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CHART PATTERN ANALYSIS
Analysts, investors and traders often ask how to determine where a trend comes to an end. The Fibonacci trading tools and the candlestick patterns provide two significant ways to answer this question. Chart patterns are a third method for analyzing trends.
We try to integrate Fibonacci trading tools, candlestick patterns, and chart patterns because, as mentioned, they are all based on the most important element that moves the markets: investor behavior.
The study of chart patterns has gone on for at least a century, and analysts have written many excellent books about this topic over the past decades. Today, many traders prefer to focus on technical indicators that are computer driven and are based on complex mathematical formulas. But the computer models have yet to prove that they can consistently outperform pattern recognition as an analyst approach.
The following chart patterns are well known, have a high analytic value, and can be combined with other trading tools described as follows:
Selected Reversal Chart Patterns
The most common reversal chart patterns share three characteristics:
- They form at the end of an uptrend or downtrend.
- The bigger the chart formation, the bigger is the following reversal.
- In general, chart formations on tops are shorter and have a bigger volatility than bottom formations.
Type Of Chart Patterns
Technical Analysis is based on the premise that history repeats itself. it follows then, that if you can analyze the recurrence of identifiable patterns and formations that have preceded or accompanied important market movements in the past, you can get important clues about the future.
Some chart patterns are more reliable than others for prices forecasting but none is infallible. some patterns are very reliable, while others do not end in the price target one would expect. Our effort here is to focus on a select group of chart patterns that have been proven to be of considerable validity over many years.
Broadly, there are two types of price patterns that develop on charts:
- Reversal Patterns
- Continuation Patterns.
There are a number of reversal pattern which indicate the end of a trend.
The most common of these are:
- Head and shoulders tops and bottoms;
- Double tops and bottoms;
- Rounding tops and bottoms;
- Broadening formations;
- Triple tops and bottoms
Continuation patterns, on the other hand, are usually shorter term in duration and are often classified as intermediate term chart patterns. Some of the most common continuation patterns include:
Common Features of Reversal Patterns
Let us consider a few important points which are common to all reversal patterns.
Many a time, you may come across a pattern on the chart which resembles a reversal pattern. However, if there was no major ongoing trend before the occurrence of such a pattern, it becomes suspect.
The Breaking of an important trend line is often the first signal of an impending trend reversal.
The Violation of a rising trend line would indicate the possibility of the trend reversing direction and moving sideways or downwards.
The Violation of a falling trend line would indicate the possibility of the scrip moving either sideways or upwards in the near future.
Importance of Height and Width of the pattern
The greater the height and width of a reversal pattern, the more powerful would be the resultant move following a breakout from the pattern.
Topping and bottoming Patterns
Topping patterns indicate the formation of a top. Upon the completion of these patterns one can expect the price to move downwards. Topping patterns are generally shorter in duration and the price swings within these patterns are quite swift and volatile.
Bottoming patterns, on the other hand, indicate the formation of a bottom and on completion of these pattern one can expect the scrip to move upwards. these patterns generally take more time to form than do topping patterns and during this time the price moves in a small range.
Volume
- if the price breakout from a bottoming pattern is not accompanied by higher than average volume, the probability of it being a false breakout should be considered quite high.
- However, the volume accompanying a topping breakdown is not that important because there are a number of examples where the market has reversed direction without being accompanied by a sizeable volume.