Technical analysis: chart patterns
Recognising and acting upon known chart patterns can play a key part in a trader's strategy employing technical analysis.
Below we take a look at some key patterns used by technical traders when studying market movements and trying to predict future directions.
ASCENDING TRIANGLE
This is a bullish pattern and is formed by a series of higher lows and an upper resistance level. As price rallies it finds resistance and begins to erase some of its gains.
The subsequent fall in price is shorter than the previous fall and this manifests the series of higher lows. The higher lows indicates more buyers are gradually entering the market and buying pressure increases as price consolidates moving further towards the apex.
Price is consolidating with a bullish bias therefore traders need to watch out for an impending breakout up through the resistance level. Be aware that price can often test the resistance level once broken which can subsequently act as support.
The breakout can occur based on technical analysis and/or be caused by news flow so it is worthwhile to also consider the fundamentals and market sentiment when using this pattern.
DESCENDING TRIANGLE
This is a bearish pattern that is used in a downtrend market and is formed by a series of lower highs and a lower resistance level. As price declines it keeps finding resistance at a certain level and recovering some of its losses.
The subsequent retracement is shorter than previous retracements and this creates the series of lower highs. The lower highs indicates more sellers are gradually entering the market as they are willing to accept a lower price in order to establish a short position.
This creates selling pressure as price consolidates moving towards the apex. Price is consolidating with a bearish bias therefore spread bettors need to watch out for impending breakout down through the resistance level. Be aware that price can often test the resistance level once broken which can subsequently act as support.
Such a breakout can occur based on technical analysis and/or be caused by news flow so it is worthwhile to also consider the relevant fundamentals and market sentiment when using this pattern.
SYMMETRICAL TRIANGLE
This is a neutral pattern which can offer opportunities both long and short depending on which side price breaks out.
The range of price increasingly narrows by making a series of higher lows and lower highs and this is caused by growing indecisiveness in the market.
Such a pattern can form during a period before a significant news announcement the market is expecting and illustrates how investors are awaiting information before they make their next move.
Tension builds as price consolidates towards the apex and spread bettors should be poised to act if either trend line is broken.
BEAR FLAG
This is a bearish pattern formed by two declines separated by a brief consolidating retracement period.
The initial sell-off comes to an end through some profit taking and forms a tight range making slightly higher lows and higher highs.
This illustrates that there is still selling pressure present although traders are also entering long positions looking for a reversal and this forces price to drift in an upwards direction.
During the consolidation spread bettors should be prepared to take action should price break down through the lower range level and/or make a new low as this indicates the bears are in control again to force another sell-off.
BULL FLAG
This is a bullish pattern formed by two rallies separated by a brief consolidating retracement period.
The initial rally comes to an end through some profit taking and price forms a tight range making slightly lower lows and lower highs.
This illustrates that there is still support in the market although the unwinding of some large long positions and traders entering short positions looking for a reversal forces price to drift in a downwards direction.
During the consolidation spread bettors should be prepared to take action should price break up through the upper range level and/or make a new high as this indicates the bulls are in control again to push another rally.
HEAD AND SHOULDERS
This is a bearish reversal pattern which begins with an uptrend with two higher highs (1 & 3) and two higher lows (2 & 4) which forms the left shoulder and head.
Point 5 makes a lower high which is lower than points 3 and 1 and this forms the right shoulder.
This illustrates that the upward trend is coming to an end although the reversal is confirmed when price drops below the neckline at point 6 moving down pass the previous low at point 4.
It is also worth observing whether the ascent into point 3 is less steep than into point 1, and whether the ascent into point 5 is less steep than point 3 – if this does occur it displays how the bulls are becoming decreasingly aggressive and the upward momentum is running out of steam adding to the probability of a reversal.
TRIPLE BOTTOM
This is basically a reverse head and shoulders and is therefore a bullish pattern.
The pattern begins with a downtrend with two lower lows (1 & 3) and two lower highs (2 & 4) which forms the first and second bottom.
Point 5 makes a higher low which is higher than both points 3 and 1 and this forms the third bottom.
This illustrates that the downward trend is coming to an end although the reversal is confirmed when price pushes up through the neckline at point 6 moving up pass the previous high at point 4.
It is also worth observing whether the descent into point 3 is less steep than into point 1, and whether the descent into point 5 is less steep than point 3 – if this does occur it displays how the bears are becoming decreasingly aggressive and the downward momentum is running out of steam adding to the probability of a reversal.
ASCENDING CHANNEL
This is a bullish pattern defined by a trend line supporting the series of higher lows and a diagonal resistance level connecting the higher highs.
Clearly this is an upward trend line although each rally finding resistance at approximately the same percentage gain adds another element to the pattern.
The common way of trading this pattern would be to trade when price is around the bottom trend line looking for long opportunities although aggressive traders could trade long and/or short at both trend lines looking for a bounce.
Another way to trade this pattern is to wait for price to break through either trend line as this would signal resistance has failed leaving a possible clear path for further movement in that direction.
DESCENDING CHANNEL
This bearish pattern is the exact opposite to the Ascending Channel defined by a trend line supporting the series of lower highs and a parallel resistance level connecting the lower lows.
Clearly this is a downward trend line although each sell-off finding resistance at approximately the same percentage drop adds another element to the pattern.
The common way of trading this pattern would be to trade when price is around the top trend line looking for short opportunities although somewhat aggressive traders could trade short and/or long at both trend lines looking for a bounce.
Another way to trade this pattern is to wait for price to break through either trend line as this would signal resistance has failed leaving a possible clear path for further movement in that direction.
BULLISH TREND LINE
A bullish trend line can be defined as two or more higher lows that can be connected with a straight line. Price can bounce as the trend line acts as support therefore spread bettors should be ready to trade when price draws near the trend line.
The strength of the trend line can be determined by how many market participants recognize the trend line.
If a substantial portion of the market acknowledges the trend line that you are viewing then the trend line becomes self-fulfilling and can consequentially be a strong supporting trend line.
Conversely short opportunities may arise when price breaks through the trend line although do be aware of false breaks which do occur.
BEARISH TREND LINE
A bearish trend line can be defined as two or more higher lows that can be connected with a straight line. Price can bounce as the trend line acts as support therefore spread bettors should be ready to trade when price draws near the trend line.
The strength of the trend line can be determined by how many market participants recognize the trend line.
If a substantial portion of the market acknowledges the trend line that you are viewing then the trend line becomes self-fulfilling and can consequentially be a strong supporting trend line.
Conversely long opportunities may arise when price breaks through the trend line, indicating a possible change in sentiment, although do be aware of false breaks which do occur.
