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Technical Chart Patterns

A Price pattern is a pattern that is formed within a chart when prices are graphed. In stock, commodity and currency markets trading, chart pattern studies play a large role during technical analysis. When data is plotted there is usually a pattern which naturally occurs and repeats over a period. Chart patterns are used as either reversal or continuation signals.

Basic Chart Patterns You Need to Know.

Symmetrical Triangle
Symmetrical triangles chart patterns usually form as a result of a lack of conviction regarding which way the price of an asset will move. A technical trader searching for this pattern looks for two converging trendlines that meet at a central point: the apex. As you can see, the converging trendlines give this pattern its distinct triangular shape. Simply put, it is created by drawing two trendlines that connect a series of sequentially lower peaks and a series of sequentially higher troughs. As the pattern develops, these trendlines act as barriers that prevent the price from dramatically moving in any one direction. However, once the price does breach one of these levels, volatility increases and, consequently, the price can experience a sharp movement in the direction of the breakout.
Traders who are able to identify this setup prior to the breakout are in a desired position because gains from this sharp price movement can be substantial. A sideways movement before the breakout is regarded as a period of rest occurring just before the price continues in the direction of the original trend. In general, a trader will wish to see the price of the asset break through one of the trendlines around three quarters of the way between the beginning of the set-up and the apex. Once the price breaks above (below) the trendline, a price target is set equal to the entry price plus (minus) the height between the two trendlines.

Ascending Triangle
A cousin of the symmetrical triangle is the ascending triangle. This is a bullish pattern and can be easily recognized by the distinct shape created by two trendlines.As you can see from the diagram, the first trendline is drawn horizontally at a level that has prevented the price from moving higher on several occasions. The second trendline is drawn so that it connects a series of increasing troughs, which is often considered to be a graphical representation of an increase in demand. It may take the buyers a few tries to push the price past the upper resistance level, but once a breakout does occur, the buyers aggressively send the price of the asset higher,usually on very high volume. Price targets are generally set to be equal to the entry price plus the vertical height of the triangle. An ascending triangle is generally deemed to be a continuation pattern, meaning that once it breaks above the upper resistance,it usually continues in the direction of the prior trend. In practice, this pattern usually takes three or four weeks to develop and is well liked by technicians because of its clear entry and exit signals. Traders who are aware of this pattern have an edge over longer-term holders because they are able to enter a position and benefit from the same sharp increase that other longer-term investors have been waiting for.

Descending Triangle
The bearish counterpart to the ascending triangle is the descending triangle. The major difference between the two triangular chart patterns becomes apparent when you examine how the two trendlines are drawn. Notice how the horizontal trendline is drawn at a level that has prevented the price from heading lower, rather than preventing it from going higher like it was in the ascending version. This type of pattern is usually identified in downtrends, and it enables traders with short positions to recognize substantial profits when the price of the asset breaks below the horizontal trendline.reaks below the lower support, it is a clear indication that the downside momentum is likely to continue.

 The reason this pattern is so popular is because it shows that the demand for the asset is weakening. When the price breaks below the lower support, it is a clear indication that the downside momentum is likely to continue. Price targets are generally set to equal the entry price minus the difference between the trendlines. The different signals provided by the ascending and descending triangles give traders unique opportunities to benefit from price changes whether the asset is set to move up or down. This strategic flexibility allows traders to have a wider view of the market without limiting themselves to trading in only one direction. After looking at the sizable gains that occur following a breakout of the patterns, the reason why these tools should be added to every trader's arsenal becomes clear.

Head and Shoulders

The head and shoulders chart pattern is undoubtedly one of the most reliable chart patterns used by technical traders. When the head and shoulders pattern is formed, it is used to predict a change in the direction of the current uptrend; therefore, it is considered a reversal pattern. It is discovered by finding an asset's price using the following characteristics:

1. Rises to a peak and subsequently declines

2. Rises above the former peak and declines again

3. And finally, rises again - but not to the second peak  and declines once more

Looking at the chart , it is not difficult to see why this pattern got its name. The large middle peak creates what looks like a person's head and the two lower peaks resemble a person's shoulders. Transaction signals are generated when the price drifts below a trendline. In the case of a head and shoulders pattern, this is known as the neckline.

