Humans are designed to recognize patterns. It’s innately built into us.
We can tap into this ancient wisdom, and apply it to the stock market to help capture profit. One common way to do this is to recognize chart patterns. Understanding stock chart patterns can help us to know what’s coming in the future, which is advantageous to us if we want to turn money into more money, of course.
But there’s no guarantee here. We can’t know the future, of course. Still – the more you know and understand about chart patterns, the better you’ll be able to predict what’s next.
This guide serves as a reference and a go-to guide to the most commonly used, and arguably most effective chart patterns used in trading. We’ll go over bullish, bearish, and neutral patterns so that you can spot patterns no matter what direction a security’s price is moving.
Let’s dive in!
What you’ll learn
What Are Chart Patterns?
Chart patterns are a technical analysis tool used by investors to identify and analyze trends to help make decisions to buy, sell, or hold a security by giving investors clues as to where a price is predicted to go. There are several types of chart patterns such as continuation patterns, reversal patterns, and bilateral patterns.
Continuation patterns indicate that the current trend in a stock’s price will continue. Examples include flags, pennants, and rectangles. Reversal patterns indicate a change in the direction, or the reverse of a stock’s price trend. Examples include head and shoulders, double tops and bottoms, and trend line breaks. Bilateral patterns indicate a stock’s price movement within a range of support and resistance levels. Some refer to this as “teeter-tottering”. Examples include rectangle, triangle, and wedge patterns.
Now, the patterns themselves begin to ‘manifest’ as lines and curves are drawn on price graphs. Moving averages, trend lines, and support and resistance levels are key indicators that help investors identify the patterns.
Lastly, chart patterns are an effective tool used in both simple and complex strategies for trading options, but they should not, and do not serve as a guarantee. So make sure you juxtapose with other forms of analysis like fundamental analysis, or other technical indicators like historical volume to give yourself the best chance at using patterns to know how a stock will move in the future.
Are Chart Patterns Reliable?
Chart patterns have been used for a long time by investors to help them make investment decisions in the market. So there is absolute reliability to them. That being said, chart patterns are not always accurate, and sometimes what is predicted to happen doesn’t happen, or even the opposite happens sometimes. It comes down to statistics.
Chart patterns are a raw technical analysis tool that points to statistically probable outcomes. The key here is to increase the statistical probability by combining what you see in a chart pattern with other indicators and factors such as moving averages and historical volumes.
Now, while the outcomes of chart patterns are based on statistics, reading them can be more intuitive. Your ability to recognize patterns is quintessential if you want to be successful in using them. And sometimes the mind sees what it wants, so be objective when you think you’ve spotted a pattern, and then add some other analysis layers to it to support what you’re seeing.
Different Types of Chart Patterns
There are heaps of different types of chart patterns, but all of them fall under three categories: continuation, reversal, and bilateral chart patterns.
We’re going to go over the most popular ones in each category so you’re fully acquainted with chart patterns and can start to spot them on price graphs yourself.
We’ll start with the three categories, continuation (bullish pattern), reversal (bearish pattern), and bilateral (neutral/ hold), and then drill into each category and review the specific patterns.
Continuation Pattern
A continuation pattern is created after there is a brief interruption in a security’s price movement, but then it resumes in the same direction as before hence, “continuation”. There are different types of continuation patterns including flags, pennants, and rectangles.
Flags and pennants are short-term continuation patterns that last for several weeks. They are characterized by a sharp price move followed by a period of consolidation or correction. This period is usually accompanied by a decrease in trading volume. After this period, the security’s price typically resumes its previous trend.
Rectangles are continuation patterns that last for several months. They are characterized by a period of consolidation or correction between two parallel lines of support and resistance. This period is usually accompanied by a decrease in trading volume. After this period, the security’s price typically breaks out in the direction of the previous trend.
Reversal Pattern
A reversal pattern is created when a stock’s price movement has been on an uptrend or downtrend for a while, but then reverses in the opposite direction it was moving before. There are several types of reversal patterns such as head and shoulders, double tops and bottoms, and trend line breaks.
Head and shoulders patterns are identified by three peaks, where the one in the middle (the head) is higher than the two (the shoulders). Double tops and bottoms are identified by two peaks or two troughs at similar price levels. Trend line breaks occur when a stock’s price breaks through support or resistance lines.
