Common Chart Pattern.

Understanding Chart Patterns

Identifying chart patterns is simply a system for predicting stock market trends and turns! Hundreds of years of price charts have shown that prices tend to move in trends. (I'm sure we've all heard the saying, 'the trend is your friend'.) Well, a trend is merely an indicator of an imbalance in the supply and demand. These changes can usually be seen by market action through changes in price. These price changes often form meaningful chart patterns that can act as signals in trying to determine possible future trend developments. Research has proven that some patterns have high forecasting probabilities. These patterns include: The Cup & Handle, Flat Base, Ascending and Descending Triangles, Parabolic Curves, Symmetrical Triangles, Wedges, Flags and Pennants, Channels and the Head and Shoulders Patterns. In my opinion, these are some of the best patterns to trade.

This section is designed to introduce you to some of these chart patterns, as well as teach you to identify repetitions in the market qualities, to make timely and more accurate decisions when predicting market trends. 

Double Bottom

The Double Bottom technical analysis charting pattern is a common and highly effective price reversal pattern.
The chart below illustrates the Double Bottom reversal pattern:

  

To create a double bottom pattern, price begins in a downtrend, stops, and then reverses trend. However, the reversal to the upside is short-term. Price breaks again to the downside only to stop again and reverse direction upwards. With the second bottom of the double bottom pattern, it is usually more bullish if the second low is higher than the first low.

Double Bottom Buy Signal

The signal to buy is given when the confirmation line is penetrated to the upside. The confirmation line is drawn across the top of the double bottom pattern (see chart above).

Often, after price penetrates the confirmation line, price will retrace for a short time, sometimes back to the confirmation line. This retracement offers a second chance to get into the market long.

Volume also plays an important part of interpreting the Double Bottom pattern; this is illustrated in the chart below :

Generally, volume should explode when the confirmation line is penetrated as it did in the above chart .

The Double Bottom reversal pattern is a heavily used and effective charting reversal pattern. Another similar and popular bottom reversal pattern is the Reverse Head & Shoulders Pattern (see: Head & Shoulders). The opposite of the Double Bottom is the bearish Double Top pattern (see: Double Top).

Double Top

The Double Top technical analysis charting pattern is a common and highly effective price reversal pattern.
The chart below illustrates the Double Top reversal pattern:

  

Double Top Formation Components

1. First High: Bulls push prices upwards making new highs; however, these new highs are short lived and prices retreat.
2. Second High: Prices don't retreat for long because bulls make another run, making a similar high. Nevertheless, this is bearish, because bulls were unable to push prices higher; bears held their ground at the previous high level. The bears push prices back to support (Confirmation line); this is a pivotal moment - either bulls will make another push higher or bears will take control and push prices even lower, more than likely taking over for good.

Double Top Sell Signal

Sell when price closes below the confirmation line.

Note that traders expect a significant increase in volume to accompany the confirmation line break; if there is very little volume when price pierces the confirmation line, then the move downward is suspect. Small volume usually means weak support of price movement (see: Volume).

Another similar chart pattern is the Head & Shoulders Pattern (see: Head & Shoulders). The opposite of the Double Top is the bullish Double Bottom (see: Double Bottom).

Triple Top Chart Pattern

   

What is Triple Top Chart Pattern?

Triple Top Pattern is very reliable, bearish reversal pattern. It is formed after an uptrend. It consists of three consecutive peaks or tops formed at a regular interval and of almost the same heights. 1.Top One: Top one or peak one is formed in continuation of the uptrend. There is a formation of new high followed by a pull back(10-20%) till the neckline(Support).2.Top Two: Price again moves from neckline to make another high called the second top or peak 2 or resistance 2 followed by a pull back(10-20%) again till the neckline.3.Top Three: Third top or third peak is formed when the price movers towards the resistance for the third time before giving a breakout.4.Neckline Support: It is the line drawn through the bottom of the top one, top two till the top three. It serves as a important support to the pattern.

