Stock or chart patterns have a significant role to play in any technical analysis. However, before a trader could actually make full use of them, the trader must first be knowledgeable about the different stock patterns and what they mean.
As a trader, being equipped with the knowledge and familiarity with the different kinds of chart patterns allows you to recognize the movement and direction of a chart thus enabling you to make more solid decisions regarding your trades. By recognizing the different chart patterns, you are able to make more accurate estimates as well as predictions in the market. This allows you to minimize risks and increase potential profits as you become aware if the market is bullish or bearish.
Why study stock patterns?
Table of content
Before you actually venture into learning about stock patterns, it is important to understand why you need to learn them.
Basically, stock patterns are ways to view the movement of prices in a chart during a specific trading period. This trading period can either be yearly, monthly, daily or even intra-day or by the hour or minute. One important piece of information that only a few traders know is that some stocks or markets repeat their price movements and chart patterns at a specific time. Now there is certainly no guarantee that history will repeat itself for a specific stock or market however chart patterns provide a psychological certainty or confirmation to a trader.
Anyone would agree that it is definitely a challenge to predict what happens to the market however these chart or stock patterns provide traders a huge leverage regarding the positions they should invest in. By making use of stock patterns, risks are reduced and a trader is able to get a future perspective on how the market would look like.
Three Chart Pattern Categories
When it comes to stock patterns, a trader should remember that there is no “one ultimate stock pattern” or a pattern that can be used for all markets or charts. Each pattern works accordingly to a specific trend and while some are used in bearish markets, others are also used in bullish markets.
In addition, there are three categories of chart patterns that a trader should bear in mind. These are reversal patterns, continuation patterns, and bilateral patterns.
Reversal Stock Patterns
A reversal stock pattern as the name implies shows a reversal or change in direction is about the happen – this is usually preferred by traders and many find this category most profitable than the others due to the expected change in direction.
Continuation Stock Patterns
Next is the continuation stock pattern which simply shows that the trend will continue with its form (either uptrend, downtrend, or sideways). In this category, traders usually hold their positions and wait for reversals or changes in direction.
Bilateral Stock Patterns
And last but not the least is the bilateral stock pattern which signifies that the market is volatile or can move either way. This is also the stock pattern category that many traders are wary of and would want to stay away from if possible due to the increased risks.
Top Stock Patterns You Should Know as A Trader
Here are the most commonly used chart or stock patterns in the market. While it is good to know what they mean, it is also important that a trader remembers their form for them to quickly recognize the patterns in a chart.
Triangle
The first stock pattern which a trader should always be familiar with is the triangle stock pattern. This pattern has a series of types that can be used effectively for bullish or bearish markets. These types of triangle stock patterns include the Pennant, Ascending triangle, Descending triangle, and Bullish or Bearish Symmetric triangle.
The Pennant triangle pattern usually shows a significant price action which slows down to consolidation. The pennant triangle shape is created by converging trend lines followed by a breakout. This pattern lasts for at least a week and usually shows a significant increase in volume followed by a decrease in volume (for bullish markets) prior to a big stock move. Pennant triangles are usual indicators for a bullish market but can also be used to gauge price drops when the lower trend line is penetrated.
Ascending and descending triangles are used for upward or downward trends respectively. Both are somewhat the same with a Pennant triangle however its base or its ceiling is usually fixed. For the ascending triangle, it comes with a top trend line which previous prices haven’t been able to penetrate until the last price action which causes a breakout – this applies to bullish markets. As for the descending triangle pattern, it comes with a base or lower trend line which hasn’t been penetrated by previous price movements until the last price action that causes the breakout – this occurs in bearish markets.
Bullish and Bearish Symmetric triangles on the other hand are quite easy to spot in any charts because of their converging symmetric trend lines. Both trend lines are symmetrical and almost have the same height. Immediately, penetration on the upper trend line shows a breakout for a bullish market. On the other hand, penetration on the lower trend line dictates a breakout for a bearish market.
Cup and Handle
The cup and handle stock pattern is named exactly after the pattern that it makes over the chart. The price action resembles a curved “U” shape which acts as the cup and a sloping price movement at the end which acts as the handle. A breakout from a cup and handle stock pattern usually occurs when its right side has a low trading volume and the pattern covers a minimum duration of at least 1 month. A breakout happens when the upper trendline of the handle is broken.
This stock pattern can be difficult to identify in a chart because it is usually surrounded by volatile price actions, however, it is known to be effective in delivering high yields and is being used by today’s top traders.
Head and Shoulders
The head and shoulders stock pattern as the name suggests is a pattern formation that is composed of a head between two shoulders. it is designed to have a “head” whose peak is higher than those of the “shoulders” and may not necessarily fall on a horizontal line. All three parts should fall under the same level of support or base prior to a breakout for a downward trend. The support level where the base of the three parts meets is called the “Neckline.” This particular pattern is usually visible at the peak or at the highest point of a rally before plummeting downward. The head and shoulders stock pattern is usually an indication of an imminent bearish market.
