Every day hundreds of thousands of market participants buy and sell securities for a wide variety of reasons: hope of gain, fear of loss, tax consequences, short-covering, hedging, stop-loss triggers, price target triggers, fundamental analysis, technical analysis, broker recommendations and many more. It’s impossible to figure out why participants are buying and selling, but chart patterns put everything in perspective by putting the forces of supply and demand into an observable picture.
Investors analyze chart patterns to make both short-term or long-term forecasts. The data can be intraday, daily, weekly or monthly and the patterns can be as short as one day or as long as multiple years. Below we will look at some of the most common.
Head and Shoulders
The Head and Shoulders chart pattern is known for its reliably in predicting a reversal in trend. There are two versions of the head-and-shoulders pattern: the kind that forms at the top of a run and the type that signals a downtrend is over (known as inverse head and shoulders).
This pattern has four main steps for it to complete itself and signal the reversal. The first step is the formation of the left shoulder. The second step is the formation of the head, then a retrace back near the low formed in the left shoulder. The third step is the formation of the right shoulder, which is formed with a high that is lower than the high formed in the head but is again followed by a retracement back to the low of the left shoulder. The pattern is complete once the price falls below the neckline (see example below).
Cup and Handle
Another popular chart pattern is the Cup and Handel. This bullish continuation pattern is preceded by an upward move, which stalls and declines. After this sell-off, the security will mostly trade flat for an extended period of time, with no clear trend. Next the stock will begin moving back towards the peak of the preceding upward move. Finally, there is a relatively smaller downward move before the security moves higher and continues the previous trend. An example is shown below:
Triangles are also often used by technical analysts to predict a breakout. Basically, the chart pattern is made when two trendlines converge with the price of the stock moving between the two trendlines. The triangle pattern can also be used to predict a collapse. Below are a few examples
Additional Chart Topics
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