Understanding Triple Top Chart Pattern:Triple top chart pattern is formed when the buyers have faith in the stock and take the price to a new high (Top1) but fails to continue so due to the resistance, results in a pull back. Again the buyers tries to rise the price but fails to get enough momentum to further increase the price result in a second pull back. Same sentiments of buyers are involved in the formation of third top. After all this attempts buyers looses their faith and sellers took over buyers resulting in the fall in price and reverse in the trend.Duration: It takes several minutes to several months for this pattern to be formed. The longer the duration the more reliable the pattern is, after the breakout occurs.Shape: Theoretically the triple top should be symmetrical that means all the three tops should be of nearly equal heights and spaced almost equally from each other. However practically the three highs are not necessarily of equal heights and spaced equally from each other. The tip of the top may be from pointed to round shape and hence for the neckline also its not necessary to be horizontal, it can be sloping upwards or downwards. Breakout:It is very important for this pattern confirmation. Triple top is considered reliable only when the price closes below the neckline support or the confirmation point(lowest low of the pattern) and there is often high jump in volume. If the price don't close below the confirmation point then it may not be a triple top pattern.One can often seen a pull back after a breakout which is in support of this pattern formation. However the important thing to note is the pull back is to test the neckline support which later becomes the resistance. It is always advisable to keep a stop loss in a pull back.

Volume:It plays a crucial role in confirming the pattern. With the formation of triple top chart pattern there is a decrease in volume. Therefore generally the volume is higher in the first peak, followed by second peak and third peak. A decrease in volume indicates that the buyers are loosing interest which is favourable to the formation of the pattern. Near breakout there in an increase in volume which further confirms the reliability of the pattern. Price Target:A rough price target can be calculated by measuring the vertical distance between the highest peak (resistance) and the neckline support. However other technical indicators have to keep in mind here as well.

Example of Triple Top Chart Pattern

Triple Bottom Chart Pattern

 

What is Triple Bottom Chart Pattern?

Triple Bottom Pattern is very reliable, bullish reversal pattern. It is formed after an downtrend. It consists of three consecutive bottoms formed at a regular interval and of almost the same heights.1.Bottom One: Bottom one is formed in continuation of the downtrend. There is a formation of new low followed by a pull back(10-20%) till the neckline(resistance).2.Bottom Two: Price again moves from neckline to make another low called the second bottom or followed by a pull back(10-20%) again till the neckline.3.Bottom Three: Third bottom is formed when the price movers towards the resistance for the third time before giving a breakout.4.Neckline Resistance: It is the line drawn through the first bottom till the third bottom. It serves as a important resistance to the pattern.

Understanding Triple Bottom Chart Pattern:
Triple bottom chart pattern is formed when the sellers have faith that the stock price will go down further which leads to a new low (bottom1) but fails to continue so due to the support, results in a pull back. Again the sellers tries to reduce the price but fails to get enough momentum to further decrease the price which results in a second pull back. Same sentiments of sellers are involved in the formation of third bottom. After all this attempts sellers looses their faith and buyers took over sellers resulting in the rise in price and reverse in the trend. Duration: It takes several minutes to several months for this pattern to be formed. The longer the duration the more reliable the pattern is, after the breakout occurs. Shape: Theoretically the triple bottom should be symmetrical that means all the three bottoms should be of nearly equal heights and spaced almost equally from each other. However practically the three lows are not necessarily of equal heights and spaced equally from each other. The tip of the bottom may be from pointed to round shape and hence for the neckline also its not necessary to be horizontal, it can be sloping upwards or downwards.

Breakout:It is very important for this pattern confirmation. Triple bottom is considered reliable only when the price closes below the neckline support or the confirmation point(lowest low of the pattern) and there is often high jump in volume. If the price don't close below the confirmation point then it may not be a triple bottom pattern.One can often seen a pull back after a breakout which is in support of this pattern formation. However the important thing to note is the pull back is to test the neckline resistance which later becomes the support.It is always advisable to keep a stop loss in a pull back.
Volume:Volume plays a crucial role in confirming the pattern. With the formation of triple bottom chart pattern there is a decrease in volume. Therefore generally the volume is higher in the first bottom, followed by second bottom and third bottom. A decrease in volume indicates that the sellers are loosing interest which is favourable to the formation of the pattern. Near breakout there in an increase in volume which further confirms the reliability of the pattern showing that the buyers are taking over the sellers.
Price Target.A rough price target can be calculated by measuring the vertical distance between the highest bottom (support) and the neckline resistance. However other technical indicators have to keep in mind here as well.

