What Are Trading Patterns and How to Use Them
Right now, at the beginning of 2022, fundamental analysis doesn’t quite work as it used to. Over the past time, the world has faced commodity crises, high unemployment rates and inflation, new strains of the coronavirus, and other troubles. If previously the market sharply reacted to every negative piece of news, now its reaction has dulled – everyone has gotten used to bad news and no longer pays attention to it.
However, technical analysis still works just as well. Essentially, it is now the main tool for predicting price movement. And what helps in this are trading patterns. Proper analysis of patterns can not only keep money safe but also bring good profits.
Trading patterns are repetitions of price movement on a chart. Often these repetitions can form a shape. In this article, we will describe the most popular figures: how to identify them, what they mean, and how to use them?
Head and Shoulders
Let’s immediately note that all patterns are named after their appearance. On the chart, you can see three peaks with the highest in the center. This is the head, next to which are two shoulders. This figure forms two minimum points and three maximum points. If you connect both minimum points, you get the neckline. If the price breakthrough passes the neckline, the figure can be considered fully formed, which is a signal to open a deal. In this case, it is a sell trade.
How to understand what price movement to expect? You need to calculate the height of the figure. Take the minimum point and count the number of points to the highest maximum point (head). This is the number of points to rely on when predicting price movement.
Inverted Head and Shoulders
If the previous figure formed on an upward trend, then the Inverted Head and Shoulders is characteristic of a downward trend. It is built the same way, only upside down. This time, the breakthrough of the neckline is directed upward, not downward, and also gives a signal to buy.
Double Top and Double Bottom
These are reversal patterns, largely similar to the patterns above. In the “Double Top,” we have, strangely enough, two peaks, and the base line of the figure passes horizontally through the minimum point. When this line is breached, downward price movement can be expected for the height of the figure.
In the “Double Bottom,” we see two lows on the chart. The base line of the figure in this case passes through a single maximum point. When it is breached, an upward price movement is expected for the height of the figure.
Always wait for the breach of the base line, it’s important. You may think you see a working pattern, but in fact, it can only be considered formed after the breach. After all, besides the double top, there may be…
Triple Top
Yes, there is also a triple top. It forms and works just like the “double” one. The only difference is that there are already two minimum points. We draw the base line through them. It can be either horizontal or with a slight tilt up or down. When the price breaches this line, you can open a buying deal. Price movement is calculated as always – by the height of the figure.
Triple Bottom
Everything is exactly the same. There are three lows, and we draw a line through two maximum points. When it is breached, we open buying deals. Again, we remind you that the figure is considered fully formed only after the price closes above the base line.
Wedge
The “Wedge” pattern also belongs to reversal patterns. The characteristic feature of this pattern is the visual narrowing of the price. We take the maximum and minimum points, draw support and resistance lines. If both lines are sloping and approaching each other, you definitely have a “Wedge”.
If the pattern is formed at the highs of the chart during an uptrend, it is recommended to sell after the price closes below the support line. Conversely, if the pattern is formed at the lows during a downtrend with the price closing above the resistance line, then buying deals should be made. The approximate price movement equals the height of the pattern’s base.
Rectangle
Sometimes there is uncertainty in the market. Bulls and bears collide, and the price seems to freeze at one level. There are no clear declines or increases. In such cases, we draw two horizontal lines through the lows and highs. The “Rectangle” pattern can indicate either a reversal or a continuation of the trend. Therefore, we recommend trading in the direction of the pattern breakout: buy when the resistance line is breached, sell when the support line is breached. The height of the rectangle suggests the likely price movement.
Flag
This is a pattern of continuing the current trend. It looks like this: after a strong price movement (flagpole), a correction zone (flag) occurs, which can resemble a “Rectangle”, “Wedge”, or “Triangle”. After the correction is complete and the line is breached, buying or selling is recommended, depending on the previous trend. The height of the flagpole indicates the price movement.
Triangles
Let’s consider three main types of triangles. The “Symmetrical Triangle” can both continue the trend and reverse it. It forms between two converging support and resistance lines. Trading in the direction of the breakout of the pattern is recommended.
Ascending Triangle
This is a pattern of continuing an uptrend. The resistance line is drawn horizontally without inclines. Buying positions are opened when it is breached. As always, the approximate price movement equals the base of the figure.
Descending Triangle
The third popular triangle is the descending one. It forms during a downtrend and continues it. After the price closes below the support level, positions for sale are opened. The base of the triangle equals the price movement.
Conclusion
There are a huge number of patterns in trading. Moreover, all of them still work and are likely to continue working in the future. If you learn to work with them, your trading will be much more successful and safer. If these figures scare you with their complexity, sign up for our Adaptive course. Our financial analysts will explain even the most complex concepts in trading very simply!
