Chart patterns are one of the most essential tools traders should consider as part of their technical analysis strategy. Every investor, whether professional or beginner, should follow chart patterns, as they can predict movements and identify new market trends. These chart patterns can be utilized in numerous markets, such as shares, forex, or commodities.
In short, chart patterns are graphical representations of the price movements that have occurred in a specified period. These patterns are the results of the collective actions of sellers and buyers, who create common chart patterns.
In this article, we will explore why chart patterns are essential and what the most recognizable examples are.
Why are chart patterns important in trading?
Chart patterns are important tools for both seasoned traders and those who have made the first steps into the intriguing landscape of trading. These patterns can reflect the emotions of market participants, and because of this, by considering them, people can discover the behavior of other traders and have a better idea of the price movements.
Predicting market trends is indeed one of the most crucial purposes of chart patterns. In this way, traders can have a better idea of what will happen in the future with the stock price, and in this way, traders can make more meaningful decisions. Chart patterns can also help traders develop better trading strategies. Chart patterns can be significant in a trading strategy, as with their help, they can set entry and exit points better and identify high-probability trade setups. In this way, they can improve their trading performance and better navigate risk management.
For even more effective results, traders can also use chart patterns together with technical indicators, such as relative strength index (RSI), moving average, and MACD (moving average convergence divergence). Thanks to the insights found both in the technical indicators and in the chart patterns, traders can be more confident with their decisions.
What are the different groups of chart patterns?
The majority of chart patterns fall into one of three groups: reversal patterns, continuation patterns, and bilateral patterns.
Continuation patterns
A continuation pattern occurs when there is an interruption in the current trend. During a bull run, a continuous pattern is the moment of pause before an uptrend. In a bear market, things happen in reverse, when things relax a little before taking a downtrend. Traders must be careful with continuous patterns, as when the price patterns are forming, you can’t really pinpoint if the trend is going to continue or reverse. If the price maintains its value based on its current trend, then traders are dealing with a continuation pattern.
There are many types of continuation patterns, such as the following ones:
Pennants
Pennants are chart patterns that result from two trendlines that unite at a set point. In this pattern, the two trendlines move in separate directions. A pennant occurs after an important price move, that is known as a flagpole. This is the initial surge that has led the way to the pennant formation. After this big event, the price can take a little break. After this, pennants break in the same direction as in the initial phase, which completes the pattern. Pennants are short-term, which is why they can last between a few days to a few weeks.
Flags
Flags are chart patterns that can help traders see if the current trend is continuing. In the incipient phase, this pattern starts with a strong price movement that also bears the name of a flagpole. Then, it is time for the consolidation phase (flag), when the price forms a parallelogram or small rectangle that starts to head in the direction of the first movement.
Reversed patterns
Reversed patterns mean that the current trend is going to reverse. These patterns can signal both bulls and bears markets, which mark a change in the trend’s current direction. Among the most common reversed patterns are head and shoulders, double bottoms, and double tops.
Head and shoulders
The head and shoulder patterns are composed of three important parts: a high peak (the head) and the other smaller peaks to the left and right, which are known as shoulders. This pattern can mark a potential reversal trend and a change from bullish to bearish. The neckline is also present in this type of pattern, and it is shown by connecting the two shoulders. If the price breaks below the neckline, then the patterns indicate a downtrend.
Double tops and bottoms
In the double tops and bottoms, traders can see a pattern similar to the letter M in a double top or W in a double bottom. A double-top pattern has two peaks at approximately the same price level, which shows resistance. On the other hand, the double bottom pattern is formed after a downtrend and consists of two lows at quite the same price level, which highlights support.
Bilateral patterns
Bilateral patterns indicate that the price can follow either an uptrend or a downtrend, which is why traders should consider both of these scenarios and prepare for them. This marks a moment of indecision in the market. Symmetrical triangles are a good example of a bilateral pattern.
Symmetrical triangles
In the symmetrical triangle patterns, the market trend reaches an equilibrium and a pause before continuing the same trend or starting a new one. This is a consolidation phase, and after it, the price will either break out or down.
The bottom line
Chart patterns are one of the most critical tools traders should keep in mind, as this graphic representation can help them a lot in their trading journey. Chart patterns are helpful both for experienced traders and beginners, as they assist traders in predicting future price movements and making more informed decisions. There are several chart patterns that traders can take into account in their strategies, and in this article, we have explored a few of them.