Example of Triple Bottom Chart Pattern 

 

Flag

The Flag pattern usually occurs after a significant up or down market move. After a strong move, prices usually need to rest. This resting period usually occurs in the shape of a rectangle, thus the word "flag". The Flag is considered a continuation pattern because after resting, prices will usually continue in the direction they did before.

The chart  shows many Flag patterns:

Windows (Gaps)

Windows as they are called in Japanese Candlestick Charting, or Gaps, as they are called in the west, are an important concept in technical analysis. Whenever, there is a gap (current open is not the same as prior closing price), that means that no price and no volume transacted hands between the gap.

 A Gap Up occurs when the open of Day 2 is greater than the close of Day 1. Contrasty, a Gap Down occurs when the open of Day 2 is less than the close of Day 1.

There is much psychology behind gaps. Gaps can act as:
Resistance: Once price gaps downward, the gap can act as long-term or even permanent resistance.
Support: When prices gap upwards, the gap can act as support to prices in the future, either long-term or permanently.Windows Example - Gaps as Support & Resistance
The chart below shows the gap up acting as support for prices.

  

Often after a gap, prices will do what is referred to as "fill the gap". This occurs quite often. Think of a gap as a hole in the price chart that needs to be filled back in. Another common occurrence with gaps is that once gaps are filled, the gap tends to reverse direction and continue its way in the direction of the gap (for example, in the chart above , back upwards).
The example of  above chart shows the gap acting as support. Traders and investors see anything below the gap as an area of no return, after all, there was probably some positive news that sparked the gap up and is still in play for the company.
The chart below shows many instances of gaps up and gaps down. Notice how gaps down act as areas of resistance and gaps up as areas of support:

 Gaps are important areas on a chart that can help a technical analysis trader better find areas of support or resistance. For more information on how support and resistance work and how they can be used for trading, (see: Support & Resistance). Also, Gaps are an important part of most Candlestick Charting patterns; (see: Candlestick Basics) for a list of candlestick pattern charts and descriptions.

Head and Shoulders

The Head and Shoulders chart pattern is a heavily used and quite profitable charting pattern, giving easily understood buy and sell signals.
The chart below shows a Head and Shoulders pattern:

Head and Shoulders Components

1. Left Shoulder: Bulls push prices upwards making new highs; however these new highs are short lived and prices retreat.
2. Head: Prices don't retreat for long because bulls make another run, this time succeeding and surpassing the previous high; a bullish sign. Prices retreat again, only to find support yet again.
3. Right Shoulder: The bulls push higher again, but this time fail to make a higher high. This is very bearish, because bears did not allow the bulls to make a new higher or even an equal high. The bears push prices back to support (Confirmation line); this is a pivotal moment - Will bulls make another push higher or have the bears succeeded in stopping the move higher.

Head and Shoulders Sell Signal

If prices break the confirmation support line, it is clear that the bears are in charge; thus, when price closes below the confirmation line, a strong sell signal is given.
Note that a downward sloping confirmation line is generally seen as a more powerful Head & Shoulders pattern, mainly because a downward sloping confirmation line means that prices are making lower lows.

Reverse Head and Shoulders

The opposite of the Head & Shoulders pattern is the Reverse Head & Shoulders pattern which is another strong pattern, this time a bottoming pattern.

  

Reverse Head and Shoulders Components

The reasoning behind a Head & Shoulders pattern is as follows:

1. Left Shoulder: Bears push prices downwards making new lows; however, bulls begin to return and push prices slightly higher.
2. Head: Price gains don't last long before bears return and push prices even lower than before; a bearish sign. Prices then find buyers at the new lower prices.
3. Right Shoulder: The bears push downward again, but this time fail to make a lower low. This is generally seen as bullish sign, bears were unable to push prices further down. Decision time occurs when the price is pushed higher back to support (Confirmation line); either bears will push prices back down or bulls will push prices higher, regaining control of the stock, future, or currency pair.

