Using Patterns in Trading – What You Need to Know in 2018

Successful trading needs you to be up to speed with technical analysis to get the best out of your trade moves. Stock chart patterns have an important part to play in developing your trading techniques. Patterns in trading can be found in every type of market, and understanding what they are and how they can be used to help you will give you a better chance of maximising your profits and minimising your losses. Trading is complex, so grasping the essentials of how markets work and how you can use a range of technical indicators to support you is crucial.

  • Types of chart
  • Chart Patterns
  • Is it useful to trade using patterns?
  • What markets can I use when using patterns?
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Types of Charts – Part 1

Before you move on to getting to grips with chart patterns, you need to know what types of charts there are that are used by traders and investors, in order to develop your trading strategies.

  • Line charts: These are the most basic sort of chart and represent solely the closing prices that relate to a set period. A line is formed that connects the closing prices over that set period, and though it doesn’t give that much insight into price movements within the day, there are many investors who think the closing price within a given period is more important than the opening, high or low price. Using a line chart can also make it easier for spotting trends because there is less happening on the chart in comparison to other chart types.
  • Bar charts: These charts expand on the line chart by adding the daily price range to the mix. You can then see the opening price, the high, the low and where it closes. A bar chart is made up of a sequence of vertical lines, representing the price range for a specific period. There is a horizontal dash on either side of the vertical, representing the opening and closing prices. The dash to the left side of the horizontal line is the opening price, with the closing price on the line’s right side.

There are four main types of charts, with line charts and bar charts being two of those, and what traders use will depend on what information they are looking for and what their desired goals are.

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Types of Charts – Part 2

Let’s look at the other two main types of charts:

  • Candlestick charts: Over 300 years ago, this type of chart originated in Japan and is now very popular with traders and investors. In common with bar charts, candlestick charts have the same thin, vertical line that shows the price range for a specific period. The line is shaded in different colours depending on whether the traded stock ended higher or lower. The difference between these charts and bar charts is that there is a wider rectangular bar that shows the contrast between where the prices open and close. Typically, falling periods will have a black or red candlestick body, whereas a clear or white candlestick body denotes rising periods. If opening and closing prices don’t change and remain the same, there will not be a rectangle or wide body, making it easy to spot what’s happened, once you have gained experience of charts.
  • Point and Figure charts: Point and Figure charts have been around since the first technical traders began to invest in and test markets. These charts reflect price movements without needing to take into account volume or time concerns, so insignificant price movements can be removed. This “noise” can distort the view a trader has of an overall trend that can skew the effect that time has on analysing a chart.

It will be entirely dependent on each specific trader as to which chart they feel is going to be of most use to them.

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Chart Patterns – Part 1

With millions of traders with different goals and experience trading every day in securities, and billions of dollars of trade being transacted, it’s effectively impossible to know what everyone’s motivations are. You can follow trends as best you can but you need technical tools to help you focus on the bigger picture. Chart patterns are the tools to help you identify trading signals and signs of future movements in price. Charts are based on the assumption that history repeats itself – though there are times when it doesn’t – but the assumption is that certain patterns constantly reappear and the tendency is that they will produce the same outcomes. There are established definitions and criteria for chart patterns but you’re not going to find any patterns that will give you 100% certainty as to where a particular security may be headed. Reversals and continuations are the two most popular chart patterns: reversals signal that a prior trend, when the pattern is competed, will reverse, whereas a continuation flags that the trend will carry on when the pattern is completed.

Though chart patterns are an important part of any trader’s technical analysis tools, you should look to combine them with other methods of technical analysis and with technical indicators. There are many types of chart patterns that you can use and it’s worth taking the time to get to understand the major types to see which will work best to give you a deeper understanding of the trading options.

