A basic visual guide
on chart patterns
By definition, Chart Patterns are repeating price action structures that form due to notable changes in buying and selling.
When the economy is good and institutional buying is strong, chart patterns form bullish formations. During bad economic conditions when institutional selling is strong, chart patterns form bearish formations.
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Simply put, think of price action in three scenarios:
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Prices go up when there is more buying than selling
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Prices go down when there is more selling than buying
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Prices move sideways when there is equal distribution in buying and selling
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Over time, these price action movements create the repeating patterns we see in the chart.
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Here are some of the basic Price Chart Patterns every trader should know:
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Bullish patterns
BEARIsh patterns
NEUTRAL patterns
Bullish Continuation
These are brief rests or pauses within a general uptrend. After the pullback or consolidation, the uptrend continues.
Bearish Continuation
These are brief rests or pauses within a general downtrend. After a technical bounce, the downtrend continues.
Consolidation
A consolidation is a sideways movement wherein the price moves in between clear horizontal support and resistance levels.
Bullish Reversal
A bullish reversal is a pattern at the bottom of a downtrend structure that shifts the trend from a downtrend to an uptrend.
Bearish Reversal
A bearish reversal is a pattern at the peak of a uptrend structure that shifts the trend from an uptrend to a downtrend.
Here are the major continuation, reversal and neutral price action patterns that every trader need to be familiar with:
1. CONTINUATION patterns
Pennant
A brief price contraction within two converging trendlines.
Wedge
A brief price contraction within two converging trendlines that are either angled up or down.
Flag
A brief price consolidation in between two parallel trendlines.
BULLISH
Appearing within a general uptrend
BEARISH
Appearing within a general downtrend
2. REVERSAL patterns
Reversal patterns are distinct price action formations wherein a notable exchange between buyers and sellers take place. Once the pattern is complete, the trend shifts to a new direction.
A. Bullish Reversal Patterns
Cup and Handle
A Cup and Handle pattern is a bullish formation defined by a “U” shaped basing formation (rounding bottom) which is followed by a brief pullback with lowering volatility. A breakout usually happens after the completion of the pattern.
Inverted Head and Shoulders
An Inverted Head and Shoulders pattern appears as a three-base formation along a neckline resistance. This reversal pattern points to a bearish-to-bullish transition.
Bullish Divergence
A Bullish Divergence is illustrated in the chart as a phase when a technical indicator (usually the RSI oscillator) begins to form a trend that contradicts the current price downtrend.
RSI is making HIGHER lows while the price action of the stock is establishing LOWER lows. This signifies weakening selling pressure that might transition to an uptrend rally.
Double Bottom
A Double Bottom formation is a reversal pattern usually forming in a multi year support level. After a stock bounces from a major downtrend, the price will likely retest the support area to validate the strength of the buying pressure. As more buyers come in, another bounce is triggered and eventually propels the stock price to break its initial resistance.
B. Bearish Reversal Patterns
Head and Shoulders
A Head and Shoulders pattern appears as three-peak formation along a neckline support. This reversal pattern points to a bullish-to-bearish transition.
Bearish Divergence
A Bearish Divergence is illustrated in the chart as a phase when a technical indicator (usually the RSI oscillator) begins to form a trend that contradicts the current price uptrend.
RSI is making LOWER highs while the stock price is completing HIGHER highs. The divergence here shows that the price action has weakening buying pressure and might soon transition to a downtrend.
Double Top
A Double Top formation is a reversal pattern usually forming in a multi year resistance level. After a stock is rejected from reaching a major resistance, a brief pullback happens and a retest of the resistance happens. Due to massive amount of selling, the price is rejected once again and proceeds to break down. When selling is sustained, the trend shifts to a downtrend.