Reverse Head and Shoulders Buy Signal

When price closes above the confirmation line, a strong buy signal is given.
Usually an upward sloping confirmation line is seen as a more powerful Reverse Head & Shoulders pattern, mainly because an upward sloping confirmation line means that prices are making higher highs.
Volume analysis is important when using the Head & Shoulders chart pattern. How to incorporate volume into the study of the Head & Shoulders pattern is discussed next.

Volume and Head and Shoulders

When the confirmation line of a Head & Shoulders pattern breaks to the downside, a large amount of volume should occur as well.
The chart below shows a sharp increase in volume when the confirmation line of the Head & Shoulders pattern was broken:

   

In addition to the sharp increase in volume, the gap down on the chart of GE also gave strong indication to sell when the confirmation line was pierced.
The same concept applies to a Reverse Head & Shoulders pattern, the break of the confirmation line should be accompanied by an increase in volume.
The chart below illustrates a rise in volume when the confirmation line was pierced:

  

The Head & Shoulders pattern is a highly effective classic charting pattern. Other similar chart patterns are the Double Top formation (see: Double Top) and the Double Bottom formation (see: Double Bottom).

The Cup & Handle Pattern

The Cup & Handle is the corrective action after a powerful stock advance. Generally a stock will have a powerful move of some 2 to 4 months, then go through a market correction. The stock will sell off into the correction in a downward fashion for maybe 20 to 35 percent off the old high point. The time factor is generally anywhere from 8 to 12 weeks depending on the overall market condition.

As the stock comes up to test the old highs, the stock will incur selling pressure by the people who bought at or near the old high. This selling pressure will make the stock price drift in a sideways fashion with a bias to the downside for about 4 days to 3 weeks.

The handle is generally about 5% below the old high point. A handle that is any lower is generally a defective stock and contains higher risk for failure.

The time to buy the stock, is as it emerges into new highs at the top of the handle and not the old high point set some 8 to 12 weeks ago.

I have found some of the biggest stock market winners have this very powerful formation. It is one of the best and most reliable formations to look for. However, it is important to note that the best stocks with this formation are found at the beginning of a market move after a good market correction, and not during, or at the end of a major market advance.

HERE IS A SAMPLE CHART WITH A CUP AND HANDLE FORMATION

The Flat Base Pattern

The Flat Base is a stock pattern that goes horizontal for any length of time. Very powerful advances can be had from this formation. What we look for is volume drying up as the stock stays at or about the same level going horizontally.

Draw a trend line across the top of this formation. As the stock proceeds through the trend line, the stock is bought as it breaks the trend line and volume increases.

HERE IS A SAMPLE CHART WITH A FLAT BASE PATTERN

 

The Parabolic Curve Pattern

The Parabolic Curve is probably one of the most highly prized and sought after pattern. This pattern can yield you the biggest and quickest return in the shortest possible time. Generally you will find a few of these patterns at or near the end of a major market advance. The pattern is the end result of multiple base formation breaks.

HERE IS A SAMPLE CHART WITH A PARABOLIC FORMATION

 

The Wedge Formation Pattern

The Wedge Formation is also similar to a symmetrical triangle in appearance, in that they have converging trend lines that come together at an apex. However, wedges are distinguished by a noticeable slant, either to the upside or to the downside. As with triangles, volume should diminish during its formation and increase on its resolve. The Following is a Typical Wedge Formation Trend Pattern

A falling wedge is generally considered bullish and is usually found in up-trends. But it can also be found in downtrends as well. The implication however is still generally bullish. This pattern is marked by a series of lower tops and lower bottoms.

A rising wedge is generally considered bearish and is usually found in downtrends. They can be found in up trends too, but would still generally be regarded as bearish. Rising wedges put in a series of higher tops and higher bottoms.

HERE IS A SAMPLE CHART WITH A WEDGE FORMATION PATTERN

The Channel Pattern

Channel Patterns should generally be considered as a continuation patterns. They are indecision areas that are usually resolved in the direction of the trend. Research has shown that this is true far more often than not, of course, the trend lines run parallel in a rectangle. Supply and demand seems evenly balanced at the moment. Buyers and sellers also seem equally matched. The same 'highs' are constantly tested, as are the same 'lows'. The stock vacillates between two clearly set parameters.

