Technical Analysis Candle and Chart Patterns

Part 8.4 Technical Analysis. Candle and Chart Patterns
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This mini-blog is part 4 of our Introduction to Technical Analysis unit which forms part of our free introductory course in financial trading. This mini-blog consists of the following:


Patterns

As the name suggests, chart patterns are recognizable patterns that form on the chart that are used by traders as potential trading signals. In this blog we will look at Candle Patterns and Chart Patterns. So, let’s get started. 

Candle Patterns

We have already looked at what a candlestick looks like. Many people look for specific types of candlesticks for market signals. Candlestick patterns can be continuation or reversal patterns. A few of the most popular are:

  • Dojis
  • Engulfing Pattern
  • Hammer and Hanging Man Pattern
  • Piercing Pattern
  • Harami Pattern

 

Common Candlestick Patterns

An important thing to remember with these candlestick patterns is firstly that they only give an indication of a potential signal – nothing is guaranteed, and secondly – and this is where many people use these incorrectly – is that these are only valid signals when they happen at a certain time in a trend.  

Chart Patterns

Let’s break this down a bit more – and this concept applies to all chart patterns, not just candlestick patterns.

In the previous unit we learnt that a market is in one of two states, trending or ranging and that the best opportunities are in a trending market. As such, the most popular patterns are used to determine whether a trend is going to change or continue.

These two categories are known as Continuation Patterns (trend continues) or Reversal Patterns (trend reverses). These changes or confirmation of trends normally happen when markets are ranging. These ranging areas are also known as areas of consolidation. 

A pattern that is used to indicate the reversal of a trend would not be valid to indicate a continuation and vice versa. 

For example, the bearish engulfing candle pattern. This is a bearish reversal pattern and as such would only be a valid signal for a reversal of a bullish (up) trend. If this pattern happens in a downtrend it is a less useful signal.This is what we mean when we say that patterns are only valid when they appear in the correct place. 

 

Market States And Pattern Types

Here are some examples of chart patterns of each type:

Continuation Patterns:

Triangles: these show a tightening of the range and a decrease in volatility. These can be ascending and descending.

 

Continuation Patterns – Triangles

Pennants: Similar to triangles but over fewer bars.

 

Continuation Patterns – Pennants

Flags: These are a pause in a trend signified by a tight channel and can be bullish and bearish.

 

Continuation Patterns – Flags

Rectangles. Rectangles form during a pause in the trend as a trading range. The pattern is easily identifiable by two or three comparable highs and two or three comparable lows.

 

Continuation Patterns – Rectangles

Reversal Patterns:

Double tops and double bottoms: these happen where the market finds and then confirms resistance/support at a certain level which can lead to a rejection of that level and a change in direction.

 

Reversal Patterns – Double Tops and Bottoms

Head and shoulders and inverted head and shoulders: another example of a pattern that confirms resistance or support.

 

Reversal Patterns – Head and Shoulders and Inverted

Confirmation

 

Confirmation Is A Second Signal Of the Same Type

As mentioned, no pattern is a guarantee of success. First make sure that you are identifying the pattern at the right time in a trend and secondly it is always worth having a confirmation signal (a second signal that is showing the same) to improve your probability of success. 

In uptrending markets look for bullish continuation patterns or bearish reversal patterns in the ranging areas.

 

Uptrending Market With Consolidation

In downtrending markets look for bearish continuation patterns and bullish reversal patterns in the ranging areas.

 

Downtrending Market With Consolidation

Ranging markets are most difficult to trade. The best advice I can give is to be patient. See what the market will do: will it continue with the trend? If so you would look for continuation patterns. Will it reverse? If so you will look for reversal patterns.

 

Consolidation Can Become Continuation Or Reversal

And of course:

Always backtest your strategy over time to  ensure that you are getting consistent results.

Justina Nothard

Justina Nothard

Hi, I’m Justina Nothard, a retail investor trading Stock Index Futures.

I understand how hard it can be for the ordinary trader to learn the basics and find useful tools and practical information.

This is why I decided to create Nothard Trading to help you take control of your trading.

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