Bilateral Pattern
A bilateral pattern is created during a period of indecision in the market and can last for an extended time. Essentially, investors don’t know what they want to do, and market psychology causes the security’s price to be sort of paralyzed.
There are several types of bilateral patterns such as rectangle, triangle, and wedge patterns. We touched on the rectangle and triangle patterns above, and we’ll dive deeper later. Wedge patterns have a slope in the support or resistance level, and can indicate a possible reversal of the current trend.
It’s important to note that while these are generally strong patterns, it’s a good idea to use them with other technical and fundamental analysis tools to cross-reference what you’re seeing on the graph.
Bullish Chart Patterns Cheat Sheet
Bullish chart patterns are used by investors when they’re looking to buy a security. This is because bullish patterns signal a reversal following a downtrend.
There are also bullish continuation patterns, where the pattern indicates that while there was a brief correction in price, the price will continue following its upward trend, such as the cup and handle pattern.
Some bullish patterns are just the reverse of a bearish pattern, such as the triple bottom, and the triple top being its bearish pattern equivalent.
Below are the most common bullish patterns used by investors, as well as some images to show you what they look like in action.
Triple Bottom (Reversal)
- A triple bottom pattern is a reversal pattern bullish reversal chart pattern that appears on a stock chart, typically after a prolonged downtrend.
- It is characterized by three distinct bottoms at roughly the same price level, separated by periods of upward movement.
- The pattern is considered to be complete when the stock price breaks above the resistance level formed by the highs between the bottoms.
- The reversal happens after the third bottom is created.
- The triple bottom pattern is used by traders and investors as a signal to buy or add to a position.
Chart pattern that signals a potential reversal in the current trend of a stock and is characterized by three equal lows followed by a breakout above the resistance level.
Double Bottom (Reversal)
- A double bottom pattern is a reversal pattern characterized by two distinct bottoms at roughly the same price level, separated by a peak or a trough.
- The pattern is considered to be complete when the stock price breaks above the resistance level formed by the peak or the trough that separates the two bottoms.
- However, it is important to note that the double bottom pattern is not a guarantee of a bullish reversal and should be considered in conjunction with other technical and fundamental analyses.
- The reversal happens after the second bottom is created, perhaps making it a slightly weaker signal than a triple top.
- The double bottom pattern is used by traders and investors as a signal to buy or add to a position.
A chart pattern that indicates that a downward trend may be reversing and that the price is likely to increase.
Inverse Head & Shoulders (Reversal)
- An inverse head and shoulders pattern is a reversal pattern characterized by a peak (left shoulder), a lower peak (head), and a higher peak (right shoulder) that forms a “V” shape.
- The pattern is considered to be complete when the stock price breaks above the resistance level formed by the “neckline” connecting the lows of the two troughs.
- The pattern is considered a reversal pattern as it forms after a downtrend.
- The reversal happens as the price is moving to the neckline, creating the last shoulder.
- The inverse head and shoulders pattern is used by traders and investors as a signal to buy or add to a position.
A chart pattern typically seen at the bottom of a downtrend, indicating a potential reversal in the market.
Rounded Bottom (Reversal)
- A rounded bottom pattern is a reversal pattern characterized by a gradual and smooth curve that forms a “U” shape.
- The pattern is considered to be complete when the stock price breaks above the resistance level formed by the highs of the rounded bottom.
- A rounded bottom pattern usually forms over a period of time and is considered more reliable as compared to other chart patterns.
- The rounded bottom pattern is used by traders and investors as a signal to buy or add to a position.
This chart shows the reversal of a downward trend in stock prices, indicated by the rounded bottom shape of the chart.
Falling Wedge (Reversal)
- A falling wedge pattern is a reversal pattern characterized by a diagonal trendline that slopes downward and two parallel trendlines that are converging.
- The pattern is considered to be complete when the stock price breaks above the upper trendline of the falling wedge.
- It is important to note that a falling wedge pattern is a bullish pattern, but it can also be a bearish pattern if it forms an uptrend.
- The confirmation of a falling wedge pattern is more reliable when it is accompanied by a strong volume breakout.
- The falling wedge pattern is used by traders and investors as a signal to buy or add to a position.
This chart shows a falling wedge pattern, which is a common reversal pattern that signals a potential bullish reversal.
