Chart patterns are one of the most effective trading tools for a trader. They are pure price-action, and form on the basis of underlying buying and selling pressure. Chart patterns have a proven track-record, and traders use them to identify continuation or reversal signals, to open positions and identify price targets.
Chart patterns are specific price formations on a chart that predict future price movements. As technical analysis is based on the assumption that history repeats itself, popular chart patterns have shown that a specific price movement is following a particular formation of price (chart pattern) with high probability. Therefore, chart pattners are grouped into (1) continuation patterns – that signal a continuation in the underlying trend, and (2) reversal patterns – that signal reversal of the underlying trend.
In this strategy post, we will show the top 5 chart patterns that traders should know about….
Reversal Chart Patterns – Head and Shoulders
Reversal Patterns – Head and Shoulder
Head and Shoulders is a reversal chart pattern, that indicates the underlying trend is about to change. It consists of three swing highs, with the middle swing high being the highest (red lines on the chart). After the middle swing high, a lower high occurs which signals that buyers didn’t have enough strength to pull the price higher. The pattern looks like a head with a left and right shoulder (the three swing highs), and that’s how it got its name. The neckline is connecting the two shoulders, and a break-out below the neckline is considered a selling signal, with a price target being the distance from the top of the head to the neckline (green arrows). If the Head and Shoulders pattern occurs during a downtrend, the same inverse pattern (with three swing lows) is called an Inverse Head and Shoulders pattern.
Reversal Chart Patterns – Triple Bottom and Triple Top
Reversal Chart Patterns – Triple Bottom and Triple Top
Triple Top and Triple Bottom formations are basically the same as Double Top and Double Bottom formations. Both are reversal patterns, with the difference that Triple Tops and Bottoms have three swing highs and swing lows, respectively. Trigger signals are again the break of support and resistance lines, with target prices being the distance between the top and support line (for Triple Tops), and bottom and resistance line (for Triple Bottoms).
Rectangles – A Nice Breakout Play
A rectangle is a continuation pattern, which means it confirms that the underlying trend should continue. It is divided into bullish and bearish rectangles, depending on the underlying trend. A bullish rectangle appears during an uptrend, when the price enters a congestion phase, during a sideways trading. The price will likely break out in the direction of the preceding trend. The trigger signal is the break of the upper line of the rectangle, with the price target being the height of the rectangle. For the bearish rectangle, the opposite rules apply. It forms during a prevailing downtrend, when the price enters a congestion phase and trades sideways. This means the trend will most likely continue downwards, with the break of the lower rectangle line. The price target is again the height of the rectangle.
Rectangles – A Nice Breakout Play
Bullish and Bearish Wedges – Wait for the breakout
Bullish and Bearish Wedges – Wait for the breakout
A wedge is another continuation pattern. A bullish wedge forms during an uptrend, as the price trades inside converging trendlines. These converging trendlines imply that sellers are trying to push the price lower, but don’t have enough strength to win against the buyers. Ultimately, the buyers win and the price breaks through the upper trendline, indicating that the uptrend will resume. Target prices are calculated as the maximal height of the wedge, which is then projected to the point of break-out.
A bearish wedge is similar to a bullish one, with the difference that it is appearing during downtrends, and the slope of the wedge is up. Converging trendlines are again showing that buyers interrupted the downtrend, trying to push prices higher. A break-out through the lower trendline indicates that sellers won the battle, and the downtrend is resuming. The target price is, like by bullish wedges, the maximal height of the wedge which is then projected to the point of break-out.
Bullish and Bearish Flags
A flag is very similar to a wedge, with the difference that the trend lines which form the flag are parallel, and not converging. A flag pole is also a part of the flag pattern, because the target price is measured in a different way than by other chart patterns. Flags can be bullish and bearish, with a bullish flag shown on the chart above. A bullish flag forms during an uptrend, with parallel trend lines above and below the price-action, which form a down slope. A break-out above confirms that the uptrend is resuming. A bearish flag is pretty much the same as a bullish flag, with the difference that it forms during downtrends and has an up slope. The price target is measured as the height of the flagpole (green arrow) to the top of the flag, which is then projected to the lowest point of a bullish flag (or highest point of a bearish flag).
To start trading chart patterns effectively you can just work on one first. Before long you can easily recognize these top 5 chart patterns that will help you gain consistent results on a weekly and monthly basis. Master one and then move on to the next. If you just can master one, it’s seriously enough to make your trading journey a profitable journey.
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