Stock chart patterns explained in 2020

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minutes read/Updated: 29.12.2018

Analyzing why some assets are appreciating in price, and why others are not, can seem like a tricky business for newcomers to trading. The term “technical analysis” is enough to bring many would-be traders out in a cold sweat, but the reality is that the task of scrutinizing current market options is made so much easier by the presence of one simple diagram: the short chart pattern.

In this short chart pattern guide, we will reveal what short chart patterns are, what they tell us, and how you can use them to ensure that your trading is supercharged in 2019 and beyond.

  • What are short chart patterns?
  • What do they tell us about current market conditions?
  • How can we use them to improve our trading?
  • Can stock charts explain the present and “predict” the future?

What are short chart patterns, and should you trade without them?

There are, literally, billions of dollars’ worth of trades happening across the world every day of the year. For traders, this means the chance to buy or sell their stocks for the maximum effect.

The question is: how do traders know what to buy and sell, and, most importantly, when to buy and sell an asset?

Every trader has their own unique motivations. Some traders are driven by rumor and hearsay – this is a shortcut to a quick and painful end to your trading career. Listening to whispers among the trading community could prove to be disastrous – why would your “competitors” tell you about what they plan to buy and sell in fear of the prices moving significantly?

Instead, smart traders use short chart patterns to offer visual analysis of the market and to identify key trends that can help them to trade successfully.

Short chart patterns are your “bigger picture” look at the market, and both trading signals and future price movements can be predicted based upon the use of these images.

As we know, market patterns tend to be cyclical: fear, confidence, bears, and bulls are all identifiable from certain trading behaviors.

The short charts can help you to reveal these before they unfold.

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Stock charts explained – An example of a short chart in action

First, you have to understand what these short charts represent before understanding their unique patterns.

The following information refers to classic candlestick charts that are commonly used by traders of all levels of expertise.

Those green and red candlesticks on the chart refer to the raw data of forex or whatever market you’re trading. These represent naked price action, i.e. whether an asset is experiencing price growth or decline.

As you probably know, green candles are bullish and positive, while red candles signify bear conditions and are negative. They represent price fluctuations over a given period of time, whether that’s five-minute charts, daily charts or anything in between.

The body of these candles shows opening and closing prices of an asset, while the shadows (those vertical lines above and below the candle bodies) reflect the highest and lowest price of the item in the chosen timeframe.

The stock chart explained above that the US dollar against the euro for the period of late November to early December 2018.

As you can see, the price opens at around the 1.1400 mark, but some mighty red candles – tempered by occasional greens – suggest bear conditions – reflected in the price closing on December 3 at 1.13495.

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Short chart patterns in action

The key to successful trading is to remain one step ahead of the market. With sentiment shifts being the chief cause of price fluctuations, you need to be able to predict these before they occur to maximize your shorts.

There is a certain amount of interpretation to be applied to the charts, but a number of patterns reveal time-served patterns that traders have used for years to get the best from their trading strategies.

There are three general types of short chart pattern: continuation, reversal, and breakout.

As the name suggests, a continuation pattern is one where the trend will continue after a temporary change in direction.

These are considered to be brief “pauses”, and that the original pattern will resume after this temporary break. There are a number of common patterns to this effect, including cup and handle, triangles, and flags and pennants (more on those later).

A reversal pattern highlights a change in the direction of a price trend, though a fact that many traders forget is that this can be positive or negative.

Looking at the charts, a reversal pattern is easy to see with stark price rises of decreases in a short space of time. The most common forms are head and shoulders, double/triple tops and bottoms, and wedges.

A breakout pattern occurs when an asset breaks through a period of resistance to reach a previously unprecedented price point.

Example of short chart patterns 1: cup and handle

A continuation pattern, a cup and handle, is a bullish trend with growth coming out of a dip (the “cup”) before a small pullback is broken out of with another bull run (the “handle”).

The cup can be a round-bottomed “U” shape or a more pronounced “V”, but both indicate a bull run of varying intensity.

Once the handle has been fully formed from the new trading range, the asset may regress to a lower level or break out to a new price high.

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Originally devised by William J. O’Neil in his timeless book How to Make Money in Stocks, this is a pattern that tends to test “old highs”, and so there is an element of pressure on buyers who engaged at that previous price to sell now.

This can lead to a temporary downturn, but this is a continuation pattern that can be used to identify sound opportunities to buy.

How should you trade a cup and handle? There are a couple of different theories, but the main ideas include:

  • Wait for the handle to form
  • Buy now, but be wary – the breakout may be over swiftly
  • Set a stop/loss marker just below the handle for security

Example of short chart patterns 2: head and shoulders

This is a reversal pattern that signifies that a change in trend is likely.