Cup & Handle (Continuatuin)
- A cup and handle pattern is a continuation pattern characterized by a rounded ‘cup’ shape followed by a small downward ‘handle’ or a brief period of downward price movement.
- The pattern is considered to be complete when the stock price breaks above the resistance level formed by the highs of the handle or the right rim of the cup.
- The confirmation of a cup and handle pattern is more reliable when it is accompanied by a strong volume breakout.
- The cup and handle pattern is considered to be a less common pattern and is considered to be more reliable when it appears after a prolonged uptrend or a period of consolidation.
- The cup and handle pattern is used by traders and investors as a signal to buy or add to a position.
This chart pattern is used to identify potential bullish trends in a stock, showing a pause in the uptrend before resuming its upward momentum.
Ascending Triangle (Continuation)
- An ascending triangle pattern is a continuation pattern characterized by a horizontal resistance level and an upward-sloping trendline connecting a series of higher lows.
- The pattern is considered to be complete when the stock price breaks above the resistance level formed by the horizontal line of the triangle.
- The confirmation of an ascending triangle pattern is more reliable when it is accompanied by a strong volume breakout.
- The ascending triangle pattern is considered to be a continuation pattern, but it can also be a reversal pattern if it forms a downtrend.
- The ascending triangle pattern is used by traders and investors as a signal to buy or add to a position.
This chart shows the price action of a security in an ascending triangle pattern, which is typically seen as a continuation pattern that signals a potential breakout in the direction of the previous trend.
Bullish Symmetrical Triangle (Continuation)
- A bullish symmetrical triangle pattern is a continuation pattern, which typically forms during a consolidation period or an ongoing uptrend.
- It is identified by two trendlines that converge toward each other, creating a triangle shape, with the upper trendline sloping downward and the lower trendline sloping upward.
- The pattern is considered complete when the price of the stock breaks above the upper trendline.
- This pattern is considered a bullish signal and traders and investors may use it as an opportunity to buy or add to their positions.
- The confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
The pattern typically appears after a sharp move up or down and is considered a sign of a possible continuation of the current trend.
Bullish Pennant (Continuation)
- A bullish pennant pattern is a continuation pattern that typically forms after a sharp price increase or an ongoing uptrend.
- It is identified by a small symmetrical triangle shape, with converging trend lines that slope upward and downward, forming a pennant shape.
- The pattern is considered complete when the price of the stock breaks above the upper trendline.
- Traders and investors may use this pattern as a signal to buy or add to their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
A chart pattern showing a continuation of an uptrend, in which a small consolidation period is followed by an upward breakout.
Bullish Flag (Continuation)
- A bullish flag pattern is a continuation pattern that typically forms after a sharp price increase or an ongoing uptrend.
- It is identified by a small rectangle shape, created by two parallel trendlines, with the upper trendline sloping downward and the lower trendline sloping upward.
- The pattern is considered complete when the price of the stock breaks above the upper trendline.
- Traders and investors may use this pattern as a signal to buy or add to their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
Bullish flag continuation shows the forecasted trend of a stock’s price over the next few trading days. It suggests that the stock will experience a strong upward trend in the near future.
Bearish Chart Patterns Cheat Sheet
Now onto some bearish patterns! Just like with the bullish patterns, bearish patterns are either signaling a reversal in a price trend, in this case, it would be reversing a strong upward trend; or, there is a brief correction in price, and a continuation pattern signals the price will continue its downtrend.
Bullish and bearish patterns are essentially mirrors of each other. We discussed the cup and handle pattern above, and its bearish equivalent is the inverted cup and handle. This lends a new perspective when analyzing charts – like having upside-down words in a crossword puzzle.
We’ll start with the triple top and continue similarly through the other patterns as we did with the bullish ones.
Triple Top (Reversal)
- A triple top pattern is a bearish reversal pattern that forms after an uptrend, characterized by three peaks at similar price levels with two troughs in between.
- The pattern is considered complete when the price of the stock breaks below the support level created by the troughs.
- Traders and investors may use this pattern as a signal to sell or reduce their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
- The Triple top pattern is considered to be a reversal pattern, and is the opposite of the Head and Shoulders pattern which is a bearish reversal pattern.
