Chart Patterns

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Introduction:

When a stock moves, the entire data trail that it leaves behind forms a pattern when seen on its chart. Based on the stock pattern that is formed and other technical parameters, we can conclude if a stock is going to move up, down or consolidate. Thus a bullish pattern tells us to BUY and a bearish pattern conveys to SELL. The entire aim of technical analysis is to trade without any emotional judgments. Patterns help us trade technically with a high accuracy. Our trades must always go hand in hand with the stock pattern and hence understanding patterns in an important skill in technical analysis. Patterns are classified as either ‘Continuation Pattern’ where the pattern is in continuation with the current trend or a ‘Trend reversal’ where the pattern will trigger reversal of the current trend. Most popular patterns comprise of the following phases.

1. Historical trail: What has the stock been doing historically?
2. Consolidation trail: A period when the stock moves sideways in a range not breaking the support and the resistance levels.
3. A breakout with high volumes: When the stock breaks the consolidation i.e breaks either the support or the resistance with heavy volumes
4. Future trail: The likely trend in which the stock may move.

Popular patterns seen on charts:

1. Up-Flag:

It is a trend continuation pattern seen when the stock is in an uptrend. Most of the times, an uptrend happens with this pattern. It is made of the following components:

1. Historical Move: It has a historical uptrend associated with it on the basis of which this pattern is formed. This historical uptrend is seen with good volumes. It shows that the investors are positive on the stock.
2. Pole of the flag: It is the distance between the first historical resistance and the highest point from where the consolidation (flag cloth) starts.
3. Flag Cloth: It is a phase of consolidation where the stock moves between two trend lines with low volumes. This is the phase when the stock has lost interest of investors. The stock trades between its resistance and support levels.
4. Break out: This is the day when the stock breaks its resistance and comes out of the consolidation phase. Heavy buying occurs in the stock and it may give a movement of 5-15% with heavy volumes on that day. It has recreated the lost interest amongst investors. It is seen as a single GREEN candle on the candlestick charts.
After an up-flag the stock starts moving up. Once the pattern is identified the analyst then calculates the next target and the duration in which the target is likely to be achieved. This pattern is a very common one and occurs frequently while the stock is rising.

UpFlag 

2. Down-Flag:

It is a trend continuation pattern seen when the stock is in a downtrend. Most of the times, a downtrend happens with this pattern. It is made of the following components:

1. Historical Move: It has a historical downtrend associated with it on the basis of which this pattern is formed. This historical downtrend is seen with good volumes. It shows loss of faith in the stock.
2. Pole of the flag: (Same as up-flag)
3. Flag Cloth: (Same as up-flag)
4. Break out: This is the day when the stock breaks its resistance and comes out of the consolidation phase. Heavy selling occurs in the stock and it may fall 5-15% with heavy volumes on that day. It has further lost faith of investors. It is seen as a single RED candle on the candlestick charts.

After a down-flag the stock starts falling further. Once the pattern is identified the analyst then calculates the next target and the duration in which the target is likely to be achieved. This pattern is a very common one and occurs frequently while the stock is falling.

DownFlag

3. Rounding Bottom:

A rounding bottom also called as the cup and handle is a trend reversal pattern where a stock is on the verge of moving from downtrend to uptrend. It is not a very common bullish pattern but a very reliable one. It is formed after a stock has been in a downtrend with a huge price decline, then in consolidation for a long time (usually years) and then breaks the consolidation and starts to rise again. Following are the key phases of this pattern.

1. Historical trail: The stock was in a strong downtrend. It has taken a massive beating and its price has declined significantly.
2. Consolidation trail: It has been moving sideways for a very long period. This period can range between a few months to even a couple of years. No movement in seen at all in this phase. You will not even hear about this stock in this phase.
3. A breakout with high volumes: From the consolidation phase it gradually starts moving up and then gives a 5-10% rise, with heavy volumes, on a single day thus coming out of the consolidation. Investors are back into it and the stock will now move up.

RoundingBottom

Note: Our experience says that 90% of the times, when a rounding bottom is seen, the stock starts moving up. An investor should not miss an opportunity to take a position at this time.

4. Head and Shoulders:

It is a trend reversal pattern seen in uptrends. It is called the head and shoulders because it has a left shoulder, a head, a right shoulder and a neck line.

1. Left shoulder: Is formed when the stock rises to some peak point ‘P1′ and then declines from there and reaches a point ‘B1′.
2. Head: Is formed when the stock starts moving up from point ‘B1′ crosses former peak point ‘P1′ and makes a new peak point ‘P2′ and declines again to form a point ‘B2′ (which is somewhat at the same levels as point ‘B1′).
3. Right shoulder: Is formed when the stock rises again from point ‘B2′, this time reaches to somewhat the same levels as peak point ‘P1′ making a peak point ‘P3′ (does not cross ‘P2′) and then declines from there and reaches somewhat the same point as point ‘B1′ and ‘B2′ thus making a new point ‘B3′.
4. Neck Line: A line is drawn connecting the bottom of the left shoulder, the head and the right shoulder. This is called the neckline. When the stock falls below the neckline with a break out (with high volumes), the head and shoulder is complete. Thus a downtrend is triggered.

HeadAShoulder
Note: It is amongst the reliable stock patterns. An investor should not miss an opportunity to take a position at this time. It is challenging to spot this pattern in the stock chart.

5. Inverted Head and shoulders:

It is just the opposite of a head and shoulder seen in downtrends. It triggers an uptrend when the stock rises above the neckline with a break out with high volumes. Again a reliable one and should be en-cashed on by investors.

InvHAS

6. Double Top (Double Shoulder):

If you remove the ‘head’ from the head and should pattern, we would see only two shoulders and thus a double top pattern. It is a trend reversal pattern which triggers a downtrend.

1. Left top: Is formed when the stock rises to some peak point ‘P1′ (Top 1) and then declines from there and reaches a point ‘B1′.
2. Right Top: Is formed when the stock rises again from point ‘B1′, this time reaches to somewhat the same levels as peak point ‘P1′ (Top 2) making a peak point ‘P2′ and then declines from there and reaches somewhat the same point as point ‘B1′ thus making a new point ‘B2′.
3. Neck Line: A line is drawn connecting the bottom of the left and right shoulder. This is called the neckline. When the stock falls below the neckline with a break out (with high volumes), the double top is complete. Thus a downtrend is triggered.

DoubleTop

7. Double Bottom (Inverted double shoulder):

It is just the opposite of a double top. It triggers an uptrend when the stock rises above the neckline with a break out with high volumes.

DoubleBottom

8. Triple Top:

It is same as the double top; it’s just that it has three tops instead of two.

TripleTop

9. Triple Bottom:

It is same as the double bottom; it’s just that it has three bottoms instead of two.

TripleBottom