Chart Patterns and their characteristics
Chart Patterns or Price Patterns are one of the many tools of technical analysis (TA) that are widely used for different investment situations.
Chart patterns take place when a price graph forms a permanent pattern from the indication of supply-resistance and trend lines. They are commonly found in every financial market and can help guide investors about the upcoming trends and can be divided as such:
1. Reversal Pattern
2. Continuous Pattern
1. Reversal Patterns are indicators of possible reversals in the market, wherein the price breaks out of the designated pattern. It is composed of:
Head and Shoulder
The Head and Shoulder pattern indicates bullish and bearish markets and is characterized by its distinctive appearance which is much like a person’s head, neck, and shoulder features.The head is the designated highest point with two shoulders and a neckline as support lines. If the support line is broken out of, it can be indicated that the market is heading in a downtrend motion.
Inverse Head and Shoulder
Much like its friend of opposition, the head and shoulder pattern contrastingly occurs when the market travels in reversal, into a downtrend trend. Its components are much like the former head and shoulder pattern but differentiate only in how everything is inverted. The head would be the lowest point and the shoulders would be resistance line indicators instead. If a break-out were to occur at this line, a full reversal would be displayed, signaling the market’s reversal into an upward trend.
Double and Triple Tops
Double and triple tops are patterns that illustrate an uptrend market of two or three consecutive high times with a brief period of decline between them and finish its duration when a price falls below the support level.
Traders have often waited for the breakout to be final before making any purchasing decisions, while also employing the use of various other tools and indicators to observe the divergence and volume of the market.
Double and Triple Bottoms
Double and triple bottoms take place when markets become bearish and make a shift to becoming bullish. The pattern designates two or three low points, before shifting upwards into an uptrend market.
Wedges are chart patterns akin to triangular shapes and travel along the same trend line, before traveling in the same motion upwards or downwards. Wedges can be divided into rising and falling wedges.
Rising Wedges are triangular patterns with upward facing support-resistance lines, resulting in price elevations. However, in such events, prices tend to fall in a bearish motion after the market volume plummets.
This pattern occurs when the market is currently in a bullish trend, however, if it takes place in a bearish one, there is a tendency that it may stay in this continuous pattern.
Falling Wedges are triangular patterns with downward facing support-resistance lines, opposing to the rising wedge. This pattern generally occurs in bearish markets, indicating a possible reversal pattern. When a price exceeds a trend line, there is a chance that there would be increased buying demand, further leading the market into an upward trend. However, if its occurrence takes place in a bearish market, there is a chance that it would stay in a continuous pattern.
2. Continuous Patterns are indicators that arise when a breakout occurs, leading to a continuous movement in that direction. Such patterns include wedges, as well as pennants and flags. Pennants and flags are patterns that represent the shape of a flag and take form when a price has fallen after a certain period of time and has exceeded the set trend line.
When found in a market, if already bearish, it would continue in that motion, as well as for bullish. Pennants are more triangular, while flags share the qualities of a rectangle with parallel trend lines.
Price Channels are composed when two trend lines travel in parallel, in accordance with the market’s trend. The main trend line and channel maintain the price movement and aid the indication of continuous movement in that certain direction.
This pattern appears in both up and downtrend markets. In bullish markets, the main trend line is created within the structure to conduct a support line, whereas the channel line is the pattern’s resistance line. While in downtrend markets, the two lines would swap roles.
Traders have been found to profit off of price channel indicators by buying when prices approach the support level and selling at the resistance line for short-term profit. Some may even wait for prices to exceed the price channel before making any decisions.
Cup and Handles
Cups and Handles is a chart pattern that resembles a cup and handle that is created when a price travels in a bullish motion after a brief pause and continuing in the same direction. The cup is an elongated “u” shape and the handle has a small downward dip. Trend lines are indicated to confirm a breakout point in this chart pattern.
Inverted Cups and Handles
Inverted Cups and Handles contrast to the previous in terms of how it is flipped over and used to indicate bearish markets wherein prices continuously fall before briefly pausing and traveling in an uptrend motion instead.
Chart Patterns in the form of triangles often occur to indicate a price’s sideways motion before continuing in its previous direction. It is worth noting that triangle chart patterns are applied to recognize the continuity of a market’s trends, but tend to be created when a market travels sideways without any clear market indications. Therefore, breakouts could be the awaited confirmation for any buying-selling decisions.
Triangles can be categorized into three variations:
Symmetrical Triangles are displayed when two trend lines travel in a triangular movement and intersect at a similar degree.
Descending Triangles have support lines traveling horizontally with resistance lines moving diagonally downwards before intersecting with a downward and acute degree. If found in bearish markets, it can often be used to indicate continuity.
Ascending Triangles occur in bullish markets and share the same characteristics with descending triangles in terms of how it is inverted. The resistance line travels horizontally with the support line travelling diagonally upwards. Often, prices continue to travel in an upwards motion.
Chart patterns have been widely used and recognized as accurately helpful. However, their usage should be in collaboration with other tools and indicators for both increased accuracy and risk management when trading. Breakouts in chart patterns can often be false breakouts, which can further lead to asset loss if not careful.