The neckline is simply an area of support that has prevented the sellers from drastically moving the price lower on previous occasions. The reason that this pattern is so popular is because it accurately depicts what is happening to the supply and demand of the security. Because this pattern is found at the top of an uptrend, the first trough is a signal that buying demand is starting to weaken. The head (large peak) is created because investors who missed the original run-up start entering into long positions because they think the asset is looking undervalued. This new buying interest causes the price to go to a new high, which is then interrupted by a flood of sellers. The sell-off at the top of the head is the second indication that sentiment is changing and that supply is outweighing demand. Once the price has touched the neckline a second time, buyers start to step in again and try to push it higher. This final attempt fails, which is used as confirmation that the trend is reversing. Transaction signals are generated from the move below the neckline, which is the time when traders start flooding the market with short-sale orders. The declines that generally follow the breakdown give traders a great opportunity to realize significant gains over a brief period of time.

Double Bottom

This chart pattern is used by traders to predict a shift from a previous downtrend to a new uptrend. This pattern is considered one of the most popular reversal patterns in technical analysis and, much like the head and shoulders pattern, it is easy to understand how it got its name.A double bottom is formed by a price that has created a series of two relatively equal lows with a small peak in the middle.Most technical analysts believe that the price should advance nearly 10-20% from the first bottom before it heads lower to make the second bottom.

The price level that has prevented the bears from pushing the asset lower on both occasions is regarded as a strong area of support and is used to determine the validity of the pattern. Many traders deem this pattern to be broken once the price falls below the support level by more than 3-4%. Traders will watch for volume to increase on the ascent from the second trough and will place a long position once the price breaks higher than the center peak. This pattern is often associated with the letter "W" because of the similarity of the two equal lows.

Double Top

The double top chart is classified as a reversal pattern; it is used by traders to predict a shift from an uptrend to a downtrend. As the name implies, the pattern is created by finding an asset that shows the following price characteristics:

1. The asset travels within a significant uptrend.

2. A strong area of resistance causes the price to decline, creating Top #1.

3. The price of the asset retraces by about 10-20% until it finds support.

4. The price rises again to the same level that was reached by Top #1.

5. The price level that caused the price to fall from Top #1 proves to be too strong of a resistance and the asset heads lower again.

Traders will take a short position once the price of the asset breaks below the support level that was established by the sell-off from the first top. Volume plays an important role in confirming the breakdown because a trader will look to see volume increase as the price of the asset moves below the support line. It is not uncommon for a broken support level to become an area of resistance and to see the price test this level several times before ultimately heading dramatically lower. This pattern is often associated with the letter "M" because of the commonality of the two peaks.

Triple Bottom
A triple bottom is a reversal chart pattern that is used to predict a shift from a longer-term downtrend to a new uptrend. As you can see from the chart, this pattern is found by identifying a situation in which the price of an underlying asset has traveled within a prolonged downtrend until it is stopped by a strong area of support.
Buyers enter at the support level, causing the price to climb and leaving Bottom #1 behind. Then, the price of the asset creates a peak and retraces back toward the prior support. This is when buyers enter again and push the price of the asset higher, creating Bottom #2. The price of the asset then creates another peak and subsequently heads downward for its final test of the lower support. The final bounce off the support creates Bottom #3; it is an early indication that demand is outweighing supply. Traders watch closely for increasing volume on the final ascent and purchase the asset once it breaks above the highest peak.

Triple Top

The triple top pattern is classified as a reversal chart pattern and it is used by traders to predict the end of a prolonged uptrend. Traders identify this pattern by finding a situation in which the price of an asset has tested a resistance level three times without successfully climbing above it. The three consecutive tops make this pattern visually similar to the head and shoulders pattern but, in this case, the middle peak is nearly equal to the other peaks rather than being higher. The reversal signal generated by this pattern is considered to be very reliable because it clearly depicts the fact that supply is outweighing demand. Short positions are taken when the price of the asset drifts below the identified support level (shown by the white line).