Chart Analysis – Common Chart Patterns
Introduction
There are hundreds of thousands of market
participants buying and selling securities for a wide variety of reasons: the hope of gain, fear of loss, tax consequences,
short-covering, hedging, stop-loss triggers, price target triggers, fundamental
analysis, technical analysis, broker recommendations and a few dozen more.
Trying to figure out why participants are buying and selling can be a daunting
process. Chart patterns put all buying and selling into perspective by
consolidating the forces of supply and demand into a concise picture. As a
complete pictorial record of all trading, chart patterns provide a framework to
analyze the battle raging between bulls and bears. More importantly, chart
patterns and technical analysis can help determine who is winning the battle,
allowing traders and investors to position themselves accordingly.
In many ways, chart patterns are simply more complex
versions of trend lines. It is important that you read and understand our
articles on Support and Resistance as well as Trend Lines before you continue.
Chart pattern analysis can be used to make
short-term or long-term forecasts. The data can be intraday, daily, weekly or
monthly and the patterns can be as short as one day or as long as many years.
Gaps and outside reversals may form in one trading session while broadening tops and dormant bottoms may require many
months to form.
The science of chart reading, however, is not
as easy as the mere memorizing of certain patterns and pictures and recalling
what they generally forecast. Any general stock chart is a combination of
countless different patterns and its accurate analysis depends upon constant
study, long experience and knowledge of all the fine points, both technical and
fundamental, and, above all, the ability to weigh opposing indications against
each other, to appraise the entire picture in the light of its most minute and
composite details as well as in the recognition of any certain and memorized
formula.
Careful and constant studies are
required for successful chart analysis.
Continuation Patterns vs. Reversal Patterns
Two basic tenets of technical analysis are that
prices trend and that history repeats itself. An uptrend indicates that
the forces of demand (bulls) are in control and a downtrend that the forces of
supply (bears) are in control. However, prices do not trend forever
and as the balance of power shifts, a chart pattern begins to emerge. Certain
patterns, such as a parallel channel, denote a strong trend. However, the vast
majority of chart patterns fall into two main groups: reversal and
continuation. Reversal patterns indicate a change of trend and can be broken
down into top and bottom formations. Continuation patterns indicate a pause in
trend and indicate that the previous direction will resume after a period of
time.
Just because a pattern forms
after a significant advance or decline does not mean it is a reversal pattern.
Many patterns, such as a rectangle, can be classified as either reversal or
continuation. Much depends on the previous price action, volume, and other
indicators as the pattern evolve. This is
where the science of technical analysis becomes the art of technical analysis.
Below is a list of common chart patterns that can be useful in Technical Analysis.
Reversal Patterns
- Double Top Reversal (Bearish Reversal)
- Double Bottom Reversal (Bullish Reversal)
- Head and Shoulders Top (Bearish Reversal)
- Head and Shoulders Bottom (Bullish Reversal)
- Falling Wedge (Bullish Reversal)
- Rising Wedge (Bearish Reversal)
- Rounding Bottom (Long Term Bullish Reversal)
- Triple Top Reversal (Bearish Reversal)
- Triple Bottom Reversal (Bullish Reversal)
- Bump and Run Reversal (Bearish Reversal)
Continuation Patterns
- Flag, Pennant (Short-Term Continuation)
- Symmetrical Triangle
- Ascending Triangle
- Descending Triangle
- Rectangle
- Price Channel
- Measured Move - Bullish
- Measured Move - Bearish
- Cup with Handle
