What are chart patterns?
Charting patterns are simply the way in which a trader may choose to view the moves taking place within the markets. Each trading platform comes with a range of different chart types, and the patterns on them show the trader the direction the market has been taking. In being able to spot the overall direction of the past movements of the charts, traders and speculators will use this information to gauge where the future direction could be headed towards.
In trading and investing there are a variety of different charting structures, participants can use. From line charts, to even bar charts, however most who are involved in trying to analyse markets for opportunities usually use the Japanese Candlestick patterns, which we will look at in greater detail below
Understanding chart patterns is one of the key aspects of trading, and one if mastered, can increase the potential of success. Below we explore this topic further.
Types of charts
Before we get into the patterns let’s look at the charts. Each trading platform usually gives user the options of 3 charting modes. MT4 is used as an example below.
On the left you have the bar graphs. The far right you have the line graph and centrally you have the Japanese candlesticks. In order to see the differences, and before we detail the Japanese candlesticks which is the most popular, let’s view the layout of the other 2.
In seeing the above, now we can look at the more popular charting pattern to understand why it is the most favored by traders and investors.
The Japanese candlesticks firstly are broken down by colour to easily show if the market is going up or down. A red candle means the market is going down, also known as a bear, and a green candle shows the market going up, also known as a bull. Each candle then shows us 4 key points which the above charting patterns do not. You can see these 4 points on the image below.
Types of chart patterns
Although there are more, there are two main types of chart patterns which stand out. Continuations and Reversals. Within both of these headings, there comes further types. We will look at the 4 most frequently used patterns below.
Continuation patterns represent the brief slowing down of a trending market with the possibilities for further upcoming trends. Note however that any and every continuation will end at some point. Turning into a Reversal. 2 examples of continuation patterns can be seen below.
One of the most popular forms of patterns are in fact triangles, which are a staple for most technical analysis traders. These are used to shed light on the direction in which the market is or has been heading.
Triangles are broken down into 2, ascending and descending triangles.
How to use an Ascending Triangle
An ascending triangle is a channel we see in upwards trending markets. The markets here usually trend in higher highs, whilst following an ascending channel. As you can see the higher highs turned into consolidation for a brief moment, before continuing in the direction of the initial trend. Most traders use the signal of this triangle along with other indicators to identify buying opportunities.
2. How to use a Descending Triangle
A descending triangle is a channel we see in downwards trending markets. The markets here usually trend in lower lows, whilst following a descending channel. As you can see the lower lows turned into consolidation for a brief moment, before continuing in the direction of the initial trend. Most traders use the signal of this triangle along with other indicators to identify selling opportunities.
Pennants are 2 converging trendlines which meet to create a bottleneck within a chart. As this falls under the continuation pattern family, it shows the gradual slowing of a trend, before breaking or continuing in the initial direction. Although the look similar to triangles, the main difference here is that 2 trendlines are used. Triangles only use 1 and a horizontal line to represent support or resistance.
Reversal patterns usually highlight the potential for an end to initially trending (continuation pattern) markets, then leading to an eventual reversal. In identifying a potential change in direction, the hurdle then becomes the timing in which the trader believes the reversal will take place. 2 examples of reversal patterns can be seen below.
Head and Shoulders
Head and shoulders patterns in terms of popularity are similar to triangles. They traditionally look like the human neckline and can appear both at the upper or lower part of a chart. This comes when an initial up/downtrend is interrupted by a “head” which is usually a buy at the support or sell at resistance point. Once the head is established, we then see the markets attempt to trend once again in the direction of the head, and this is where reversal traders anticipate the forming of the second shoulder.
2. Double Tops
Double tops are essentially head and shoulders patterns minus the formation of the 2nd shoulder. Similar to the above, this 2nd top is used in anticipating a potential reversal in direction.
How can you use chart patterns?
Depending on the charting pattern being used, a trader would look to gauge the following information. Firstly the direction in which the charts show us the markets have been moving. Secondly which areas do the big spikes take place leading to either upwards or downwards flow. Lastly using the previous 2 points to ascertain where the markets may be heading in the future.
Specific to the Japanese candlesticks, traders can use this to see the level of selling/buying taking place at particular pricing levels. This is more visible than any other chart pattern due to the colour dynamics.