On the other hand, if you see an upside-down version of this pattern on a chart, there will be high chances for a reversal from a downward trend or a breakout towards a bullish market. The upside-down formation of this pattern is called “Inverse/Reverse Head and Shoulders”, which is a positive indication of a bullish market.
Double Top and Double Bottom
The formation of consecutive rounding tops represents a double top stock pattern. Each rounding top forms an inverted “U” or “V” pattern and when combined together forms a letter “M”. The letter M that is formed doesn’t necessarily need to be perfect – what’s important is that the rounding tops should meet on the same resistance level and the bases at the support level. A bearish breakout is expected from this pattern as soon as the latest price movement penetrates the support level.
The bullish counterpart of the double top stock pattern is the double bottom stock pattern which forms the letter “W.” Again, the formation may not look like a perfect “W” however the rounding bottoms should touch the support level. A bullish breakout is expected to happen as soon as the last price action penetrates the resistance level.
Triple Top and Triple Bottom
There will be times when an expected stock pattern would fail. For the case of a failed double top or double bottom stock pattern, it could lead to a formation of another rounding top – this evolves the previous pattern into a triple top or triple bottom stock pattern.
The only difference between this pattern with the double top or double bottom pattern is that it has a third rounding top or bottom. A breakout occurs the same way – when the support level or the resistance level is penetrated. This pattern can be identified when all three rounding tops or bottoms are touching the resistance or support level respectively.
Wedge
A wedge stock pattern is identified during the contraction of price ranges paired with an upward trend (for a rising wedge) and a downward trend (for a falling wedge). Usually, the wedge stock pattern can be found forming around the bottom or at the top of a trend within a minimum duration of three to four weeks.
Depending on the slant or slope of the wedge, the pattern can either be a rising wedge or a falling wedge which are both reversal patterns. The rising wedge has a slope that goes up which indicates a bearish market while the falling wedge has a downward slope which indicates a bullish market. A breakout happens as soon as the sloping top or bottom support is penetrated.
A major difference between the wedge stock pattern with the previously mentioned triangle patterns that resemble the same form is that wedge stock patterns usually cover longer durations and involves a series of tops and bottoms. It requires at least three to four weeks to complete a wedge whereas triangle stock patterns can take a few days. In addition, wedge stock patterns have both trend lines (support and resistance levels) sloping as compared to the triangle stock patterns which only have one sloping trend line.
Flag
A flag stock pattern follows the parabolic rise or fall of a market. It dictates or signals the continuation of a trend and is made up of parallel upper and lower trend lines that build a channel. It is made up of a flag pole which represents the preceding trend and the flag which represents the series of price action in the channel. A breakout happens as soon as the last trend penetrates either of the trend lines.
A bullish flag stock pattern points downward with its last trend piercing the upper trendline whereas a bearish flag stock pattern shows a flag that points upward with the last trend line piercing the lower trendline for a bearish breakout.
Many traders tend to assume a wedge to a flag stock pattern because of their seemingly similar formation. However, it is important to note that these two patterns have different effects and interchanging one with the other can lead to catastrophic losses. A wedge stock pattern has both sloping trend lines that converge or meet, whereas a flag stock pattern has both trend lines parallel to each other and does not meet or converge.
Rounding Bottom
The rounding bottom stock pattern which is also called the “Saucer Bottom” indicates a reversal of a trend. it starts with a downtrend followed by a curved consolidation and continuation to an uptrend bullish breakout. Traders capitalize on this stock pattern by making an investment on the middle portion of the bottom.
For a pattern to be considered as a rounding bottom stock pattern, the last trend should continue to an uptrend movement – penetrating resistance levels. If in case the price goes down from the resistance level, the pattern formation becomes a Cup and Handle stock pattern which still leads to a bullish market.
While the rounding bottom stock pattern is for bullish markets, the rounding top stock pattern is applied for bearish markets.
Our final thoughts
With the list of stock patterns, you’ve learned from this article, you’ll have better chances of identifying opportunities in a chart. However, you should bear in mind that there are a few other things to consider when dealing with stock patterns. One of these considerations includes indicators such as the support and resistance levels that make up a channel. The support and resistance levels are the upper and lower trend lines of most stock patterns. It tells the direction as well as the slope of the pattern.
Another consideration is the duration of the stock pattern. While other stock patterns may take effect and complete within a few days, others need at least a few weeks or even months before it can be considered as a specific pattern.
One way to confirm a stock pattern is by referring to the volume. To do this, check the chart for pivot points that matches the requirements of a specific stock pattern. Say for a rounding bottom stock pattern, the volume should gradually decrease until it reaches the midpoint of a specific duration. As soon as the mid-point is reached, a gradual increase in volume commences until it makes a breakout from its resistance level.
Being able to combine these considerations, confirmations, and other indicators such as RSI, Moving Average, and so on in assessing a stock pattern, provides better feasibility on your technical analysis. And combining your technical analysis with a sound fundamental analysis can lead to more profitable and less risky decisions.
A stock pattern is your friend when trading. It is the one thing you can rely on when having difficulties interpreting a chart. The best way to improve your skills in reading stock patterns is to simply get into actual trade. eToro is a great platform that comes with a virtual account where you can practice your skills in reading stock patterns and build experience as a trader.
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