Triple Top Reversal pattern, a bearish reversal pattern. It is formed when a stock or index attempts to break above a level of resistance three times, but fails each time. The third failure is usually seen as a strong sign of a reversal and a signal to sell.
Double Top (Reversal)
- A double top pattern is a bearish reversal pattern that forms after an uptrend, characterized by two peaks at similar price levels with a trough in between.
- The pattern is considered complete when the price of the stock breaks below the support level created by the trough.
- Traders and investors may use this pattern as a signal to sell or reduce their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
- The Double top pattern is considered to be a reversal pattern and is the opposite of the Inverse Head and Shoulders pattern which is a bullish reversal pattern.
The Double Top Reversal shows a sharp decline in a security’s price after it has hit a high twice in succession. It is a bearish signal that suggests the security is likely to continue declining.
Head & Shoulders (Reversal)
- A head and shoulders pattern is a bearish reversal pattern that forms after an uptrend, characterized by a peak (the head) followed by two smaller peaks (the shoulders) on either side, with a trough (neckline) in between.
- The pattern is considered complete when the price of the stock breaks below the support level created by the trough.
- Traders and investors may use this pattern as a signal to sell or reduce their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
- The Head and Shoulders pattern can be an inverted pattern which is called an Inverse head and shoulders pattern which is considered to be a bullish reversal pattern.
The left shoulder is the peak of the uptrend, followed by a higher peak (the head), and then a lower peak (the right shoulder). This pattern is often seen as a signal for a potential downtrend in the future.
Rounded Top (Reversal)
- A rounded top pattern is a bearish reversal pattern that forms after an uptrend, characterized by a gradual rise to a peak and then a gradual decline, creating a rounded shape.
- The pattern is considered complete when the price of the stock breaks below the support level created by the low of the decline.
- Traders and investors may use this pattern as a signal to sell or reduce their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
- This pattern is also sometimes referred to as a “saucer top” or a “cup and handle” pattern.
- The rounded top pattern is considered to be a reversal pattern as it forms after an uptrend but it may take longer to form than other reversal patterns.
This chart pattern is characterized by a gradual incline followed by a rapid decline, creating a rounded top on the graph.
Rising Wedge (Reversal)
- A rising wedge pattern is a bearish reversal pattern that forms after an uptrend, characterized by two upward-sloping trendlines that converge, forming a wedge shape.
- The pattern is considered complete when the price of the stock breaks below the lower trendline.
- Traders and investors may use this pattern as a signal to sell or reduce their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
- The rising wedge pattern can also be considered a bearish continuation pattern if it forms a downtrend.
- The Rising Wedge pattern is similar to the Falling Wedge pattern, the only difference is that the Rising Wedge pattern forms after an uptrend, while the Falling Wedge pattern forms after a downtrend.
The pattern begins with an upward trend, followed by a series of higher highs and higher lows that form a wedge shape. Eventually, the trend reverses and the price begins to fall, indicating a bearish reversal is underway.
Inverted Cup & Handle (Continuation)
- An inverted cup and handle pattern is a bearish continuation chart pattern that appears on a stock chart, typically during a downtrend.
- It is characterized by an inverted “cup” shape, which is an upward-sloping trend, followed by an inverted “handle” shape, which is a small downward-sloping trend.
- The pattern is considered to be complete when the stock price breaks below the support level formed by the low of the handle.
- The inverted cup and handle pattern is considered to be a relatively reliable indicator of a potential trend continuation and can be used by traders and investors as a signal to sell or reduce a position.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
- The inverted cup and handle pattern is considered to be a continuation pattern as it forms within an existing downtrend and is used to confirm the continuation of the downtrend.
This chart pattern is often seen as a bullish continuation pattern, indicating a possible increase in the price of the underlying asset.
Descending Triangle (Continuation)
- A descending triangle pattern is a bearish continuation pattern that forms during a downtrend, characterized by a downward-sloping trendline connecting lower highs and a horizontal trendline connecting lows at the same level.
- The pattern is considered complete when the price of the stock breaks below the horizontal trendline.
- Traders and investors may use this pattern as a signal to sell or reduce their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
- The descending triangle pattern is considered to be a continuation pattern as it forms within an existing downtrend and is used to confirm the continuation of the downtrend.
