We’ve discussed indicators and trends as well as popular trading strategies using technical indicators in our previous articles. In this blog, we discuss the most popular stock chart patterns for trading.
Chart patterns are essentially shapes formed on trading charts, which may help identify price action signals like reversals and breakouts.
Over the years, several stock chart patterns have been widely recognized. Using these chart patterns can give your trading an edge by allowing you to confirm a specific signal or trend.
Whether or not you’re new to stock patterns, it’s time to familiarize and refresh yourself with these 8 popular chart patterns.
1. Head and shoulders pattern:
This pattern forms when a stock’s price increases and reaches a certain level and then comes back to the base from where it started earlier.
After this, it again starts rising and crosses the previous peak, reaches a new high price, and then declines to reach the base.
Finally, the stock price again rises but goes only to the level of the first peak. Then, it falls, and while declining, if it breaks the established baseline with a reasonable volume, the bearish reversal occurs.
2. Double Top:
This is a bearish reversal chart pattern that is formed when a stock is on an uptrend for some time.
The stock’s price increases and reaches a level and declines to the support after creating a peak.
This support level is called the neckline.
It rises after getting to the neckline, reaches the previous level, and forms a peak.
Finally, the formation of this pattern completes when the price comes back to the neckline after creating the second peak. If the price breaks through the neckline while retracing back, it confirms a bearish trend reversal.
3. Double Bottom:
This is a bullish reversal trading pattern comprising two lows below a resistance level referred to as the neckline.
The price will hit the first low just after the bearish trend. However, it stops at this level and retraces back to the neckline.
After hitting the neckline, the price rebounds and enters a bearish trend, reaching a price almost the same as the previous low.
Finally, the price again starts increasing and comes to the neckline. Further, if this bullish trend breaks the neckline and continues moving upwards, it confirms the uptrend.
4. Rounding bottom:
This pattern shows a bullish upward trend and can be divided into three parts.
First, excess supply forces the stock price to go down, thus forming the declining slope of a rounding bottom.
The transition to an upward trend occurs when buyers enter the trade after seeing the stock at a low price, thus increasing the demand for the stock.
After completing the rounding bottom, the stock’s price breaks the resistance line and continues the uptrend. The trading volume is less at the lowest point of the chart and high at the decline and when the stock price reaches its previous high.
5. Cup and handle pattern
This pattern shows a bullish market trend after a pullback.
It features a rounding bottom followed by a handle-like consolidation, which might look like a pennant, wedge, or a smaller rounding bottom followed by a solid upward trend after that.
The breakout towards the upward trend must be confirmed by a substantial volume above the handle’s resistance, or it might come out to be a fake breakout.
The limitation of this pattern is that it takes a longer duration to form, leading to late decisions. Further, sometimes a very shallow cup can be a signal, whereas other times, even a deep cup can be a false signal.
This pattern is formed by converging trend lines on the chart.
Two trend lines are generated by connecting the highs and lows of the price of a stock over a period.
Highs and lows either rise or fall at a different rate, resulting in a wedge-like appearance.
Wedge patterns are primarily used for forecasting price reversals and can signal both bullish or bearish price reversals.
There are three standard features in both cases: converging trend lines, a decline in volume with the price progression, and finally, a breakout from one of the trend lines.
The two types of wedge patterns that form are the rising wedge and the falling wedge.
Rising wedge patterns result in a decline in stock prices after the breakout at the lower trend line.
This offers an opportunity for short-selling.
In the case of falling wedges, price breaks the upper trend line, and the stock price reverses and trends higher. This provides an opportunity for entering a long position.
7. Pennants and flags:
Flags are consolidation phases where the trend lines are parallel to each other.
This pattern is formed by a sharp counter-trend (flag), which is succeeded by a short-lived trend (flag’s pole).
This pattern is primarily used in combination with volume indicators and signifies trend reversal or breakouts after consolidation.
Pennants are identical to flags in their implications, but the trend lines converge instead of being parallel in pennants. Further, it’s crucial to observe the volume in a pennant. Volume should be low during consolidation, whereas during the breakouts, it should be on the higher side.
Perhaps one of the most commonly used patterns is triangles – ascending, descending, and symmetrical. Go to our blog post to read up on the triangle pattern.
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