“Chart Patterns — Introduction and how it helps traders to make smart decision”
As defined by Investopedia, technical analysis (TA) is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume.
Chart patterns are the building blocks to conducting TA. These charts look for repeatable patterns to predict future price patterns. They are a trader’s best friend and traders trade using these patterns based on the following core concept.
Traders utilize chart patterns to trade on the basis that stock prices display repeatable behaviors under repeatable circumstances. Upon identification of specific chart patterns, traders can apply strategies to capitalize on anticipated trends.
However, chart patterns are never completely accurate. Similar to weather forecasts, they serve more as predictors of future events rather than confirmation of upcoming movements. Therefore, unpredictable events would render TA ineffective as there were no historical trends to predict future stock price movements.
Chart patterns are often used in candlestick trading as they show more detailed information, such as daily opening and closing prices. Chart patterns fall broadly into two categories: continuation patterns and reversal patterns.
A continuation pattern signals that an ongoing trend will continue. An example is the cup and handle pattern. It is used to show a period of bearish market sentiment before it reverses into a bullish trend.
The cup in the pattern resembles a rounding bottom and signals the trend reversal. The handle would be a temporary retracement after the initial reversal. After the short-term retracement, the stock price will likely reverse out of the retracement and continue on the overall bullish trend.
Reversal chart patterns indicate that a trend may be about to change direction. A good example would be the head and shoulders chart pattern. As its name suggests, the pattern consists of a tall peak with shorter peaks at either side of it. Traders typically look at head and shoulders patterns to predict when a price trend will switch from bullish to bearish.
As mentioned, the first and third peaks will be smaller than the second. However, they will all fall back to the same level of support, otherwise known as the ‘neckline’. Once the third peak has fallen back to the level of support, it is likely that it will break out into a bearish downtrend.
The ascending triangle is a bullish continuation pattern. Ascending triangles can be drawn onto charts by placing a horizontal line along with the closing highs — the resistance — and then drawing an ascending line along with the closing lows — the support.
Ascending triangles often have two or more identical peak highs which allow for the horizontal line to be drawn. The trend line signifies the overall uptrend of the pattern, while the horizontal line indicates the historic level of resistance for that particular asset.
Chart patterns are essential for a trader to execute good trades as they provide a reliable gauge of future price trends to capitalize upon. Unless you are a professional trader, constantly scouring the market to identify trends can be a tedious and time-consuming process.
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