Chart Patterns – Part 2

Here are some examples of chart patterns that you can go on to study in more detail:

  • Head and Shoulders: This is an example of a reversal chart pattern and indicates that once a trend has been completed, it is likely to reverse. The top of a Head and Shoulder has three peaks, with the middle one being the highest (the head) and the other two (the shoulders) being lower and about equal. A trend line, known as the neckline, connects the lows between these peaks, and this line depicts the key support level, so you might be able to detect a breakdown and reversal of trend. The bottom of a Head and Shoulders is the inverse of the top, and the neckline is a resistance level, so you can look out for a higher breakout.
  • Cup and Handle: The Cup and Handle is a continuation pattern that is shown when an upward trend is paused, but when the pattern is confirmed, will continue going up. The portion of the pattern that forms a cup should be in a “U” shape, depicting a rounded bowl, rather than a “V” shape. There should be equal highs on either side of the cup, and a handle forms to the cup’s right side, which is a short pullback and looks like a pennant or flag chart pattern. When the handle is completed, the security might breakout to new highs and then resume its trend even higher.

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Chart Patterns – Part 3

Double Tops and Bottoms: Some chart patterns are considered by traders to be more reliable than others. The Double Top or Double Bottom pattern is one of these and is also easy to recognise. For traders who are technically orientated, these charts are a favourite tool. A pattern is formed when there has been a sustained trend and a support or resistance level has been tested twice by a price without a breakthrough. What the pattern signals is the beginning of a trend reversal that can happen over the intermediate or long term. As this pattern can give a useful and quick overview as to where a particular security is going or has been, it’s a useful tool, especially when you are starting out.

Triangles: These are another popular type of chart pattern that is used in technical analysis because they happen frequently when compared to other patterns. You may be familiar in maths with isosceles or equilateral triangles, but in chart patterns, there are three common types: symmetrical, ascending and descending. These can be short-term, up to two or so weeks, or can last for several months. Two trend lines converging towards each other are when symmetrical triangles happen, and though this is a signal that a breakout could occur, it does not indicate the direction of a breakout. An ascending triangle suggests that a higher breakout is likely, whereas a descending one may mean that a breakdown could occur.

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Chart Patterns – Part 4

Flags and Pennants: These are short-term continuation patterns and they represent a consolidation after a sharp price movement, and a prevailing trend then continues. These are useful when examining patterns in trading. When you look at this type of chart, you will note flags that look like a small rectangular pattern, and these slope against a prevailing trend, with pennants being small, symmetrical triangles. The length of the “flagpole” determines the short-term price target when a flag and pennant pattern is examined and they typically last for only a few weeks.

Wedges: A wedge pattern is a reversal, though it can, on occasion, be a continuation pattern. It’s similar to a symmetrical triangle but it slants downward or upward. A rising wedge happens when a trend is moving higher, prices are converging and there is a loss of momentum with the prevailing trend. A falling wedge happens when a trend is heading lower when processes are converging, signalling that the bearish trend’s momentum is being lost and it is likely there will be a reversal. It’s not the easiest of patterns to identify, so if you choose to use it, you should also consult other technical indicators that may or may not confirm the information.

Gaps: Gaps happen when there is a significant decrease or increase in price that creates an empty space between two periods of trading.

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Market Trading with Patterns

You can use patterns in trading with whichever market you want to work in, and if you are developing a portfolio of investments, you can find those that best suit your trading instincts. If you are starting out, the best way is to sign up for a demo account with a broker – always do a broker comparison first to see what costs and other requirements are – so you can learn the ropes before investing your own money in trades. Whether you’re looking for quick profits or for longer-term investments, such as for retirement or to buy a property in the future, you should take plenty of time to acquire the knowledge and skills that will help you navigate the complex financial world.

You may want to go into commodities, seeing where prices for the likes of oil, natural gas, renewable energy, steel, aluminium or agricultural products have been and are going. The price of commodities, as with all securities, fluctuates due to market conditions and can be very responsive to political decisions, such as putting on tariffs for imports. Keeping an eye on economic and political news can help you determine what commodities, currencies, stocks or other tradable items might be a good place for your investment.

Conclusion:

Patterns in Trading – A Useful Tool?

Put simply, the answer is yes, but patterns are only one set of technical tools you can use to trade successfully. However, because there are so many types of charts, if you can get through how all of them work and blend what works for you into your trading strategies, they can provide a high level of support and information to back up your own inclinations. Whatever field you decide to trade in, you should use all the tools available to give you the best opportunities for success.

When you understand what types of charts you can use and then how you can decipher patterns, you are in a strong position to invest with confidence. No trading is without risk, so learn the business with a demo account before stepping into the maelstrom of the markets. Time spent practising, understanding patterns and other indicators, could set you up to become a successful trader.

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