If you have ever come across a chart and thought it was just about lines and candles, you are not the only one. Behind those price movements there are shapes giving hints of trading market direction. These shapes are chart patterns and traders have been using them for decades as guides to what’s coming next. Pattens show whether a price is likely to continue its movement in the same direction or if it is about to turn around.
What’s interesting about chart patterns is that you don’t have to know math or use complicated formulas to use them. With practice, you will start noticing them naturally. Once you are able to identify these patterns, you can use them to improve your timing, avoid false moves, and make more informed trading decisions.
Read on to learn about some of the most important patterns, how they might change your trading strategy and how you view the markets.
Head and shoulders chart pattern
This pattern is among the most reliable reversal signals. Think of three peeks in a row, where the middle one is the tallest, also known as the head and the two others on the right and left are shorter, known as the shoulders. The line drawn across the lows in between is called the neckline. Once the price falls below the neckline, it usually means the upward trend has come to an end and the price may start decreasing.
There’s also the opposite version also known as the inverse head and shoulders. The only difference is that it is flipped upside down often showing up after a long downtrend indicating that the price may start going up again. This pattern is widely preferred among traders due to the fact that it is easy to identify and it has the tendency to be a bit more accurate compared to others.
Double tops and double bottoms chart patterns
This is another common reversal pattern type. A double top is like the letter “M” and happens when the price rises, goes down, then rises again to nearly the same level. However, it fails to keep going up, meaning that the market has tried 2 times to break higher but could not do it. Therefore, it may start going down instead.
A double bottom is the contrary, looking like the letter “W”. The price goes down, bounces up, decreases again to almost the same level and then goes up. This is an indication of a strong support in the market at that level and that it could start going up. These patterns are vital because they usually show the point where buyers and sellers become weaker and the trend is ready to change.
Triangles and Wedges
Triangles are continuation patterns. This means that they often show that the existing trend will continue after the pattern finishes. A symmetrical triangle happens when prices keep making lower highs and higher lows, forming a tight, squeezed shape.
An ascending triangle has a flat top and rising bottom. While sellers keep holding the top level, buyers get stronger, slowly pushing the price upwards. Most of the time, the price eventually breaks upward. On the contrary, a descending triangle has a flat bottom and lower highs, and it usually breaks downward. Triangles are useful for identifying the price direction after a period of sideways movement.
Although at a first glance wedges are similar to triangles, there is a key difference. Wedges are patterns where both lines lead to the same direction, either up or down. A rising wedge happens once prices keep rising but start moving in smaller steps. This can be a warning that the upward trend is becoming weaker and might decrease shortly.
In a falling wedge on the other hand, prices move to lower levels, but the steps get smaller and closer together, showing that sellers are losing strength and the price may go up once it breaks out. Wedges do not show up so frequently compared to other patterns. Once they do, however, they can give very useful hints on what might follow.
Flags and pennants
This chart pattern usually appears once there is an unexpected move in prices. Let’s say there’s a strong rally upward. After such a big move, the price pauses for a bit, moving sideways or a bit against the trend. This creates a small shape that looks like a flag. Shortly after that, the markets usually keep going the initial direction with another strong move.
Despite being similar, pennants are like very small triangles rather than rectangles. Flags and pennants are short-term continuation patterns that traders often use to get into markets that move fast without going after the initial big move.
Cup and handle & rounding bottoms
The cup and handle pattern is an easy-to see pattern. Imagine a “U” shape, similar to a tea cup, followed by a small dip, the handle. Once the price breaks above the handle, it often leads to a strong upward movement. Traders use this pattern to spot a healthy pause before the next push higher.
A rounding bottom, which is also known as a saucer, is another gradual pattern showing that direction has changed. The price gradually changes from going down to going up, instead of moving up and down quickly. Although formation can take some time, when it does form it often starts a longer upward trend.
Candlestick chart patterns
Some patterns do not take weeks to form but instead appear within one or two candlesticks only. For example, a doji candlestick patterns forms when a candle’s open and close prices are nearly the same, showing uncertainty and a possible market turn.
The engulfing candle is another common candlestick pattern. Here, one candle covers the previous candle’s body completely. A bullish engulfing, which appears once there’s a downtrend, shows a reversal upward. On the other hand, a bearish engulfing can act as a downturn warning.
Hammers and hanging man candles have small bodies and long lower wicks and suggest reversals based on their location on the chart. When used with careful analysis, candlestick patterns can provide helpful short-terms signs, despite their small size in comparison to the larger shapes mentioned above.
How to use chart patterns
Always wait for a clear signal before taking any action. A strong move above or below a key level is more reliable when it is supported by enough trading activity. This helps you avoid false signals, which can lead traders to make the wrong decision.
Support and resistance levels should be taken into account because many patterns form around these. Those patterns that break major levels are usually more reliable than those at minor ones.
Combine these patterns along with other tools like timelines or market news and always use solid risk management like stop-loss orders.
Final thoughts
Chart patterns are helpful, but they do not promise success. They make your trading approach more effective and your decisions more informed. Chart patterns do not predict the future, but they give useful clues about what might follow. By learning to spot them, you can better see the balance between buyers and sellers and notice trading opportunities you might otherwise miss.
Disclaimer: This information is not considered investment advice or an investment recommendation, but instead a marketing communication.
