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Monday, November 12, 2007

Chart Patterns – Introduction

What Is Chart Patterns?
Chart Patterns
provide a complete, concise pictorial documentation of all buying and selling (supply and demand) forces.
Chart Patterns allow investors / traders to analyze the battle between bulls (buyers) & bears (sellers) and help determine who win the battle, so that they can position themselves accordingly.

Why Chart Patterns Can Help In Trading / Investing?
Because price patterns form as a result of market psychology.
Although a chart only presents stock prices & volume, it actually reflects human behavior, psychology and reactions towards the forces of supply vs. demand.
For example:
A consolidation pattern (sideways movement) does not develop because the pattern is controlling price movement.
A consolidation pattern develops because there is no enough belief or confidence in the market that the price should be heading up or down. Here, investors / traders are still trying to analyze the market to come at a conclusion about where they think the stock price should be heading based on their new price expectations for the stock.
Usually, the price will trade sideways until an “event” occurs to shift the market’s psychology one way or the other, which then results in a price breakout from the consolidation pattern.
The investors / traders who observe the pattern could then assume positions to trade or “ride” the breakout move.

Types of Chart Patterns
Chart patterns can generally be grouped into 2 types of patterns:

1) Continuation patterns:
Continuation patterns are price patterns that are formed in periods of price consolidation during a trend. They suggest that the market is still not sure where the price should be heading, but ultimately deciding to confirm the existing trend.
Hence, when price breaks out from this consolidation period, it is usually in the direction of the trend.
Continuation patterns offer opportunities to take or add to a position.
The following are some Continuation patterns:
Ascending Triangle, Descending Triangle, Symmetrical Triangle, Bullish / Bearish Flag, Bullish / Bearish Pennant, Rectangle, Price Channel, Cup and Handle.

2) Reversal patterns:
Reversal patterns are price patterns that occur at the end of the trend.
These patterns imply the market momentum is slowing and provide signals that a trend may be coming to an end and that prices may change direction.
The following are some Reversal patterns:
Head And Shoulders Top, Head And Shoulders Bottom, Double Tops, Double Bottom, Triple Tops, Triple Bottoms, Falling Wedge, Rising Wedge, Saucer / Rounding Bottom.

A Few Caution Notes
* Identifying, analyzing & interpreting chart patterns are more of an art than science. It’s quite subjective and needs some degree of imagination & skills to identify them.
* Some patterns are easier to identify and repeat themselves quite frequently, while others are more difficult to be recognized and rarely formed.
* Different market, industries and stocks can behave differently.
For instance, some stocks are more volatile than the others; some stocks often experience gaps, whereas the gaps seldom occur in the other stocks, etc.
* No pattern provides certainty even though all the signals it gives comply the pattern characteristics / rules perfectly. Even a “perfect” pattern merely presents us a higher probability that it may behave as what we expect from the pattern. Pattern failures do happen frequently. Therefore, what is more important is money management.

In the next posts, we’ll cover various common chart patterns further.
Hope it can be useful for you. Stay tune. :)

To read about chart patterns, go to: Learning Charts Patterns

Related Posts:
* FREE Trading Educational Resources You Should Not Miss
* Learning Candlestick Charts
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks


Tony Chai said...

Hi OTB :

Wow! You're now moving forward from candlestick chart patterns to technical analysis chart patterns.

Good Work!!

Just want to add that the decision to make a short-term or long-term trade could sometimes be determined by the formation of the crucial chart pattern in different time-line (ie. hourly chart, daily chart). And of course, observation of trading volume with such chart patterns would always be useful.

Yours Truly,

Tony Chai
My Options Trading Blog


Thanks for your support, Tony.