Learning Series: Useful Chart Patterns to Double-Down on
Chart patterns are useful in looking at the big picture and can help identify trading signals (signs of future price movement). The primary assumption when using chart patterns is that certain patterns consistently appear and tend to produce similar outcomes. The two primary types of chart patterns are continuation and reversal of trend.
Technical analysis is not always correct. This is largely because identifying trading signals/chart patterns is subjective in nature. Charting is really just a study of human psychology. Analysis of human fear and greed has led to the identification of the following common chart patterns:
Reversal Patterns:
Head and Shoulders
Figure 1 — Head and Shoulders Pattern — Source: Investopedia.com
The Head and Shoulders pattern indicates a reversal in trend once completed. The longer the pattern takes to form, and the larger the pattern is in terms of height, the further the price will probably decline. Not every H&S will look like Figure 1. There is varying height of shoulders as well as the possibility of multiple shoulders on one or both sides of the head. However, as long as the head has at least one shoulder on each side the pattern is valid. The inverse of this pattern indicates a reversal upward.
Double Top
Figure 2 — Double Top Formation — Source: Investopedia.com
A Double Top is identified by two highs roughly the same size next to each other. Double Tops form because people who did not sell at the first top do not want to miss the selling opportunity the second time the price reaches that high level. This pattern generally indicates a major price downturn is on the horizon. The decline is quite sizeable no matter the distance between the tops. On certain occasions, a third top may form. The inverse of this pattern indicates a reversal upward.
Continuation Patterns:
Cup and Handle
Figure 3 — Cup and Handle Formation — Source: thebalance.com
The Cup and Handle is a bullish continuation pattern that occurs when an upward trend has lost momentum but continues to rise upon the completion of this pattern. The ‘Cup’ is identified by a U shape with roughly equal highs on both sides. This is followed by the ‘Handle’, which is located on the right-hand side of the ‘Cup’. The ‘Handle’ is a short correction resembling an Ascending Triangle (see Figure 4).
Ascending Triangle
Figure 4 — Bullish Ascending Triangle — Source: chart-formations.com
Ascending triangles occur when buyers are more eager than sellers. For a while, the sellers decide a certain price that is good to sell at. This results in the horizontal resistance line. During this period, the buyers are willing to pay higher and higher prices. This results in a series of higher lows. Ascending triangles are generally considered to be a continuation pattern. However, they sometimes act as a reversal pattern following a prolonged downtrend. The inverse of this pattern is called a descending triangle and indicates a bearish continuation.
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Disclaimer: The information here is intended to be used for educational purposes only and is not financial advice. I am not a financial adviser.
