Chart Patterns in Stock Markets

 

Chart Patterns

Technical analysts and chartists often study stock charts for recurring price patterns, or stock chart formations, that appear on price charts on fairly a regular basis. These recurring chart patterns are one of the key elements of price action as well as technical analysis that can be used on their own or as confirmation for signals from technical indicators. They are based, by and large, on trendlines, which are lines drawn on a chart to indicate support and resistance levels. A support line is a level where the stock price appears to have difficulty moving or penetrating below due to increased demand, while a resistance line is a level where the stock price appears to have difficulty moving above due to a potential hike in supply.

Chart patterns can be based on any price chart of any time frame, and usually provide clear entry and exit signals and price projections, stop levels, and profit targets. Most patterns fall into two categories: continuation patterns and reversal patterns, but some are both continuation and reversal patterns, depending on the price breakout.

Continuation patterns indicate a higher probability of the continuation of the existing trend. These patterns are usually momentary consolidations or retracements within the existing market trend. The common continuation patterns include cup and handle patterns, bullish and bearish flags, bullish and bearish pennants, rising and falling wedges, and various triangle patterns, namely symmetrical triangles, ascending triangles, and descending triangles.

Reversal patterns indicate a high probability that the existing trend has come to an end and will soon reverse direction. The common reversal patterns include double tops and double bottoms, triple tops and triple bottoms, head and shoulders, rising and falling wedges, and the less common rounded tops and rounded bottoms.

However, a few of these recurring chart patterns, such as the rectangle pattern, wedge pattern, and symmetrical triangle pattern can be either continuation or reversal patterns.

Most of these chart patterns can be applied to bar charts, candlestick charts, and line charts. Some technicians suggest that the best type of chart for identifying common chart patterns is the line chart, as it cancels out all the noise that comes with random price movements. However, some chart patterns are specific to bar charts, candlestick charts, and point and figure charts namely the flags, wedges, pennants, etc.

Quite a number of these patterns, such as the flag, pennant, head, and shoulders, and rising and falling wedges have logical price objectives where a trader could seek to take profits. However, these price objectives do not represent the end of particular price action and should not be misunderstood as a point at which you should reverse your positions, as it does not mark the start of a new trend in the price action.

Furthermore, technical analysis is not an exact science, thus these patterns indicate direction and target prices not with absolute certainty, but with a degree of high probability. However, there is always a danger of seeing patterns that are not there. For this reason, the use of volume as confirming tool to the underlying market psychology and possibly the use of other technical indicators are highly recommended.