As the name suggests, this is a pattern with three peaks, with the first being considered as the left shoulder, the second as the head, and the third as the right shoulder.

The lows that connect the peaks can be thought of as a neckline, and it is these that dictate the major support level. This enables traders to predict a breakout or downturn.

There is an inverse head and shoulders where the opposite is true: the neckline marks the resistance level prior to a breakout.

This pattern can occur on all trading graphs, so both day traders and long-term investors can utilize its information.

How do you trade a head and shoulders pattern? Again, it is imperative that traders wait for the pattern to be complete. This will be indicative by following the trend lines and waiting for that right shoulder to be completed.

Our next steps are to:

  • Wait for the price action to move lower than the neckline after the right shoulder
  • Plan stop and profit targets as the trend line is heading downwards
  • Pull the trigger as soon as the initial breakout occurs at the neckline

Example of short chart patterns 3: triangles

One of the most commonly occurring short chart patterns, triangles can take three forms: symmetrical, ascending and descending.

A symmetrical triangle shows two trend lines that are converging on one another, with a triangle from the highest and lowest points to somewhere in the middle visible. The concept is that the market is forming lower highs and higher lows, e.g. consolidation and that neither buyers nor sellers are committing to push the price.

With a symmetrical triangle pattern, a breakout is likely, though the direction is unknown.

An ascending triangle is an indicator that a breakout to a higher price point is possible, with a flat upper trend line supported by a rising lower line. Usually, there is some resistance at the upper price point, but the higher lows mean that the ball is in the buyer’s court.

Within the ascending triangle formation, the buyers will either push through the resistance line, or the resistance will prove too strong with not enough buying power to force through it.

The descending triangle is the opposite, with a flatter low trend line and a descending upper line hinting that a fall-back is highly likely. The support at the high priceline regresses, and resistance at the lower level can be broken, with the price subsequently falling, or standing firm.

Traders can assess the scale of the breakout or fall-back using the left vertical of the associated triangle as a guide.

Example of short chart patterns 4: flags and pennants

Flags and pennants are short-term continuation patterns that dictate a trend based upon their shape. They typically represent some kind of leveling out, or retracement, from the norm, before the prevailing market force subsequently takes control. There is, rarely, any breakout above or below the resistance and support lines.

A flag is a horizontal pattern identifiable on the chart where the trend lines run parallel with one another to create a flag shape.

In contrast, pennants have trend lines that converge with one another to meet at a point. These are typically smaller than the main triangle short chart pattern, as befitting of their short-term stature.

These are short-term in their nature and depict a sharp change in confidence, which would be likely in assets experiencing a good or bad “news event”, or where trade volume falls but by nowhere near enough to break resistance or support.

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Here’s a key insight for traders: pennants and flags almost always accompany falling volume. If trading volume isn’t forming, but one of these patterns appears to be forming, then it is a typical trigger for a reversal and downturn.

Generally, the preceding trend will continue upon the formation of a flag or pennant, and this is determined by the direction in which the eventual breakout occurs.

If the breakout shifts in a direction opposite to the main trend, then that could well be over.

 

Example of short chart patterns 5: double/triple tops and bottoms

For traders who prefer medium to long-term forecasts, tops and bottoms are a strong indicator of an asset’s strength.

These patterns are easy to spot and are also a very reliable guide given that they tend to unfold over longer periods of time, compared to some of the other more aggressive chart patterns.

A double or triple top comes when a new price tests lines twice or three times without making a significant breakout. Buyers are unable to push through the resistance and so a new high cannot be established – these are the “tops” or the peaks of trading.

The price will bounce away from the top, and then, if there is enough trading volume, it will test the resistance once more. If it fails to break through again, then you have a double top, and subsequently a triple top if the process repeats itself.

Tops and bottoms tend to signal a reversal of trend over the medium to long term, and so trading them is straightforward enough once the top has been formed: the neckline will always be broken, and so an entry point can be accurately predicted. For traders, this accurate prediction is worth its weight as it affects their trade.

 

Conclusion

Quite simply, there are no better indicators of market mood and confidence than short chart patterns.

Short chart patterns are time-served, having been used by traders for many years, and the patterns – while not being guarantors of trading profit – are an accessible trading guide for newcomers that helps you to understand exactly what is going on.

As the old trading mantra goes, “You cannot predict the future by looking to the past.” However, short chart patterns have been well-established among the trading elite, and newcomers can benefit from their teachings just as well as through buying and selling assets for seven-figure sums each day.

Remember that if short chart patterns were guaranteed to bring success, then we would all kick our nine-to-five jobs to the curb and start trading.

However, if you want a sound theological process to use as a grounding to your actions, you simply won’t find any better.