Technical Analysis – Trading Chart Patterns

Introduction

Technical analysis involves studying historical price data and identifying patterns that could forecast future price movements. Among the various tools used by traders, chart patterns are some of the most powerful indicators of market sentiment and direction.

This document outlines the most common trading chart patterns, with additional focus on range patterns and range breakouts.

1) Range Patterns

Range patterns occur when prices oscillate between parallel support and resistance levels, forming a horizontal channel for a Horizontal Range, an ascending channel for an Ascending Range or a descending channel for a Descending Range. This behaviour reflects a period of indecision in the market where supply and demand are balanced.

Ascending Range:

Characteristics of Range Patterns

· Boundaries: Defined by a support line (lower boundary) and a resistance line (upper boundary).

· Volume: Typically decreases within the range, indicating a lack of strong buying or selling interest.

· Duration: Can last from a few days to several months, depending on the market conditions.

Strategies for Trading Range Patterns

1. Buying at Support: Entering long positions when the price approaches the support level.

2. Selling at Resistance: Initiating short positions when the price nears the resistance level.

3. Using Oscillators: Indicators like RSI or Stochastic can help identify overbought or oversold conditions within the range.

1.1) Range Breakouts

A range breakout occurs when the price moves beyond the established support or resistance levels, signalling the end of the range-bound movement. There are two types of Breakouts:

· Bullish Breakout:

§ Condition: Price moves above the resistance level.

§ Confirmation: Increased trading volume accompanies the breakout.

§ Implication: Signals a potential uptrend.

· Bearish Breakout:

§ Condition: Price falls below the support level.

§ Confirmation: High volume reinforces the validity of the move.

§ Implication: Indicates a potential downtrend.

Identifying False Breakouts

False breakouts occur when the price temporarily breaches the support or resistance but fails to sustain the movement. To avoid false signals:

· Volume Check: Confirm breakouts with substantial volume.

· Retest Levels: Look for the price to retest the breakout level as new support or resistance.

Trading Strategies for Range Breakouts

1. Breakout Entry:

· Place buy orders above resistance for bullish breakouts or sell orders below support for bearish breakouts.

2. Stop-Loss Placement:

· Position stop-loss orders just below the breakout level for bullish trades or above for bearish trades.

3. Target Setting:

· Use the height of the range to estimate potential price targets post-breakout.

2) Continuation Patterns

Continuation patterns indicate that the price trend is likely to persist.

· Flags and Pennants:

§ Formation: A sharp price movement (flagpole) followed by a brief consolidation period.

§ Implication: Resumption of the prior trend after breakout.

Flag:

· Triangles:

§ Types: Ascending, Descending, and Symmetrical.

§ Implication: Ascending triangles are bullish; descending triangles are bearish; symmetrical triangles depend on the breakout direction.





Ascending Triangle:

Descending Triangle:

3) Bilateral Patterns

Bilateral patterns suggest that the price could move in either direction, requiring traders to wait for a breakout confirmation.

· Symmetrical Triangle:

§ Formation: Converging trendlines creating a triangle shape.

§ Implication: Breakout can occur in either direction, so watch for volume confirmation.




Symmetrical Triangle:

· Wedges:

§ Types: Rising and Falling Wedges.

§ Implication: Rising wedges are generally bearish; falling wedges are typically bullish.








Rising Wedge:

4) Reversal Patterns

Reversal patterns signal a potential change in the direction of the price trend.

· Head and Shoulders:

§ Formation: A peak (shoulder), a higher peak (head), followed by another lower peak (shoulder).

§ Implication: Signals a trend reversal, often from bullish to bearish.

§ Key Level: Neckline, which is broken to confirm the reversal.


Head and Shoulders:

· Double Top and Double Bottom:

§ Formation: Two consecutive peaks (double top) or troughs (double bottom) at roughly the same level.

§ Implication: Double top indicates a bearish reversal; double bottom suggests a bullish reversal.

Double Top:



Double Bottom:

· Triple Top and Triple Bottom:

§ Formation: Three peaks (triple top) or troughs (triple bottom) at similar levels.

§ Implication: Triple top suggests a bearish reversal; triple bottom signals a bullish reversal.

Triple Top:

Triple Bottom:





Breakouts

A breakout occurs when the price moves beyond established support or resistance levels, signalling a potential new trend. Following are the types of Breakouts:

· Bullish Breakout:

§ Condition: Price moves above the resistance level.

§ Confirmation: Increased trading volume accompanies the breakout.

§ Implication: Signals a potential uptrend.

· Bearish Breakout:

§ Condition: Price falls below the support level.

§ Confirmation: High volume reinforces the validity of the move.

§ Implication: Indicates a potential downtrend.

Identifying False Breakouts

False breakouts occur when the price temporarily breaches the support or resistance but fails to sustain the movement. To avoid false signals:

· Volume Check: Confirm breakouts with substantial volume.

· Retest Levels: Look for the price to retest the breakout level as new support or resistance.

Trading Strategies for Breakouts

· Breakout Entry:

§ Place buy orders above resistance for bullish breakouts or sell orders below support for bearish breakouts.

· Stop-Loss Placement:

§ Position stop-loss orders just below the breakout level for bullish trades or above for bearish trades.

· Target Setting:

§ Use the height of the pattern to estimate potential price targets post-breakout.

Conclusion

Understanding and identifying chart patterns are essential for technical analysis. They provide valuable insights into market behaviour and potential price movements. Traders must combine pattern analysis with other technical tools, such as EMAs, Volume and Momentum indicators, to enhance accuracy and manage risks effectively.