- Written By Avinash
Chart patterns for trading
Introduction
Chart pattern analysis is probably one of the most popular forms of technical analysis. Chart patterns help to identify market tops and bottoms as well as trend continuations. Chart patterns also indicate the minimum price movement expected once the pattern is completed. Chart patterns are a consequence of human behavior. They are a direct result of knowledge‐based bias at work in the markets
There are two types of chart pattern
1- Reversal Chart Pattern
when a price trend is in the process of reversal either from up to down or from down to up a characteristic area or pattern takes shape on the chart which becomes recognizable as a Reversal Formation
Reversal Formation Patterns
1- Head and Shoulders
2- Inverted Head and Shoulders
3- Double Top
4- Double Bottom
5- Rounding Top and Bottom
6- Wedge Formation
7- The Broadening Formation
8- The Diamond
2- Continuation Chart Pattern
Continuation patterns occur during a trend and help to explain the stage of development of that trend. A continuation pattern that occurs within a long-term trend is expected to be resolved by continuing in the direction of the trend. If prices fail to move in the direction of the trend following a major continuation pattern, then the trend is considered over
1- Symmetrical Triangle
2- Ascending Triangle
3- Descending Triangle
4- Rectangle
5- Pennant or Flag
1- Head and Shoulders
A. A strong rally, climaxing a more or less extensive advance, on which trading volume becomes very heavy, followed by a Minor Recession on which volume runs considerably lower than it did during the days of rise and at the Top. This is the “left shoulder.”
B. Another high-volume advance that reaches a higher level than the top of the left shoulder, and then another reaction on less volume that takes prices down to somewhere near the bottom level of the preceding recession, somewhat lower perhaps or somewhat higher, but, in any case, below the top of the left shoulder. This is the “Head.”
C. A third rally, but this time on decidedly less volume than accompanied the formation of either the left shoulder or the head, which fails to reach the height of the head before another decline sets in. This is the “right shoulder.”
D. Finally, decline of prices in this third recession down through a line (the “neckline”) drawn across the Bottoms of the reactions between the left shoulder and head, and the head and right shoulder, respectively, and a close below that line by an amount approximately equivalent to 3% of the stock’s market price. This is the “confirmation” or “breakout.”
Nevertheless, the Head-and-Shoulders is not complete, and an important Reversal of Trend is not conclusively signaled until the neckline has been penetrated downside by a decisive margin.
Figure 1
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Figure 2
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Figure 3
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Figure 4
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The Head and shoulder Pattern Target
Measure the number of points down vertically from the Top of the head to the neckline Then measure the same distance down from the neckline at the point at which prices finally penetrated it following the completion of the right shoulder. The price level thus marked is the minimum probable objective of the decline
• Head and Shoulders Breakout Downward Price Target: • Breakout Price - (High Price of Head - Neckline Price)
Figure 5
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2- Inverted Head and Shoulders
A. Decline, climaxing a more or less extensive downtrend, on which trading volume increases notably, followed by a Minor Recovery, on which volume runs less than it did during the days of final decline and at the Bottom. This is the “left shoulder.”
B. Another decline that carries prices below the Bottom of the left shoulder, on which activity shows some increase (as compared with the preceding recovery) but usually does not equal the rate attained on the left-shoulder decline, followed by another recovery that carries above the Bottom level of the left shoulder and on which activity may pick up, or at any rate, exceed that on the recovery from the left shoulder. This is the “head.”
C. A third decline on decidedly less volume than accompanied the making of either the left shoulder or head, which fails to reach the low level of the head before another rally starts. This is the “right shoulder.”
D. Finally, an advance on which activity increases notably, which pushes up through the neckline and closes above by an amount approximately equivalent to 3% of the stock’s market price, with a conspicuous burst of activity attending this penetration. This is the “confirmation” or “breakout.”
• Head and Shoulders Breakout Downward Price Target: • Breakout Price - (High Price of Head - Neckline Price)
Figure 6
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• The measuring implications of the Head-and-Shoulders Bottom are the same in all respects and are applied in the same way as with Tops
D. Finally, an advance on which activity increases notably, which pushes up through the neckline and closes above by an amount approximately equivalent to 3% of the stock’s market price, with a conspicuous burst of activity attending this penetration. This is the “confirmation” or “breakout.”
