Technical chart patterns are used to identify the future direction of a security price. They may be continuation patterns – which means that the price will follow the same trend after a brief pause or reversal patterns. Reversal patterns indicate the change in the trend direction, so they are very important in technical trading. Below, we’ll discuss some of the most common technical chart patterns and what they may indicate.
A continuation pattern simply means that the price temporarily interrupts the existing trend, but it will return to the same trend after a while. So, in an uptrend, the price temporarily pauses, and then it continues its upward movement. Similarly, in a bear market, the price pauses for a while before it continues the downtrend.
Pennants are essentially two trendlines that converge, forming a small symmetrical triangle.
A pennant is different from a triangle chart pattern in that it is preceded by a strong move (either up or down, depending on whether the chart pattern is bullish or bearish). This initial move is called a flagpole. The two trendlines forming the pennant are opposite (one is up and the other one is down).
A pennant also has two breakouts, one at the end of the flagpole, and another at the end of the consolidation period. After the second breakout, the initial trend continues.
Flags consist of two trendlines that are parallel and may slope up, down, or horizontally. In a bullish market, a flag may form temporarily with the prices decreasing temporarily, until a breakout, after which the price continues the initial trend. You can find out more about the bearish flag in ThinkMarkets’ article on this topic.
A wedge in a bull market has a price consolidating between the upward sloping support and resistance lines. The higher lows are typically quicker than higher highs, leading to a wedge-like chart pattern.
Usually, if the rising wedge appears after an uptrend, it may be a reversal pattern. If it forms during a downtrend, it is usually a continuation pattern.
Cup and Handle
Another popular continuation pattern is the cup and handle. It is a bullish pattern (which occurs during an uptrend). The “cup” is a “U” shape with equal highs on both sides of the cup, while the handle is on the right side and is a short pullback (may look like a pennant or flag as discussed above). Once the handle is complete, the price usually reaches new highs and continues its uptrend.
Head and Shoulders
Head and shoulders is one of the most common reversal patterns. When it interrupts a downtrend, it is known as an inverse head and shoulders or a head and shoulders bottom.
The head and shoulders pattern usually has an initial peak (the first “shoulder”), followed by a higher peak (the head), then a third peak that resembles the first one (the second “shoulder”). Whenever possible, the pattern should be associated with relevant indicators that confirm the direction of the price.
In a double top or a double bottom, the price has unsuccessfully attempted to break through the support or resistance. A double top usually resembles the letter M. At the end of the second attempt, the trend usually reverses. In a bear market, the double bottom resembles the letter W.
Triple tops are rare patterns, but they act similarly and are considered powerful signals for trend reversal. Just like with the double top or bottom, the price tries to break through the support or resistance level three times and fails.
Some other reversal patterns you may want to check out are the bullish/bearish engulfing candlestick patterns (check this ThinkMarkets article on it) and, for more advanced traders, the morning and evening star candlestick patterns may be very insightful (detailed in this ThinkMarkets article).
All in all, there are many technical chart patterns that you may come across in your trading journey. In this article, we’ve discussed some of the most important and common ones, such as the pennant and the head and shoulders.
It’s important to keep in mind that patterns should be consistent with other technical indicators. Using other tools to confirm a pattern will help you increase the accuracy of the prediction to avoid possible mistakes.
By Staff Writer.