Basic, Common Chart Patterns
Chart patterns present buying and selling information as a pictorial record of trading activity. On the basis that history has a habit of repeating itself, it is claimed by supports of Technical Analysis that historic chart patterns can be used to arrive at short and long term forecasts for the price of a particular security. Chart patterns can form over intraday periods, daily, weekly and monthly timescales, with the common perception that the longer a pattern takes to form, the more reliable it may be.
Some patterns are, in my view, more reliable than others. There are many chart patterns:
- Double Top
- Double Bottom
- Triple Top
- Triple Bottom
- Head and Shoulders
- Ascending Triangle
- Descending Triangle
- Ascending / Rising Wedge
- Descending / Falling Wedge
I’ll focus on what I class as the most important and reliable ones in my experience, but as with all things in trading, what I find important and reliable may not be important and reliable to others!! And of course, that’s what makes the market, because for every buyer there must be a seller, and hence my comments here and here about how Technical Analysis can be subjective. And now here too…
Double Top – sign of a reversal
This pattern comes about when price reaches the same level of resistance twice. Price trades up, then trades away for a period, then trades up and away again from the same level. You could simplify it, not classify it as a Double Top, and just say it’s resistance, which would be just as accurate. Here’s an example in EURUSD from 2018 where it trades away from 1.2540 twice before eventually selling off.
Double Bottom – sign of a reversal
No need to post a picture of this one. You can imagine how it looks by turning the above chart upside down in your head. Also known as ‘support‘
Triple Top / Triple Bottom – sign of a reversal
I think you can guess how this looks from the whole Double Top / Double Bottom thing. It’s the same, but with one more touch on the same resistance/support line, lending additional support (forgive the pun) to the price level reached.
Head and Shoulders Pattern – sign of a reversal
The Head and Shoulders is probably the most glorified, sought after and praised pattern in Technical Analysis. I’ve seen it work, and I’ve seen it fail in real-time on many occasions, so like all other elements of TA, it won’t work every single time. The trick is knowing when to play it.
The Head and Shoulders pattern is constructed of three price peaks as shown below in this image which I have stolen borrowed from another site on the web, no prizes for guessing which site given the text on the chart.
My personal favourite way to trade this is to try and get in early. In the above example, that’d be mid April as the price falls through the Neckline at about $60.
Well, usually what happens with a H&S pattern is that the price falls away, pulls back and touches the neckline again … and then sells off properly. But it doesn’t always do it that way. So, I’ll have a sell order just under the neckline that gets triggered as price falls, and I’ll usually trail that down a ways to see if it’s going to reverse and pullback to the neckline. If it does, I’ll take some small profits then, and then short it again as it gets back to the neckline – a double whammy. If it doesn’t pullback and continues the sell-off, then I’ll move the stop to protect some profits and let it sell off further. It’s supposed to sell off to the same distance away from the neckline as the head is away from the neckline, but don’t be greedy – place your limit order inside of that distance to guarantee you some good profits. Alternatively, if you’re trading with multiple contracts or multiple lots, you could take half off as it approaches the target price and leave the rest to run. You can even do this with Spread Betting – trade at £2/point and get rid of £1 to bank some profits.
Ascending Triangle – sign of a continuation
This is a classic bullish chart pattern that signifies that price is likely to continue after a sideways period. It looks a bit like a right-angled triangle, certainly in this example from StockCharts. As the pattern develops, volume usually contracts *but not always*.Often, a confirmation of this move can be seen when prices breaks north of the resistance price, then returns to form a support/resistance switch, with resistance now becoming support, before prices continues in the same upwards direction.
Descending Triangle – sign of a continuation
In contrast to the above Ascending triangle, this is a bearish chart pattern that signifies that price is likely to continue downwards. As with it’s bullish counterpart, a confirmation of this move can be seen when prices breaks south of the support price, then returns to form a support/resistance switch, with support now becoming resistance, before prices continues in the same southerly direction. In the above example, this can be seen around the 16/17 June when price ticks back up through 42 before continuing the sell off.
Descending triangles are sometimes seen to signify reversals when they occur at the top of an uptrend, but this pattern is more usually associated with being in an existing downtrend.
Ascending / Rising Wedge – sign of a reversal
This is a typically bearish sign that price is likely to reverse. The pattern show below is typical and, as with all chart patterns, the longer it takes to form, the more reliable it may be considered to be.
You might also notice in the example below that there is a sort of head and shoulders pattern forming just before this particular wedge completes; again, in my experience that is not uncommon but equally should not be expected.
Descending / Falling Wedge – sign of a reversal
This is a bullish pattern that begins wide and narrows down. As such, and along with the two previous patterns, it can present a reasonably low-risk entry, as your stop loss point can be positioned some way below the recent low / support price, giving a clear sign to exit the trade in the event of failure.