- The descending triangle pattern is similar to the symmetrical triangle pattern, the only difference is that the descending triangle pattern has a downward-sloping trendline, while the symmetrical triangle pattern has no clear trend direction.
This chart shows a descending triangle continuation pattern, where prices move lower within a downward trend, creating a pattern of lower highs and flat lows.
Bearish Symmetrical Triangle (Continuation)
- A bearish symmetrical triangle is a bearish continuation pattern that forms during a downtrend, characterized by two trendlines converging to form a symmetrical triangle shape.
- The pattern is considered complete when the price of the stock breaks below the lower trendline.
- Traders and investors may use this pattern as a signal to sell or reduce their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
- The bearish symmetrical triangle pattern is considered to be a continuation pattern as it forms within an existing downtrend and is used to confirm the continuation of the downtrend.
- The bearish symmetrical triangle pattern is similar to the descending triangle pattern, the only difference is that the descending triangle pattern has a downward-sloping trendline, while the symmetrical triangle pattern has no clear trend direction.
The chart shows a bearish symmetrical triangle continuation pattern, which is typically seen as a bearish signal in the market and indicates that the price of the security is likely to continue to decline.
Bearish Pennant (Continuation)
- A bearish pennant is a continuation pattern that forms during a downtrend, characterized by a small symmetrical triangle shape following a sharp price move.
- The pattern is confirmed when the price breaks below the lower trendline of the pennant.
- It is a signal for traders and investors to sell or reduce their positions.
- The breakout direction is more reliable when it is accompanied by a high volume.
- The bearish pennant pattern is considered to be a continuation pattern as it forms within an existing downtrend and confirms its continuation.
- The bearish pennant pattern is similar to the symmetrical triangle pattern, but it is considered to be more reliable as it forms after a sharp price move.
The pennant pattern is formed by two converging lines of support and resistance and indicates a continuation of the prior bearish trend.
Bearish Flag (Continuation)
- A bearish flag is a continuation pattern that forms during a downtrend and is characterized by a small rectangle shape following a sharp downward move.
- The pattern is confirmed when the price breaks below the lower trendline of the flag.
- Traders and investors may use this pattern as a signal to sell or reduce their positions.
- Confirmation of the breakout direction is more reliable when it is accompanied by a high volume.
- The bearish flag pattern is considered to be a continuation pattern as it forms within an existing downtrend and confirms its continuation.
- The bearish flag pattern is similar to the bearish pennant pattern, but it is characterized by a rectangle shape and flatter upper and lower trendlines.
This chart pattern indicates that the downward price trend is likely to continue and the price could drop further.
Neutral Chart Patterns Cheat Sheet
Lastly, the neutral chart patterns. The price of a security doesn’t always make a drastic move in one way or another, sometimes the price is sort of trapped between resistance and support levels.
These levels are the result of market psychology, and in the case of neutral patterns, perhaps hesitancy is the cause of the stagnation. Many investors want others to make a move first. We see this all the time in our lives, “no, you first”. And once that person tries it, the floodgates open.
This is just one example of what happens with prices in the market due to psychology, but it’s a very common theme at that. Let’s dive into the most well-known and used neutral chart patterns.
Rectangle Top
- A rectangle top pattern is a reversal pattern that forms during an uptrend, characterized by a period of consolidation where the stock price moves within a well-defined range with a horizontal resistance level and a horizontal support level.
- The pattern is confirmed when the price breaks below the support level.
- Traders and investors may use this pattern as a signal to sell or short the stock.
- Confirmation of the breakout direction is more reliable when it is accompanied by a high volume.
- The rectangle top pattern is considered to be a reversal pattern as it forms within an existing uptrend and confirms a potential reversal of the trend.
- The rectangle top pattern is similar to the rectangle bottom pattern, but it forms at the top of an uptrend and signals a potential reversal while the rectangle bottom pattern forms at the bottom of a downtrend and signals a potential reversal.
This chart shows the top performance of a stock over a period of time, with a strong upward trend, suggesting that the stock has been in an extended period of stability, with minimal price fluctuations.
Rectangle Bottom
- A rectangle bottom pattern is a reversal pattern that forms during a downtrend, characterized by a period of consolidation where the stock price moves within a well-defined range, with a horizontal resistance level and a horizontal support level.
- The pattern is considered complete when the price of the stock breaks above the resistance level.