While volume doesn't seem to suffer like it does in other patterns, there usually is a lessening of activity within the pattern. But like the others, volume should noticeably increase on the breakout.
HERE IS A SAMPLE CHART WITH A CHANNEL FORMATION

Triangles

The Triangle is a continuation pattern using the concepts of support and resistance and price breakouts.

The chart below shows the Triangle continuation pattern:

Generally, when prices make significant moves, they go through a period of resting. Usually with a Triangle pattern, the price consolidation period consists of higher lows and lower lows, forming the shape of a "triangle". When the resistance and support lines (see: Support & Resistance) begin converging, price will usually burst out of the consolidation area and resume trending in the direction that prices have been moving previously.

Triangle Breakout Buy Signal

The signal to buy is given when the resistance line is penetrated to the upside. The signal is generally stronger if prices have been in an uptrend prior to the upside breakout.

Triangle Breakout Sell Signal

A sell signal occurs when the support line is penetrated to the downside. Usually the sell signal is considered stronger if prices have been in a downtrend prior to the downside breakout.

Two other closely related variants of the Triangle pattern are the Ascending and Descending Triangle pattern; these two patterns are shown next.

Ascending & Descending Triangles

Two closely related variants of the Triangle pattern are the Ascending and Descending Triangle pattern; these two patterns are shown below in the chart :

Ascending Triangle

An Ascending Triangle is viewed as being more bullish than the regular Triangle patterns. With an Ascending Triangle, higher lows are being made (bullish sign) and sometimes higher highs are being made (also a bullish sign).

Ascending Triangle Buy Signal

As with the regular Triangle formation, the Ascending Triangle gives a buy signal when the resistance line is penetrated to the upside. Also, the signal is generally stronger if prices have been in an uptrend prior to the Ascending Triangle and upside breakout.

Descending Triangle

The Descending Triangle is viewed as being more bearish than the regular Triangle patterns. When a Descending Triangle is formed, lower lows are being made (bearish sign) and quite often, lower highs are being made (generally seen as bearish).

Descending Triangle Sell Signal

With the Descending Triangle formation, a sell signal occurs when the support line is penetrated to the downside. Traders usually view the sell signal as being stronger if prices have been in a confirmed downtrend prior to the Descending Triangle formation and downside breakout.

The Triangle formation is an effective chart analysis tool for placing buy and sell orders. A similar chart formation is the Flag pattern (see: Flag)

Symmetrical Triangles

Symmetrical Triangles can be characterized as areas of indecision. A market pauses and future direction is questioned. Typically, the forces of supply and demand at that moment are considered nearly equal. The Following is a Typical Symmetrical Triangle Pattern

• Attempts to push higher are quickly met by selling, while dips are seen as bargains.
• Each new lower top and higher bottom becomes more shallow than the last, taking on the shape of a sideways triangle. (It's interesting to note that there is a tendency for volume to diminish during this period.)
• Eventually, this indecision is met with resolve and usually explodes out of this formation (often on heavy volume.)

Research has shown that symmetrical triangles overwhelmingly resolve themselves in the direction of the trend. With this in mind, symmetrical triangles (in my opinion) are great patterns to use and should be traded as continuation patterns.

HERE IS A SAMPLE CHART WITH A SYMMETRICAL TRIANGLE PATTERN

 

The Flag & Pennant Pattern

Flags and Pennants can be categorized as continuation patterns. They usually represent only brief pauses in a dynamic stock. They are typically seen right after a big, quick move. The stock then usually takes off again in the same direction. Research has shown that these patterns are some of the most reliable continuation patterns. Here is a Typical Flags and Pennants Pattern

• Bullish flags are characterized by lower tops and lower bottoms, with the pattern slanting against the trend. But unlike wedges, their trend lines run parallel.
• Bearish flags are comprised of higher tops and higher bottoms. "Bear" flags also have a tendency to slope against the trend. Their trend lines run parallel as well.

Pennants look very much like symmetrical triangles. But pennants are typically smaller in size (volatility) and duration. Volume generally contracts during the pause with an increase on the breakout.

HERE IS A SAMPLE CHART WITH A FLAG & PENNANT PATTERN

 Chart Sheet 

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