If we were to present you with a spreadsheet full of numbers, it’s unlikely you’d immediately recognize any patterns; however, when those numbers are displayed in a chart, understanding market movements becomes much clearer. Chart patterns condense all the buying and selling activity in a financial market into a straightforward visual format. These charts allow you to see when buyers (bulls) or sellers (bears) take control or lose it, which can assist in identifying potential trend reversals. They offer an objective view of market activity, solely driven by price movements, free from subjective judgments about whether something is overvalued or undervalued.
Below are our top-10 chart patterns that we believe, you as a pro-trader or beginner-trader must know.
Pattern-1: Head and Shoulders
The popularity of this pattern is mainly attributed to the fact that it is easier to spot than other patterns. The head and shoulders pattern tries to predict a reversal. Characterised by a large peak with two smaller peaks on either side, all three levels fall back to the same support level as the neckline. The trend is then likely to break out in a downward motion. Its name comes from what the pattern looks like: a head and two shoulders (and a neckline). With this pattern, you would enter a short or sell trade below the neckline and a stop around halfway between the second shoulder. The target move would be around the distance between the head (peak) and neckline.
Pattern-2: Inverse Head and Shoulders
The inverse head and shoulders or reverse bottom is a bullish pattern and it indicates that sellers have been exhausted. You would enter a long trade just above the neckline and a stop towards the recent low of the second shoulder. The target would be a continuation of the head move giving a fairly good risk-to-reward potential.
Pattern-3: Double Bottom
A double bottom looks similar to the letter W and indicates when the price has made two unsuccessful attempts at breaking through the support level. It is a reversal chart pattern as it highlights a trend reversal. After unsuccessfully breaking through the support twice, the market price shifts towards an uptrend. You will also see triple bottoms play out. Here we see the initial decline and attempt to rally, a second decline, which does not go below the first decline, forming support. You would buy just above the neckline and stop towards the middle of the up move, with a target at the same level that the initial decline started at.
Pattern-4: Double Top
Opposite of a double bottom, a double top looks like the letter M. The trend enters a reversal phase after failing to break through the resistance level twice. If the price fails to move higher, then it is likely to go back to the neckline, which is support. If it fails there, it will move lower back down to the lows of the recent move. In this type of setup, you would look to take a short trade with a stop above the neckline, and your target would be the recent lows. It’s worth adding that you will also find multiple bottoms (support) or tops (resistance) in markets, so you could see a triple top or triple bottom.
Pattern-5: Cup and Handle
The cup and handle is a continuation stock chart pattern that signals a bullish market trend. It is the same as the rounding bottom or saucer (also a pattern worth looking out for) but features a handle after the rounding bottom. The handle resembles a flag or pennant and once completed, you can see the market break out in a bullish upwards trend. The handle is a temporary retracement pattern and breaks out to continue the move higher. This pattern can be fairly rare and takes time to complete; however, the upside move can be fairly explosive. The move-up is often the same distance as the cup height, so once the handle completes the next move higher, it gives us a target move of the same distance as the cup.
Pattern-6: Rounding Top
A rounding top usually indicates a bearish downward trend. It tends to show that the market is losing strength, with each high being lower than the previous one. We then see a move through the neckline as support fails, then we see a smaller retest (bounce) back to the neckline before a larger fall. The fall is normally the same distance as the recent high to the neckline. This pattern is often seen in cryptocurrencies such as Bitcoin.
Pattern-7: Rounding Bottom
The flip side of the rounding top is the rounding bottom, which is a bullish pattern. The market is in a downtrend but then starts to make a series of lows, higher than the previous ones, which form the rounded bottom or saucer. We then break out of the cup and move higher. You would look to buy around the halfway point of the formation of the U shape or once the breakout occurs. A rounded bottom can take weeks to form, but you can use a stock screening site to identify a selection of stocks and markets that make this pattern and add them to your watch list. You would only open trades once you are heading to the breakout point. This is very similar to the cup and handle pattern previously covered.
Pattern-8: Ascending Triangle
The ascending triangle is a bilateral pattern meaning that the price could break out from either side. A breakout is likely where the triangle lines converge. To draw this pattern, you need to place a horizontal line (the resistance line) on the resistance points and draw an ascending line (the uptrend line) along the support points. This pattern shows the price moving into smaller and smaller ranges before the big break out. Your buy entry would be just above the resistance, with a target the same distance as the triangle’s height. For the sell entry, you would do the exact opposite, sell below the support line, and expect a drop of at least the triangle’s height.
Pattern-9: Descending Triangle
The descending triangle is a bilateral pattern, meaning that the price could break out from either side. A breakout is likely where the triangle lines converge. To draw this pattern, you need to place a horizontal line (the support line) on the support points and draw a descending line (the downtrend line) along the resistance points. This pattern is the exact opposite of the ascending triangle previously covered. This pattern shows the price moving into smaller and smaller ranges before the big breakout. Your sell entry would be just below the support line, with a target the same distance as the triangle’s height. For the buy entry, you would do the exact opposite, buy above the resistance line and expect a rise of at least the height of the triangle. You can place a stop just below the resistance line.
Pattern-10: Rising and Falling Wedges
Rising wedge:
Wedge patterns are normally reversal patterns. A rising wedge occurs when the price makes multiple swings to new highs, yet the price waves are getting smaller. Essentially, the price action is moving in an uptrend, but contracting price action shows that the upward momentum is slowing down. Eventually, the price breaks out, and in the case of the rising wedge, the price moves lower. You would enter a stop just above the wedge, and you would enter short. Place your sell trade just below. The target would be a move-up of the same distance as the height of where the wedge started.
Falling wedge:
The falling wedge is a bullish pattern that begins wide at the top and contracts as prices move lower. The trading range becomes tighter and tighter until it breaks out. In the case of the falling wedge, the price normally breaks higher, so it is a bullish pattern. You would have a stop, as shown on the chart just below the wedge. You would buy just as we break out of the pattern and then look for a target of the same distance as the height of where the wedge started. Take care as many confuse a falling wedge with a bearish pattern.
Conclusion
These patterns often recur, reflecting the influence of human and trader psychology. It’s typical for markets to react to round numbers or find support at previous price levels. With the advent of the internet, accessing chart patterns has become extremely simple. Numerous websites now provide screeners that enable you to filter stocks based on particular chart patterns. For example, we use Finviz.com, where we can select major patterns and instantly see a list of all the stocks that fit that criteria.
