattern is complete. These patterns can be established over charts of any timeframe. Now, we will review some of the more popular chart patterns.
Head and Shoulders
Head and shoulders is one of the most accepted and consistent chart patterns in technical analysis. This is a reversal chart pattern that when created, indicates that the shield is likely to move against the earlier trend. As you can see in Figure 1, there are two different types of the head and shoulders chart pattern. Head and shoulders top (show on the left) is a chart pattern that is created at the high of an upward movement and indicates that the upward trend is about to end. Head and shoulders bottom, also renowned as contrary head and shoulders (shown on the right) is the lesser known of the two, but is used to indicate a reversal in a downtrend.
Both of these head and shoulders patterns are alike in that there are four main parts: two shoulders, a head and a neckline. Also, both head and shoulder is included of a high and a low. For instance, in the head and shoulders top image shown on the left side in Figure 1, the left shoulder is twisted of a high trailed by a low. Here in this pattern, the neckline is a level of resistance or support. Consider that an upward trend is a period of consecutive rising highs and rising lows. The head and shoulders chart pattern, consequently, explains a weakening in a trend by showing the deterioration in the following movements of the highs and lows.
Cup and Handle
A cup and handle chart is a bullish extension pattern in which the upward trend has stopped but will resume in an upward direction once the pattern is established.
As you can see in Figure 2, this price pattern shapes what looks like a cup, which is headed by an upward trend. The handle follows the cup pattern and is twisted by a usually downward/sideways movement in the security’s price. When the price action drives above the resistance lines created in the handle, the upward trend can continue. There is a wide ranging time frame for this type of pattern, with the span ranging from numerous months to more than a year.
Double Tops and Bottoms
Double Tops and Bottoms chart pattern is another popular pattern that indicates a trend reversal and it is known to be one of the most consistent and is universally used. These patterns are twisted after a continued trend and indicate to chartists that the trend is about to overturn. The pattern is twisted when a price action tests support or resistance levels twice and is unable to break through. This pattern is frequently used to indicate intermediate and long-term trend reversals.
In the case of the double top pattern in Figure 3, the price action has twice tried to move over a solid price level. After two failed attempts at approaching the price higher, the trend overturns and the price heads lower. In the case of a double bottom (shown on the right), the price action has tried to move lower twice, but has established support each time. After the next bounce off of the support, the security makes a new trend and heads upward.
Triangles are some of the most renowned chart patterns used in technical analysis. The three kinds of triangles, which differ in construct and implication, are the regular triangle, upward and downward triangle. These chart patterns are considered to last anywhere from a number of weeks to quite a few months.
The regular triangle in Figure 4 is a pattern in which two trend lines join toward each other. This pattern is impartial in that a breakout to the upside or downside is a proof of a trend in that direction. In a climbing triangle, the upper trend line is flat, even as the bottom trend line is upward downward. This is usually consideration of as a bullish pattern in which chartists search for an upside breakout. In a downward triangle, the lower trend line is flat and the upper trend line is downward. This is usually seen as a bearish pattern where chartists search for a downside breakout.
Flag and Pennant
These two short-term chart patterns are continuation patterns that are twisted once there is a spiky price action followed by a normally sideways price progress. This pattern is then formed upon another spiky price action in the similar direction as the move that started the trend. The patterns are normally considered to last from one to three weeks.
As you can see in Figure 5, there is small difference among a pennant and a flag. The major difference among these price actions can be observed in the middle part of the chart pattern. In a pennant, the middle part is formed by joining trend lines; much similar to what is seen in a regular triangle. The middle part on the flag pattern, on the other hand, illustrates a channel pattern, with no junction between the trend lines. In both cases, the trend is estimated to continue when the price moves over the upper trend line.
This kind of chart pattern can be either a reversal or continuation pattern. It is alike to a regular triangle but that the wedge pattern slants in an upward or downward direction, while the regular triangle usually shows a sideways movement. An additional difference is that wedges tend to twist over longer periods, typically between three and six months.
Even that wedges are organized as both continuation and reversal patterns can twist reading signals confusing. Though, at the most fundamental level, a rising wedge is bearish and a falling wedge is bullish. In Figure 6, we have a falling wedge in which 2 trend lines are joining in a downward direction. If the price was to climb higher above the upper trend line, it would construct a continuation pattern, even as a progress below the lower trend line would indicate a reversal pattern.
A gap in a chart is a blank space between a trading period and the following trading period. This happens when there is a big diversity in prices between two chronological trading periods. For instance, if the trading variety in one period is between $25 and $30 and the next trading period starts at $40, there will be a huge gap on the chart among these two periods. Gap price actions can be establish on bar charts and candlestick charts but will not be found on basic line charts or point and figure. Gaps usually show that something of importance has occurred in the security, for example a better-than-expected earnings statement.
There are 3 major types of gaps, runaway (measuring), breakaway and exhaustion. A breakaway gap figures at the start of a trend, a runaway gap figures during the middle of a trend, and an exhaustion gap figures near the end of a trend.
Triple Tops and Bottoms
These are another kind of reversal chart patterns in chart analysis. Triple tops and triple bottoms are not as common in charts as double tops and bottoms and head and shoulders, but they work in a similar manner. These two chart patterns are twisted when the price action tests a level of resistance or support three times and is unable to break through; this indicates a reversal of the previous trend.
Confusion may appear with triple tops and bottoms throughout the formation of the pattern because they can seem similar to other chart patterns. After the first two support/resistance tests are twisted in the price action, the patterns will appear like a double top or bottom, which might direct a chartist to open a reversal position too soon.
A rounding bottom, also referred to as a bowl bottom, is an enduring reversal pattern that indicates a shift from a downward trend to an upward trend. This pattern is usually considered to last anywhere from various months to various years.
A rounding bottom chart pattern seems similar to a cup and handle pattern but exclusive of the handle. The enduring nature of this pattern and the lack of a verification trigger, such as the handle in the cup and handle, constructs it a complex pattern to trade.
We have ended our look at some of the more well-liked chart patterns. You must now be able to identify each chart pattern as well the signal it can figure for chartists.