- Traders and investors may use this pattern as a signal to buy the stock.
- Confirmation of the breakout direction is more reliable when it is accompanied by a strong volume breakout.
- The rectangle bottom pattern is considered to be a reversal pattern as it forms within an existing downtrend and is used to confirm a potential reversal of the downtrend.
- The rectangle bottom pattern is similar to the rectangle top pattern, the only difference is that the rectangle bottom pattern forms at the bottom of a downtrend and is used to signal a potential reversal while the rectangle top pattern forms at the top of an uptrend and signals a potential reversal.
This chart shows a rectangle bottom pattern, where a stock’s price fluctuates within a defined range for a period of time before eventually breaking out in a bullish trend.
Broadening Wedge
- A broadening wedge pattern is a reversal pattern that can occur in both uptrends and downtrends and is characterized by two trendlines that are diverging and will eventually converge at a point in the future.
- A bearish signal is triggered when prices break below the lower trendline of the pattern in an uptrend, and a bullish signal is triggered when prices break above the upper trendline of the pattern in a downtrend.
- Confirmation of the breakout direction is more reliable when it is accompanied by strong volume.
- The broadening wedge pattern is considered to be a reversal pattern as it forms within an existing trend and is used to indicate a potential reversal of the trend.
- The broadening wedge pattern is also known as a “broadening formation” or “broadening top/bottom” pattern and can be found in both bullish and bearish market conditions.
- This pattern is also considered to be a continuation pattern as it forms within an existing trend and confirms its continuation.
This chart shows the broadening wedge chart pattern, a bearish chart pattern which indicates a potential for a sharp downturn in the market.
Understanding the Psychology of Trading
Movements in prices within the stock market can all be reasonably deduced to one thing: market psychology. It’s the reason behind every move in a stock’s price; and without it, complex patterns like those we’ve discussed above would not form. But what is market psychology, or the psychology of trading, exactly?
Well, we’ve seen the effects of emotions throughout history: fear, greed, and overconfidence have led humans to do some pretty outlandish things, and these same emotions permeate into decisions in the stock market.
When investors are fearful, for example, they tend to close their positions quickly, and often without thinking very much about what they’re doing because they’re blinded by fear. Conversely, when investors are greedy, they may feel the need to enter into more positions, or hold positions too long.
This is what creates the bullish and bearish trends patterns we’ve discussed, as well as teeter-totter movement, bubbles, and crashes. Decisions fueled by greed and overconfidence can often look similar, with some subtle differences.
When traders are overconfident, they may make impulsive trades without fully analyzing the risk versus reward. Overconfidence also causes traders to double down on investments. Basically, if their current position took a loss, say it’s a call option, they decide to re-roll it because they’re overly confident, and they may end up losing twice as much as they would have if they just held their nerve.
Lastly, crowd mentality is also an important aspect of stock market psychology. This is when investors hop on a bandwagon following the actions of others, without fully analyzing the information. This herding behavior can lead to making irrational decisions, but it also gives rise to contrarians who want to trade against trends.
Market psychology is an extremely complex subject, but at its essence, it’s just human emotions that cause both drastic changes and stagnation in security’s prices.
Risk Management in Trading
Most, if not all decisions in life boil down to a cost versus benefits analysis. Essentially, what am I willing to give up, and is the potential reward worth what I am going to give up? In the stock market, this translates to, what are the risks involved, and am I willing to take on that risk knowing that I could be burned? We’ve all heard the famous axiom, “risk equals reward”. But this works both ways, as risk also equals loss.
Diversification and hedging are two of the most common ways to protect yourself against risk. With hedging, you’re buying or selling a position that will counteract such as the butterfly spread, to serve as a sort of insurance for the position that you are mainly focused on. Diversification is when you spread your investments out into different sectors, or different securities like commodities and bonds. In this way, if one sector or type of security is negatively affected, the hope is that the other ones protect it.
The key here is to be clear as to what your goals and intentions are. Your goal will serve as a lodestar, a prism to look through that will guide you in making decisions where you will inevitably take on some level of risk.
Here at The Trading Analyst, our trading strategy uses a number of key factors which makes risk management our number one priority. These include implementing stop losses immediately upon entering a position, and calculating an immediate sell target where we will sell one half of our position for a gain. Over the long-term, it is not the win rate which makes a successful strategy, but the profit factor at play – and risk management is the key consideration here.
