Understanding stock chart patterns can help you identify market consolidation and spot probable market trends ahead of time. Chart patterns can be used to spot long-term trends for investing or to measure short-term market sentiment for day trading. Understanding those patterns is an important part of becoming a successful trader.
Chart patterns are distinctive patterns on a chart that can serve as a trading signal or provide insights into potential future price changes. Traders use these patterns to guide their buying and selling decisions.
Do Chart Patterns Work?
Stock chart pattern accuracy and reliability is a matter of probabilities. They often, but not always, point to future movements in the stock market. When you are playing the market, you should also make your trading decisions based on knowledge of the company and on your risk tolerance rather than relying solely on different types of stock charts.
Reversal Patterns
A reversal pattern indicates a potential change in the prevailing trend. It identifies the end of a trend and potential opportunities to enter a new position in the opposite direction. Examples of reversal stock chart patterns include Head and Shoulders, Double Tops, Double Bottoms, and Rounded Tops and Bottoms.
Continuation Patterns
Continuation patterns like Triangles (Ascending, Descending, and Symmetrical), Rectangles, Flags, and Pennants suggest a temporary pause or consolidation in an ongoing trend before it resumes. Traders use these stock trading patterns to anticipate trend continuations and look for opportunities to add to positions.
Breakout Patterns
Breakout patterns occur when the price breaks through a significant support or resistance level. Traders use breakout patterns like Cup and Handle, Gaps, and Wedges to identify potential breakout opportunities and to take positions in the direction of the breakout.
Exhaustion Patterns
These types of stock charts suggest that a prevailing trend is losing momentum. Gaps (exhaustion gaps), Climax Tops, and Climax Bottoms often anticipate potential trend reversals or significant price movements.
If a stock trades at higher highs and higher lows, it is on an upward trend. If it's trading at lower highs and lows, it's trending downwards. These are the key concepts you need to remember when learning how to read a stock chart.
Our chart patterns cheat sheet will introduce you to some of the most crucial stock patterns and advise you on how to respond to them when trading. All these different patterns can seem overwhelming at first, but with a little bit of study, you’ll find that you understand the market better and make more profitable trades.
A head and shoulders pattern has three peaks. The first and last are similar in height, while the second peak is taller. The head and shoulders is considered a very strong sign that the trend is moving from bullish to bearish.
Market analysts consider head and shoulders stock charts patterns as an indication that a bull run is ending and a downturn is imminent. When you see a head and shoulders, it’s a good time to sell or short.
An inverse head and shoulders is the head and shoulders upside down. These stock charts patterns are a strong sign that the stock’s price is about to break upward.
When the stock’s price rises above the neckline, you should consider a long position. But you may also want to set a stop loss a bit below the neckline to hedge your losses, especially if there is only a short stretch below the head and shoulders formation.
Triangles are trade patterns that suggest the market is consolidating. Triangles come in three forms: ascending, descending, and symmetrical. Each offers different guidance as to the stock price's future direction.
Ascending Triangle
Ascending triangles are bullish chart patterns that suggest prices will likely continue rising as they move toward the resistance level. The longer the triangle pattern continues, the stronger the breakout will be. If you see a stock that has been trading sideways for a while with a series of increasingly higher lows, your best strategy is to buy but to set a stop loss order slightly below the resistance level to guard against a false breakthrough.
Descending Triangle
Descending triangles are bearish chart patterns that signify a downward trend. In a descending triangle the lows fail to break below a support level, but the highs become progressively lower. A descending triangle shows that buyer support is weakening. A descending triangle suggests that this is a good time to sell or to place a short position as there is a very good chance the stock will decline below the resistance shortly.
Symmetrical Triangle
A symmetrical triangle is a pattern of higher highs and lower lows. A symmetrical triangle generally follows earlier trends. If the price was trending higher, a symmetrical triangle will often break higher. If the price was moving downward, there is a good chance that it will break lower. Look at that past price history and trade accordingly.
Rectangles are stock graph patterns that show the stock price bouncing between clearly defined support and resistance levels. A rectangle is a continuation pattern that shows that neither buyers or sellers hold the upper hand. A rectangle ultimately ends in a breakout that will see the price go decisively up or down. Many day traders buy at the rectangle’s support level and sell when it reaches resistance.
Flags show a move in the opposite direction following a sharp price change. Upward flags are typically bullish while downward flags are bearish. An upward flag shows increased volume in the trades leading up to the flag with declining volume as the flag consolidates, while bearish trends see volume hold steady or increase.
While flags typically show a continuation of the previous trend, it is best to wait for the breakout before investing and to use the opposite side of the flag as a stop loss indicator.
The Cup and Handle is a bullish stock patterns chart that suggests a stalled upward trend will continue when the pattern is confirmed. The "cup" portion of the pattern is a "U" shape rather than a "V". The "handle" on the right side of the cup is a short pullback that looks like a flag or pennant chart pattern. Once the handle is complete, the stock may reach new highs. The Cup and Handle signifies an investment opportunity.
The double top or bottom are reversal patterns, signaling areas where the market has made two unsuccessful attempts to break through a support or resistance level.
Double Top
A double top often looks like the letter M. This stock patterns chart shows an initial push up that hits a resistance level, which is then followed by a second failed attempt. This often signifies a trend reversal and a break below the support level. A double top suggests this is a good time to sell or short the stock in question.
