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Chart patterns

Buying and selling pressure shape the price in a visual format. They will show you patterns that are the history script of the bulls versus bears war.
Studying this story, you will identify their significant moves, what they mean for each parties, and who is the more likely to win.

Patterns are a key to technical analysis, although they still need to be confirmed by other indicators, mainly volume and RSI.
You will learn the RSI in the next chapter, you can also read the RSI class before this one.

Summary:

Reversal patterns

Reversal patterns indicate the possible reversal of the current trend, let It be bullish or bearish.
A key principle here is the concept of neckline which is a support/resistance level needed to be broken to get further confirmation that the pattern will be fulfilled.
It is discouraged to open a position before a breakout of the neckline.

Once the neckline gets broken, the first target is the last support/resistance formed before the pattern.

The “Head and Shoulders” pattern

Often abbreviated “H&S” or even “HS” by traders.

Head and shoulders chart pattern Head and shoulders chart pattern

The real-case example I took is deliberately an ugly one, to show you to be flexible in your visual interpretation.

Volume confirmation: From the head down to the right shoulder, an increase of CH along with volume shows you bears are in position of force.
Same for the right shoulder to the neckline.

RSI confirmation: From the head down to the right shoulder, a strong downward momentum and/or a oversold signal, show you that bears are confident.

The story behind: The left shoulder gives a first warning to buyers, but they still try to push the price and succeed to the head, however the momentum is lacking. Sellers get in with greater force on the head.
Buyers try a last time to increase the value, but fail to even reach the head again, the point of reversal of the first shoulder acting as a resistance: they are now in a really bad position.

The “reversed Head and Shoulders” pattern

This is the bullish version of the H&S.

Reversed Head and shoulders chart pattern Reversed Head and shoulders chart pattern

The real-case example here is much more cleaner than the previous one.

Volume confirmation: From the head up to the right shoulder, an increase of CH along with volume shows you bulls are in position of force.

RSI confirmation: From the head down to the right shoulder, a strong downward momentum and/or a oversold signal, show you that bears are confident.

The “double top” pattern

Double top chart pattern Double top chart pattern

Volume confirmation: On the second top, a recrudescence of volume on bearish candles is an encouraging indication.

RSI confirmation: The second top ideally shows a lower bullish momentum. This can show up as a bearish divergence.

The story behind: After a small defeat on the first top, bulls try again, but getting defeated at the very first resistance is a big sign of weakness.

The “double bottom” pattern

This is the bullish version of the double top.

Double bottom chart pattern Double bottom chart pattern

Volume confirmation: From the neckline, a shy downward action is a supportive sign.
On the second bottom, a recrudescence of volume on bullish candles is an encouraging indication.

RSI confirmation: The second bottom ideally shows a lower bearish momentum. This can show-up as a bullish divergence.

Double tops and double bottoms are very strong patterns with a high rate of fulfilment. You will encounter them a lot more than head and shoulders.
Their volume and RSI confirmations are more open to interpretations.
They are also safer to trade even if the neckline has not been pierced. However, be careful as it could not break it and start to draw other patterns such as flags or even wedges (see below).

Continuation patterns

Continuation patterns are consolidations that shows that the current trend is mean to continue. It can help you to keep your calm and have more confidence in letting your position open, to profit from further gains.
If you were not in the market, it can show you that it’s not too late and that there might be a good entry point.
Reversely, it can also points you that a downtrend is mean to evolve even more, and encourage you to sell, putting an end to your hopes of reversal.
They are all extremely common.

The flags

Bullish flags Bearish flags
Bullish flag chart pattern Bullish flag chart pattern Bearish flag chart pattern Bearish flag chart pattern

RSI confirmation: A RSI confirmation is extremely important when it comes to flags, rectangles or pennants. The pole must shows as overbought for bullish patterns, and oversold for bearish patterns. It shows there was a good momentum, which ought to continue after a small breath-taking pause.
The pole must be taller than the flag width.

Rectangles and pennants are simply some sub-categories of flags. They require the same kind of confirmations.
Having a lot of terminology make some people feel smart. I personally refer them all as being flags.
I show them to you for the sack of teaching vocabulary.

Bullish rectangle Bearish rectangle Bullish pennant Bearish pennant
Bullish rectangle chart pattern Bearish rectangle chart pattern Bullish pennant chart pattern Bearish pennant chart pattern

Note that for the pennants, their trend lines point in contrary directions: one point up while the other point down, unlike the wedges where both trend lines point either up or down at the same time.

Wedges

Wedges can be continuations of reversal patterns, depending of their context.
They are very strong indications with a high rate of fulfilment.

Falling wedges

They are bullish patterns: they can be found in bulltrends and beartrends: they are a signal of reversal in bear settings.

Bull setting Bear setting
Falling wedge chart pattern in a bullish setting Falling wedge chart pattern in a bearish setting
Falling wedge chart pattern in a bullish setting Falling wedge chart pattern in a bearish setting

They don’t necessarily have a pole. If they have one, the fact that the formation grows taller in width than it, doesn’t invalidate the pattern.

Both trend lines must point downward. The line at the bottom must have a lower horizontal angle than the top one.

Rising wedges

They are bearish patterns, as their counterpart, they can be found in all kind of trends.

Bull setting Bear setting
Rising wedge chart pattern in a bull trend Rising wedge chart pattern in a bear trend
Rising wedge chart pattern in a bull trend Rising wedge chart pattern in a bear trend

Both trend lines must point upward. The line at the top must have a lower horizontal angle than the bottom one.

Trading wedge patterns

It is recommended to open a position when the price is squeezing and nearing the apex. The volume should also be narrowing at this time, before a sharp bounce.

For increased safety, it’s a great idea to wait the breakout before opening a position.

If the price continues to squeeze until touching the apex, be cautious as this could invalidate the pattern: the breakout usually occurs within the first 75% width of the formation.

Triangles

Triangles don’t indicate any bullish or bearish future: you have to wait a breakout to know what direction will be followed.
In the meantime a volume analysis could give you more insights.

Symmetrical triangle Ascending triangle Descending triangle
Symmetrical triangle chart pattern Ascending triangle chart pattern Descending triangle chart pattern
Symmetrical triangle chart pattern Ascending triangle chart pattern Descending triangle chart pattern

A breakout with high volume and strong momentum implies that the trend is more likely to continue for a while before reversing, thus allowing greater gains.

Conclusion

The patterns I showed you here are the most common and trustworthy.
I invite prudence with triangles, as newbies often think that it will break upside rather than downside, for no reason except hope.
There is many other less reliable patterns, such as the “cup and handle”, this one has great success with newcomers, but should be discarded, as they start to hallucinate it everywhere.

Exercises

  1. Open a chart and identify by yourself each one of the patterns we learned.
    Go as far in the past than needed. Check everything on multiple time-frames.
    Observe closely the corresponding volumes.
    After a few months, your eyes and brain will get used to identify them easily and rapidly.

  2. Draw all the trend-lines you need and ask yourself how you’d have traded that, and how you could have get tricked by the market.
  3. When you find a pattern, observe how it looks on smaller time-frames, even on the minutes one. Examine how it show-up on higher time-frames such as the daily, weekly, and even the monthly.

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