In this essential guide to the top 10 chart patterns, we are going to make you ready to spot your first trade through chart patterns.
In technical analysis, chart patterns are one of the integral parts and most powerful tools during trading.
1. What are Chart Patterns?
Well, well, well we know that you should understand what a chart pattern is before going deeper into it.
Chart pattern of stocks are the graphical diagram made in technical charts of security that play an important role in stock market analysis. Data plotted on the charts are analysed based on old trends and patterns, which are expected to repeat naturally over some time.
The chart patterns are the patterns drawn from the buying and selling of stocks which are happening in the markets every day. You can learn to use these patterns for future prediction and the direction of the stock market. Moreover, you can also learn about candletsick pattern lists in the coming blogs.
Now, we should get into understanding the top 10 chart patterns that a trader must know. Trader chart pattern like the pros.
Let’s get into the detail.
2. Types of Chart Patterns
There are no best or worst chart patterns as all the types of chart patterns predict a specific direction or aim in the market. It is important to know which type of chart pattern does what in the market.
2.1 Head and Shoulders
Head and shoulders are a common chart pattern which is widely used among the community of traders.
It is a chart pattern which forms with a large growing peak and has a slightly smaller and decreasing form on the other side. You can call it a bullish-bearish reversal pattern in the head and shoulders.
As shown in the figure, you can spot a ‘head’ and ‘shoulders’ pattern when the first and third peaks will be smaller than the second peak. The second peak will be the head and the other two will be the shoulder. All the three peaks will fall back to the same support zone forming a ‘neckline’
2.2 Double Top
A trend reversal is formed using a double top pattern which is extremely bearish. It is formed when the price of a security reaches a high price at a certain level consecutively two times. In between, retracement will form back at the support price.
What does a double top indicate is that you can spot the ‘double top’ pattern through an ‘M’ shape in the chart. It indicates bearish price movement and should be used likewise.
2.3 Double Bottom
A double bottom pattern is formed in a trend reversal pattern from bearish to bullish journey. It develops when an asset’s price drops below the support zone from the resistance level.
It will rise back from the support zone and form a ‘neckline’ while showing reversal. Soon, it will turn into an uptrend which can be denoted by the ‘W’ pattern.
2.4 Ascending Triangle
The ascending triangle is a bullish chart pattern where you need to draw a horizontal line between the swing highs and swing lows in a rising pattern.
The two lines form a triangle which often indicates a breakout trend. In this pattern, the trend line and horizontal line indicate the support and resistance level for the security.
2.5 Descending Triangle
Descending triangles signals a bearish trend and traders often make use of this pattern to make profits in the bearish market. A descending triangle is formed when there are several lower peaks formed in an attempt to make a falling downtrend in the chart.
You can identify a descending triangle through a horizontal and slopping line that shows the support and resistance in the trend. Sellers intensify through the descending triangle when the trend breakdown through support and the downtrend is most likely to continue after that.
A wedge is a price pattern where two trend lines are drawn on a security chart to analyse the highs and lows of the price series. Wedges are of two types: ‘rising wedge’ and ‘falling wedge’ that estimates the market movement.
Rising wedge – A rising wedge can be defined by two trend lines i.e., support and resistance with an increasing or rising trend.
Falling wedge - A falling wedge develops where resistance and support lines are in downward sloping movement with a decreasing trend.
You need to remember that wedges of rising or falling nature will be reversal patterns of bullish and bearish markets respectively. The formation of a wedge pattern can indicate an important market direction.
2.7 Symmetrical Triangle
Like, any other chart pattern symmetrical triangle pattern can also be bullish and bearish. Although, it is a ‘continuation pattern’ which means there is no breaking of the trend while this pattern develops.
The continuation pattern suggests that the market will continue to rise or fall in the same direction as the symmetrical triangle portrays on the screen.
The symmetrical triangle is formed through sequential peaks and troughs (high and lows) in the chart pattern.
A symmetrical pattern can be bilateral when the triangle pattern miraculously breaks out and is mostly used in volatile markets.
2.8 Cup and Handle
A cup and handle pattern forms when the market shows a bearish ‘period’ through a cup for a short span and converts into a bullish continuation pattern through a handle. Ultimately, it is a buying opportunity.
‘Handle’ is a strong pattern as when it consolidates minutely, the traders can make an entry into the buy trade. As the price formation is over, the security price reaches high aims.
A cup is similar to the rounding bottom chart pattern whereas, a handle is similar to the wedge pattern. The asset in this case during online trading will reverse from the bearish-looking handle and covert into a bullish trend.
Further, there is an inverted cup and handle pattern that triggers the sellers of the market and indicates bearish movement. You can invert the chart pattern and see the following inverted chart.
A pennant pattern or flag is an upward movement pattern in its early stage of development. Due to its early increase of movement in the chart, a bullish sign will be followed, although there will be a consolidation to sustain the market trend in one place.
Pennant can be bearish and bullish with a continuation pattern and a reversal pattern. In simple words, when you observe the candles reaching higher highs but consolidating after a few upward movements, is when you spot a pennant pattern.
2.10 Rounding Top or Bottom
The rounding top or bottom pattern is termed a reversal pattern which is designed to find the potential reversal signal in down and up trends. You can identify the rounded pattern by an uptrend/downtrend, rounded top or bottom and the neckline. The pattern will be similar in both rounded patterns only the top and bottom will be differentiated.
A rounding top pattern is shaped like an upside-down ∩ shape that extends its upward movement and has a potential for a reversal from its position.
A rounding bottom pattern on the other hand is ‘shaped like U’ which is an example of a reversal to reach from bearish to bullish uptrends.
3. Understanding the Chart Patterns
The ultimate guide to chart patterns are easier to understand when you truly follow what’s given. You need to carefully plot the support and resistance lines for each chart, which makes your chart perfect for analysis.
In this blog, we learned 10 kinds of stock chart patterns and we feel it is important for every trader to use them during trading. So, don’t forget the important points for each pattern as you go.
Spot head and shoulders pattern with three peaks where the second one is higher than the other two, making all fall in the support line.
Double top pattern can be analysed by ‘M’ shape with a bearish trend whereas double bottom pattern is ‘W’ shape with a bullish trend.
Ascending triangle forms a breakout movement and descending triangle forms a breakdown movement.
Wedges are denoted by two lines of support and resistance where; the rising wedge is in the rising trend (bullish) and the falling wedge is in the downtrend (bearish).
Symmetrical triangle forms peaks and troughs and can be both bearish and bullish.
Cup and handle pattern is a bullish opportunity whereas, inverted cup and handle is a bearish opportunity.
A pennant/flag can be both bearish and bullish with consolidation in between.
A rounding top is ‘inverted U’ whereas a rounding bottom is ‘U’ shaped.