Conclusion
Chart patterns are a fantastic tool used by millions of traders to help them make decisions as to whether to buy, sell, or hold a position. These include continuation, reversal, and bilateral patterns, with loads of different subtypes. Familiarizing yourself with chart patterns will lend a new perspective, therefore strengthening the investment decisions you make in the market.
It’s a good idea to combine other forms of analysis that resonate with you with what a chart pattern could be pointing to. This is because, as we’ve touched on, chart patterns aren’t a guarantee, just a prediction. So if you can find other indicators that support what the pattern is pointing to, you can have more confidence that you’re making an effective decision.
It’s a great idea (and for many, it’s a fun idea too), to look at historical price graphs and start searching for these patterns so that you can develop the “eye” for it. There could be a strong pattern right in front of you but without a trained eye, it can pass by. Also remember to take note of what happens after the pattern, and see if the pattern predicted the outcome correctly. With practice, patience, and this cheat sheet, you’re all set to start using chart patterns!
Deciphering Stock Charts: FAQs
What is the Most Successful Chart Pattern?
Support and resistance levels are arguably the most popular indicator in technical analysis, as they capture a myriad of specific indicators such as moving averages, Bollinger bands etcetera.
It’s important to note, though, that there is not one pattern that is “better” than another. Whether one is better and another depends on the investor using the pattern and how & when they use it.
What is the Easiest Way to Get Chart Patterns?
There are heaps of websites that identify patterns on price graphs. One of the more popular sources for this information is Yahoo Finance. Another is TradingView.
Many brokerages also have built-in tools to help spot patterns by giving you drawing tools to annotate graphs. Thinkorswim by TD Ameritrade is a popular option.
Which Timeframe is Best for Chart Patterns?
This is something investors have to play around with, as different time frames can capture different patterns. A 15-minute graph might be good for predicting short reversals within a couple of hours, but not very good for predicting consolidation periods.
As a general rule, continuation patterns can happen in a few days, reversal patterns take about a few weeks to complete, and consolidation patterns can take a few months to complete.
Do Chart Patterns Fail?
Yes, chart patterns fail all the time. They are not statistically “supposed” to, but they do. As with every prediction, there is always a chance it won’t go as predicted.
This starts to get into risk tolerance. How much risk are you willing to take on? Knowing that chart patterns don’t always work, you have to ask yourself if you’re willing to take that chance.
You can always paper trade to practice without repercussions, follow patterns without investing in them, or follow trade alerts to help fill in the blanks to save time and stress.
Which Indicator is Best for Trading?
The indicator that is best for swing trading depends entirely on the individual investor and their goals. In a general sense, perhaps the ‘best’ indicator is to aggregate as many strategies, or indicators into a single decision as you can – giving yourself the highest chance to profit.
Through trial and error, you can discover what indicators and strategies resonate with you and employ those. Maybe using Bollinger Bands just makes sense to you and using MACD crossover doesn’t as much.
Keeping a trade journal to document what strategies you employ and how successful (or unsuccessful) they were might be helpful.
What Chart Do Most Traders Use?
There is not necessarily a chart pattern that most traders use, but one could be the most used chart pattern given a specific circumstance.
Perhaps the most common you’ll see are double tops and bottoms, because resistance and support lines are created naturally by human psychology, so they’ll always be present. And, based on both statistics and psychology, if the price breaks out of that support or resistance, it should move drastically shortly after.
Do the Chart Patterns Really Work?
Yes, chart patterns have worked since the birth of the stock market. Because while we haven’t always been aware of them, they’ve always been there. There will always be a chaotic, but predictable nature to the stock market fueled by human psychology.
This includes our emotions like fear, greed, and overconfidence. Because of this, chart patterns will indeed “always” work, but maybe not for every single case, as there’s always a chance a prediction is not going to happen.
Is Chart Analysis Accurate?
Chart analysis is a fairly accurate way to assess/ predict the direction a security’s price will move. Their accuracy depends on a few factors, perhaps the most important being the strength of the pattern.
Namely, if the pattern “kind of sort of maybe looks like it could be a head and shoulders”, then it’s probably not very accurate. Versus if it was a “no questions asked that’s a head and shoulders”, it’s almost always going to be more accurate.