The only Technical Analysis Price Patterns you need to Understand!
Price patterns are frequently used in technical analysis to highlight transitions between rising and sliding trends. A pricing pattern is defined as a recognised arrangement of price movement that may be detected using a succession of trendlines and/or curves.
A reversal pattern happens when a price pattern suggests a shift in trend direction; a continuation pattern occurs when the trend continues in its current direction after a brief break.
Price patterns have long been employed by technical analysts to assess current market movements and anticipate future market movements.
Trendlines in Technical Analysis
Because price trends are discovered using a sequence of lines and/or curves, understanding trendlines and knowing how to draw them is beneficial. On a price chart, trendlines assist technical analysts in identifying regions of support and resistance. Trendlines are straight lines that connect a succession of descending peaks (highs) or ascending troughs on a chart (lows).
A trendline that is inclined up, also known as an up trendline, happens when prices experience higher highs and lower lows. The rising lows are connected to form the up trendline. A trendline that is inclined down, known as a down trendline, happens when prices have lower highs and lower lows.
The look of trendlines will change depending on which segment of the price bar is utilised to “connect the dots.” While different schools of thought exist regarding which part of the price bar should be used, the body of the candle bar—rather than the thin wicks above and below the candle body—often represents the majority of price action and thus may provide a more accurate point on which to draw the trendline, particularly on intraday charts where “outliers” (data points that fall well outside the “normal” range) may exist.
On daily charts, chartists frequently create trendlines using closing prices rather than highs or lows because closing prices represent traders and investors ready to hold a position overnight, over the weekend, or during a market holiday. Trendlines with three or more points are more reliable than those with only two points.
A continuation pattern is a price pattern that suggests a momentary interruption of an existing trend.
A continuation pattern may be regarded of as a pause in a dominant trend—a period when the bulls catch their breath during an uptrend or the bears rest for a little spell during a decline. While a price pattern is building, it is impossible to predict whether the trend will continue or reverse. As a result, careful consideration must be given to the trendlines used to form the price pattern, as well as whether the price breaks above or below the continuation zone. Technical analysts often advise that a trend will continue unless it is proven to have reversed.
In general, the bigger the price movement inside the pattern and the longer the price pattern takes to build, the more dramatic the move after price breaks above or below the region of continuation.
If the price trend continues, the price pattern is known as a continuation pattern. Examples of common continuation patterns include:
- Pennants formed by two converging trendlines
- Flags formed by two parallel trendlines
- Wedges, which are made comprised of two converging trendlines that are either tilted up or down.
Pennants are formed by the intersection of two trendlines. A crucial feature of pennants is that the trendlines travel in opposite directions, with one being a down trendline and the other an up trendline. A pennant is depicted in the diagram below. Volume will frequently decline during the creation of the pennant, followed by an increase when the price finally breaks through.
Flags are made up of two parallel trendlines that might slant up, down, or sideways (horizontal). A flag with an upward slope appears as a halt in a downtrending market, whereas a flag with a downward bias seems as a break in an uptrending market. The creation of the flag is typically accompanied by a period of dropping volume, which rebounds once price breaks out of the flag formation.
Wedges, like pennants, are formed by drawing two converging trendlines; however, a wedge is distinguished by the fact that both trendlines move in the same direction, either up or down. A wedge inclined down signifies a pause during an upswing, whereas a wedge oriented up represents a momentary interruption during a downtrend. Volume often decreases throughout the construction of the pattern, similar to pennants and flags, before increasing after price breaks above or below the wedge pattern.
The cup and handle pattern is a bullish continuation pattern that indicates that an upward trend has stalled but will resume if the pattern is validated. Instead of a “V” form with equal highs on both sides of the cup, the “cup” section of the design should be a “U” shape that resembles the rounding of a bowl.
The “handle” appears on the right side of the cup as a short pullback pattern resembling a flag or pennant chart pattern. When the handle is finished, the stock may break out to new highs and resume its upward trajectory. The figure below depicts a cup with a handle.
A reversal pattern is a pricing pattern that indicates a shift in the current trend. These patterns indicate that either the bulls or bears have run out of steam. As new energy arises from the other side, the established trend will halt and then shift in a new direction (bull or bear).
For example, an upswing accompanied by bullish excitement might stall, indicating equal pressure from both bulls and bears, before succumbing to the bears. As a result, the trend shifts to the downside.
At market peaks, reversals are known as distribution patterns, in which the trading instrument is more excitedly sold than bought. Reversals that occur during market bottoms, on the other hand, are known as accumulation patterns, in which the trading instrument is aggressively acquired rather than sold. As with continuation patterns, the higher the price movement within the pattern and the longer the pattern takes to develop, the larger the projected move after price breaks out.
The price pattern known as a reversal pattern occurs when price reverses after a halt. The following are some examples of frequent reversal patterns:
- Head and Shoulders, indicating two minor price movements surrounding one bigger price movement.
- Double Tops, indicating a short-term swing high followed by an unsuccessful effort to break above the same resistance level.
- Double Bottoms, which depict a short-term swing down followed by a failed attempt to break below the same support level.
Head and Shoulders
Head and shoulders patterns can emerge as a sequence of three pushes at market peaks or bottoms: an initial peak or trough, a second and greater one, and then a third push that repeats the first.
When an uptrend is broken by a head and shoulders top pattern, the trend may reverse, resulting in a decline. A downturn that results in a head and shoulders bottom (or an inverted head and shoulders) will almost certainly reverse to the upside.
As seen in the figure below, horizontal or slightly sloping trendlines can be constructed to link the peaks and troughs that emerge between the head and shoulders. Volume may fall while the pattern develops, but it will rise again if the price breaks above (in the event of a head and shoulders bottom) or below (in the case of a head and shoulders top) the trendline.
Double tops and bottoms indicate locations where the market has failed twice to break through a support or resistance level. A double top, which commonly resembles the letter M, occurs when an initial push up to a resistance level is followed by a second failed effort, culminating in a trend reversal.
A double bottom, on the other hand, resembles the letter W and happens when price tries to break through a support level, is refused, and then tries again unsuccessfully. This frequently results in a trend reversal, as seen in the graph below.
Triple tops and bottoms are less common reversal patterns than head and shoulders or double tops and double bottoms. However, they behave similarly and can be a significant trading indication for a trend reversal.
The patterns are generated when a price tests the same support or resistance level three times and is unable to break through.
The Bottom Line
Price patterns are frequently discovered when prices “take a break,” indicating areas of consolidation that might result in the continuation or reversal of the existing trend. Trendlines are useful in recognising these pricing trends, which might take the appearance of flags, pennants, or double tops.
Volume plays a part in these patterns, frequently decreasing during the construction of the pattern and increasing when price breaks out of it. Price patterns, including trend continuations and reversals, are used by technical analysts to anticipate future price behaviour.