Chart Patterns

What Are Chart Patterns?

In technical analysis, a chart pattern is a distinct formation on a chart that creates a trading signal, or a sign of future price movements. Chart patterns are the basis of technical analysis and are believed to be a reflection of the collective psychology of market participants. They can be categorized as either reversal or continuation patterns.

Reversal Patterns

Reversal patterns signal that a prevailing trend is likely to change direction. They indicate that the sentiment of the market is shifting.

• Head and Shoulders: A pattern that resembles a baseline with three peaks, the outside two are close in height and the middle is highest. It signals a potential trend reversal from bullish to bearish. An inverse head and shoulders signals the opposite.
• Double Top / Double Bottom: A double top is a bearish reversal pattern where the price makes two consecutive peaks at roughly the same level. A double bottom is the bullish equivalent.

Continuation Patterns

Continuation patterns signal that a prevailing trend is likely to continue after a temporary pause or consolidation.

• Triangles: These can be symmetrical, ascending, or descending. They represent a period of consolidation where buyers and sellers are in a temporary state of equilibrium before the price breaks out and continues the trend.
• Flags and Pennants: These are short-term continuation patterns that form after a sharp price movement. They represent a brief pause in the market before the trend resumes.

The Importance of Confirmation

No chart pattern is foolproof. It is crucial to wait for a pattern to be confirmed before acting on it. Confirmation typically comes in the form of a breakout, where the price moves decisively above a resistance level or below a support level that defines the pattern. This breakout should ideally occur on increased volume.