• Head and Shoulders Breakout Downward Price Target: • Breakout Price - (High Price of Head - Neckline Price)
Figure 7
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3- Double Top
DT formation occurs after an uptrend when buyers fail to break out the last peak then price decline and break below the bottom between the two peaks
Figure 8
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Figure 9
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Figure 10
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• The important points are:
(1) that buying cannot push prices up into the clear by a decisive margin
(2) the Support below is subsequently broken
How to trade double top formation?
The short signal is triggered when the price breaks below the support level and the stop loss above the chart formation with a target equal to the height of the formation projected from the breakdown level
Figure 11
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4- Double Bottom
Double Bottom occurs after a downward trend when the seller fails to break below the last bottom then bounces up and breaks out through the top between the two bottoms
Figure 12
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Figure 13
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Figure 14
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How to trade double bottom formation?
Buying signal is triggered when the price breaks out through the resistance level and the stop loss below the chart formation with a target equal to the height of the formation projected from the breakout level:
Figure 15
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Rounding Top and Bottom Formation
The Rounding Turn is a much simpler and more logical manifestation of this technical phenomenon. It pictures simply and plainly a gradual, progressive, and fairly symmetrical change in the trend direction, produced by a gradual shift in the balance of power between buying and selling. Rounding Bottoms are commonly referred to as Bowl or Saucer Patterns. Rounding Tops are sometimes called Inverted Bowls. The determination of the exact point of completion is not always clear and obvious with rounding formations
Figure 16
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Traders will seek to capitalize on this pattern by buying halfway around the bottom, at the low point, and capitalizing on the continuation once it breaks above a level of resistance
Figure 17
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5- Wedge Formation
The Wedge is a chart formation in which the price fluctuations are confined within converging straight lines but differs from a Triangle in that both boundary lines either slope up or slope down There are two types of wedges:
A- The Raising Wedge
Prospective buyers are more reluctant to pay high prices than low, and owners are more willing to sell at high prices than at low in other words any sort of rising tends to increase supply and diminish demand.
Figure 18
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How to trade The Raising Wedge?
A sell signal is triggered when the price breaks below the lower boundary of the raising wedge with the target at the beginning of the formation and stops loss above the last peak
Figure 19
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Figure 20
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Figure 21
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B- The Falling Wedges
Prospective sellers are more reluctant to push prices lower and owners are more willing to exit their long positions
Figure 22
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How to trade The Falling Wedge?
The buy signal is triggered when the price breaks out through the upper boundary of the falling wedge with the target at the beginning of the formation and a stop loss below the last bottom
Figure 23
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Figure 24
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Figure 25
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6- The Broadening Formation
Broadening Formation may be said to suggest a market lacking intelligent sponsorship that is out of control a situation, usually, in which the “public” is excitedly committed and is being whipped around by wild rumors. Broadening Formations have sometimes been called Inverted Triangles. The Broadening formation is a Five-Point Reversal
Figure 26
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Figure 27
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7- The Diamond
The Diamond Reversal Formation might be described either as a more or less Complex Head-and-Shoulders with a V-shaped neckline or as a Broadening Formation that, after two or three “swings,” suddenly reverts into a regular Triangle that is nearly always of the Symmetrical form. It carries a minimum measuring implication that having studied the Head-and-Shoulders and Triangle formulas, you can probably deduce for yourself. Prices should move at least as far from the breakout point as the greatest width in points of the pattern from its Top (head) to Bottom (V in neckline)
Figure 28
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1- Symmetrical Triangle
The most common form of a Triangle is composed of a series of price fluctuations, each of which is smaller than its predecessor, each Minor Top failing to attain the height of the preceding rally, and each Minor Recession stopping above the level of the preceding Bottom. The converging upper and lower boundary lines of the price formation come together somewhere out to the right of the chart, at the apex of our Triangle
Figure 29
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Figure 30
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How to trade using a symmetrical triangle?
After the triangle is completed the buy signal is triggered by the breakout of the upper boundary of the triangle if it comes after an upward movement and the stop loss is below the last bottom of the triangle and target will be the height of the triangle projected from the breakout level
Figure 31
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Figure 32
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