MAKING HEADS AND SHOULDERS OUT OF PEAKS AND TROUGHS
Chart patterns, or price patterns, are formed by the changes in price activity of the asset you are trading, whether that’s stocks, commodities or currencies. There are essentially two main types of price patterns; continuation patterns and reversal patterns.
Continuation patterns are used to identify if the market is taking a bit of a break, or entering a period of consolidation, before continuing along its previously indicated trend and reversal patterns will indicate whether a price trend has reached its peak (or trough) and is about to change direction.
There are several well-known price patterns and you’ll cover some of them in the second lesson of the Traders Campus course.
Each with its own simple descriptive name such as Head and Shoulders (not the anti-dandruff shampoo), triangles, pennants, diamonds, etc. They all have a particular story to tell about the continued performance of the market you are trading.
A Brief Overview of Continuation and Reversal Patterns
Head and Shoulders, Top and Bottom – You’ll cover this in the lesson and it can signal a reversal of trend at either the peak of a bullish run or the trough of a bearish run, just in
Double Top and Bottom – two shoulders at approximately the same height but with no head
Triple Top and Bottom – Like a Head & Shoulders but the “head” is not discernibly higher (or lower) than either of the shoulders
Wedges – Needs a prior trend to reverse. While the trend continues the resistance and support lines get closer together. Falling wedges indicate a potential break into an upward trend, confirmed when the price chart breaks the upper resistance line. Rising wedges indicate a potentially imminent bearish break from the current uptrend and is confirmed when prices breach the lower support line.
Rounding Bottom – A slow reversal indicator, best viewed in weekly charts. It looks a bit like a saucer or shallow bowl. It will show a curved decline to a low point over several weeks and will then form the upward curve over a very similar period of time.
Bump & Run Reversal – When a trend line shows a steady increase, but there is a sudden “bump” or spike driving prices higher far more quickly than the market can sustain, there is a corrective reversal to account for the sudden spike.
Flags/Pennants – Short-term continuation patterns. These indicate a period consolidation and price stabilization before continuing on their previous trend. Usually preceded by a spike in price.
Triangles – Symmetrical, Ascending & Descending – Symmetrical triangles form after a discernible spike with at least two successive lower highs and two successively higher lows, attempting to find a median before continuing the existing trend. Ascending triangles triangle indicate a continuing bullish trend with two reasonably close highs (they don’t need to be exactly the same, but very close) and two successively higher lows, showing a period of validation of the current high before continuing on its uptrend. Descending triangles are the direct opposite and indicate a continuing downward trend.
Rectangles – this formation requires a prior trend to exist to call it a continuation pattern. It indicates a pause in the market where the price ranges between two strongly indicated support and resistance lines before continuing along its previous trend.
If this sounds too easy, you learned to identify shapes in kindergarten, then we will up our game and add in oscillators for the lesson. Some interesting and valuable line charts to add value to your chart analysis.