Double Bottom
A double bottom looks like the letter W. Double bottoms occur when the stock price tries to push through a support level, fails, and then makes a second unsuccessful attempt to break through the support. Following W pattern trading strategies, a trader would anticipate a trend reversal upwards and invest in or go long on the double bottom signal.
Triple Top Reversal
Triple top reversals are bearish reversal stock trading patterns that usually form over a 3 to 6-month period. They consist of an uptrend leading into three approximately equal highs followed by a break below the support level. As the price drops, traders who bought during the triple top face increased pressure as long sellers sell and short sellers set positions. If you spot a triple top reversal, it’s a good time to sell or set a stop loss.
Triple Bottom Reversal
The triple bottom reversal is the same pattern upside down with a series of three lows that fail to break through support. The triple bottom reversal is bullish. When the price breaks through the resistance level, bears and short-sellers will feel increasing pressure to buy. As with w pattern trading, this break is a signal to buy with a stop loss set at or slightly below the breakthrough point.
Rounded tops and bottoms are formed over a period of weeks, months or even years, and signify a reversal in trends. Because these are longer-term patterns, they are best used by traders looking for long positions and may be of limited value to day traders.
Rounded Tops
A rounded top pattern looks like an inverted bowl, with higher volume at the top of the bowl and lower trading volume on either side. While a rounded top is generally bearish, double and even triple tops are not unheard of so you should exercise caution before shorting.
Rounded Bottoms
Rounded bottom stock graph patterns are a series of price movements that form a U shape. A rounding bottom happens at the end of an extended downward trend and signifies a reversal toward higher prices. The stock has bottomed out and over the course of several weeks or months the stock gradually reaches a price low enough to attract buyers and shake out bears.
Pennants form when there is a significant price change in a stock followed by a consolidation movement with converging trend lines as the distance between highs and lows becomes more narrow. You interpret these stock market patterns by looking at the preceding trend. If it was a downtrend the pennant is bearish, while pennants after an uptrend are bullish. A pennant has high volume on the first upward trend with declining volume as the pennant forms.
Wedges form over a two to ten-week period. As with pennants, volume declines as the wedge pattern forms. But unlike a pennant, a wedge is not preceded by a significant price change. And while a pennant is a continuation pattern that typically breaks in the same direction as the preceding trend, wedges are a reversal pattern that suggests a change from the preceding trend.
If the support and resistance lines are moving downward, you have a falling wedge. Falling wedges are an even more reliable bullish sign. They reflect that the downward trend is beginning to lose momentum. Most traders buy on falling wedges.
Because the distance between high and low prices becomes more narrow as the wedge forms, you can minimize your risks by entering the wedge later rather than sooner and by placing a stop loss near the bottom of the wedge.
Bump and Runs start with a lead-in phase, a moderately steep but not unreasonable rise over several weeks. The “bump” is a sudden sharp advance that is well above the lead-in trend line.
This speculation-driven bump only lasts briefly before the prices break back below the lead-in trend line and may drop well below it. When you see day trading chart patterns, avoid joining the crowd and buying a “hot” stock that is likely to turn cold very soon.
Determine the Market
Look at the pattern with the help of our stock patterns cheat sheet. Determine if the pattern signifies a continuation or a reversal, and if the prices are likely to move up or down.
Decide Chart Patterns to Use
A trading patterns cheat sheet is a great way to master stock patterns. Look at previous stock charts to find the patterns you want to use for trading purposes, and see how often they produce the predicted result. This will give you a solid understanding of stock trend patterns and how they work.
Look for the Chart Patterns History
The direction in which the market is likely to trend after the pattern breaks often depends on the direction of the market before the pattern formed. Check both the price and volume leading into the pattern. The strongest chart patterns are where the price has reacted to the trend lines repeatedly in high volume trading.
Find Indicators of Price Reaction
Map out the support and resistance levels. Look for major swing points that have reversed a trend or caused a major pullback into a trend.
Make Trading Rules
If you make your trading rules and stick to them, you will be able to avoid making emotionally charged decisions that are likely to go badly. Set your stop points to fit your risk tolerance and stick to them.
Trading computers bring efficiency, speed, and accuracy to the analysis process.
Processing Power
A trading computer with a powerful processor can handle large datasets and complex calculations required for the technical analysis of stock patterns.
Display and Graphics
Trading computers provide clear and detailed chart visuals. Graphics are essential for accurately identifying chart patterns for day trading. A larger screen, or multiple monitors, can help traders view multiple charts simultaneously.
Stock Charting Software
Trading computers can handle resource-intensive charting software to find stock patterns for day trading. You can apply your preferred analysis techniques and tools with ease.
Find Indicators of Price Reaction
Map out the support and resistance levels. Look for major swing points that have reversed a trend or caused a major pullback into a trend.
Backtesting and Simulations
Backtesting applies historical data to see how a particular stock market pattern chart would have performed in the past. Simulations on trading computers let you test your strategies in real-time market conditions without risking capital, and help you fine-tune your chart pattern analysis and improve your trading performance.
Our trading computers are built for traders and designed for effective chart pattern analysis. Many professionals use our desktops and laptops to spot stock patterns and make lightning trades. See our many Falcon Trading computer reviews from satisfied customers.
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Mastering the art of reading stock chart patterns is a must if you want to be a serious trader. Trading chart patterns give you clues as to where the market is going and help you make informed investments. When you combine your chart reading knowledge with our desktop and laptop trading computers, you can take your trading career to the next level. And if you're just getting started, you can learn the basics on our day trading for beginners page.