Top 7 Chart Patterns in Trading Every Trader Needs to Know
In this article, I will discuss the Top 7 Chart Patterns in Trading Every Trader Needs to Know. Please read our previous article, where we discussed Supply and Demand Trading.
What are Chart Patterns?
Chart patterns are the basis of price action analysis and technical analysis and require a trader to know exactly what they are looking at in chart pattern and what they are looking for in chart pattern.
- Chart patterns are collective human behavior. Human behavior in the market creates some patterns type on the charts. Chart pattern trading is really about understanding the psychological human behavior of the market using those patterns.
- Price patterns form the structure of the market. You can’t predict with 100% accuracy where the market will go next but Price patterns. Chart Patterns Can help reduce uncertainty and show you the probable next move of the market.
Types of Chart Patterns in Trading
The changes in trend usually require a period of transition. The problem is that these transition periods do not always signal a trend reversal. Sometimes, these transition periods indicate a pause or consolidation in the existing trend, after which the original trend is resumed.
Chart patterns are divided into three types: continuation patterns, reversal patterns, and bilateral patterns.
- A continuation chart pattern signals that an ongoing trend will continue
- Reversal price patterns signal that a trend may be about to change direction
- Bilateral chart patterns signal that the price could move either way, meaning the market is highly volatile
Best Chart Patterns in Trading
Here are 7 chart patterns every trader needs to know.
- Head and shoulders
- Double top and Double bottom
- Rounding bottom
- Cup and handle
- Pennant or flags
- Ascending Triangle and Descending triangle and Symmetrical triangle
Elements of Price Pattern
- Trend and bias
- Pattern Description:
- Price action characteristics
- Supply and demand (volume)relation
- Stop loss
Let’s discuss all the above points in detail in each chart pattern
Cup and Handle Chart Pattern
- Directional Bias: Bullish
- Pattern Type: Continuation pattern
- Price Action Characteristics: This pattern occurs within the context of an uptrend. the price forms a U-shaped cup (rounding bottom) with a short handle on the right like a flag pattern
- Logic: The last retracement (handle) is the last bearish move. When the price falls, we expect the market to rise. Like a bullish flag pattern
- Volume behavior: Volume will typically follow the shape of the cup (or rounding boom), with high volume as the left lip forms, falling volume as the bottom of the cup forms, and rising volume toward the right lip, and again, volume decrease on last bearish push
- Entry: The conservative entry for the Cup and handle chart pattern is to buy on break-out of the cup’s high. The aggressive entry can take place once the handle breaks out.
- Breakout Confirmation: A strong candle close above the upper trend line drawn across the handle with above-average volume
- Target /Measuring Technique: The price target is obtained by measuring the start of the cup to the bottom of the cup and then adding to the price level of the cup
Ascending Triangle Chart Pattern
- Directional Bias: Bullish
- Pattern Type: Continuation
- Price Action Characteristics: This pattern occurs within an uptrend and consists of equal highs and rising lows, forming a triangle
- Logic: A relatively strong horizontal upper resistance line was holding the price from going higher. Each time the price hits the resistance line, it drops. However, each time it drops, the fall weakens. Thus, it starts making higher lows. From a smart money psychology point of view, this seems to suggest a large sell order placed at a fixed price (where the horizontal upper resistance line is located). Each time the buyers push the price to that level, the price is rejected from the resistance line and drops as part of the order gets triggered. This process continued for a while until the entire order was cleared from the resistance line, and once there weren’t any more sellers, the price was pushed higher by strong buyers.
- Volume behavior: The volume declines throughout the triangle formation
- Entry: In a bull trend, buy on break-out above an Ascending Triangle
- Breakout Confirmation: The confirmation for this pattern is a strong candle close above the highs on above-average volume.
- Measuring Technique: Subtract the height of the highs of the pattern and the lowest low of the pattern, and then add this amount to the breakout level.
Top 7 Chart Patterns in Trading Summary:
Chart patterns are essential tools in technical analysis as they help traders understand market psychology and anticipate potential price movements. Here are seven of the most commonly recognized and traded chart patterns:
Head and Shoulders (and Inverse Head and Shoulders):
- The Head and Shoulders pattern is a reversal pattern that indicates an uptrend’s end and a downtrend’s beginning. It is characterized by a peak (shoulder), followed by a higher peak (head), and then another lower peak (shoulder).
- The Inverse Head and Shoulders pattern is the opposite, suggesting a reversal from a downtrend to an uptrend.
Double Top and Double Bottom:
- The Double Top is a bearish reversal pattern seen at the peak of an uptrend, where the price hits a resistance level twice and then starts a reversal.
- The Double Bottom is the bullish counterpart, occurring after a downtrend, with the price finding support twice before reversing upwards.
Triangles (Symmetrical, Ascending, and Descending):
- Symmetrical triangles are continuation patterns formed by converging trendlines with a similar slope converging to a point. The breakout direction determines the trade.
- Ascending triangles have a flat upper trendline and a rising lower trendline, typically breaking upwards, indicating continuation or reversal.
- Descending triangles have a flat lower trendline and a downward-sloping upper trendline, usually breaking downwards.
Flags and Pennants:
- Both are short-term continuation patterns that show a small consolidation before the previous move resumes.
- Flags appear as small rectangles generally sloped against the prevailing price trend.
- Pennants are small symmetrical triangles that start wide and converge as the pattern matures.
Cup and Handle:
- The Cup and Handle is a bullish continuation or reversal pattern that looks like a teacup on the chart. The “cup” has a round bottom with a slight drift down followed by a rise up, and the “handle” has a slight downward drift.
- A breakout from the handle’s resistance indicates a potential continuation of the prior trend or reversal of the prior downtrend.
- Rectangles are consolidation patterns where the price moves between horizontal support and resistance levels, representing a trading range.
- Breakouts or breakdowns from the range indicate the potential continuation of the previous trend.
Wedges (Rising and Falling):
- Wedges are patterns marked by converging trend lines with a noticeable slope against the prevailing trend and usually signal a reversal.
- A Rising Wedge forms during an uptrend and suggests a bearish reversal as the price consolidates and narrows.
- A Falling Wedge occurs during a downtrend and indicates a bullish reversal with a tightening price consolidation.
Traders often look for these patterns to appear on charts, as they can provide actionable trading signals. They are used with other forms of technical analysis, such as indicators and oscillators, to confirm signals. Additionally, volume analysis can often confirm the pattern’s strength or weakness, particularly on breakouts or breakdowns. It’s important to note that no pattern always works, and using stop losses and risk management strategies is crucial to successful trading.
In the next article, I will discuss How to Trade Bull Flag and Bear Flag Patterns in Trading. In this article, I explain the Top 7 Chart Patterns in Trading That Every Trader Needs to Know. I hope you enjoy this article. Please join my Telegram Channel, YouTube Channel, and Facebook Group to learn more and clear your doubts.
About the Author: Pranaya Rout
Pranaya Rout has published more than 3,000 articles in his 11-year career. Pranaya Rout has very good experience with Microsoft Technologies, Including C#, VB, ASP.NET MVC, ASP.NET Web API, EF, EF Core, ADO.NET, LINQ, SQL Server, MYSQL, Oracle, ASP.NET Core, Cloud Computing, Microservices, Design Patterns and still learning new technologies.