Important Chart Patterns: The stock market is a dynamic place where the price of securities fluctuates based on various factors. The participants who are involved in the market try to gain from these fluctuations using various tools and techniques that are ready at their disposal. One such tool that can be used by new traders, as well as experienced traders, is chart patterns.
Chart patterns are a study of historical price movements that help traders get an idea about the potential direction of the security. In this article, we will explore the top 10 essential chart patterns that every trader should know.
Top 10 Essential Chart Patterns that every trader should know
Important Chart Patterns #1 – Ascending triangle pattern
Ascending triangle is a bullish continuation pattern that is formed when the price of a security makes higher lows which is followed by a downward reversal from a horizontal level of support.
A breakout above the triangle signals that the bulls are gaining momentum and is an indication of a further uptrend in the market. The best scenario for this pattern to appear is during an uptrend in the market.
Trading using the ascending channel pattern:
Entry: When the price of the security breaks above the resistance level of the pattern, you should a long position in the security as it suggests the continuation of the uptrend.
Profit Target: The profit target for this pattern should match the distance between the lowest point in the pattern and its resistance level. When the price matches the calculated distance, one can book profits from the trade.
Stop Loss: The resistance line of the ascending triangle pattern should act as a trigger stop-loss while trading using this pattern. One should place a stop loss a few points below the resistance line of the pattern.
(source: TradingView)
Important Chart Patterns #2 -Descending triangle pattern
Descending triangle is a bearish continuation pattern that is formed when the price of a security is making lower highs which is followed by an upward reversal from a horizontal level of support.
A breakdown below the triangle signals that the bears are gaining momentum and is an indication of a further downtrend in the market. The best scenario for this pattern to appear is during a downtrend in the market.
Trading using the descending channel pattern:
Entry: When the price of the security breaks below the support level of the pattern, you should a short position in the security as it suggests the continuation of the downtrend.
Profit Target: The profit target for this pattern should match the distance between the highest point in the pattern and its support level. When the price matches the calculated distance, one can book profits from the trade.
Stop Loss: The support line of the descending triangle pattern should trigger stop-loss while trading using this pattern. One should place a stop-loss a few points below the resistance line of the pattern.
(source: TradingView)
Important Chart Patterns #3 – Falling Wedge Pattern
A falling wedge is a bullish reversal pattern that is formed when the price of the security forms lower highs and trend lines drawn converge as the price falls.
The downward convergence in the trendline indicates that the bears are losing momentum in the security and the price is likely to reverse from the existing trend.
Trading using the Falling pattern:
Entry: When the price of the security breaks above the upper trendline of the pattern, you should enter a long position in the security as it indicates a bullish reversal in the security.
Profit Target: The profit target for this pattern should be the immediate resistance level in the security..
Stop Loss: The upper trendline of the candlestick pattern should be the trigger for stop-loss while trading using this pattern. One should place a stop loss a few points below the upper trendline line of the pattern.
(source: TradingView)
Important Chart Patterns #4 – Rising Wedge Pattern
A Rising wedge is a bearish reversal pattern that is formed when the price of the security forms higher lows and trend lines drawn converge as the price rise.
The upward convergence in the trendline indicates that the bulls are losing momentum in the security and the price is likely to reverse from the existing trend.
Trading using the Falling pattern:
Entry: When the price of the security breaks below the lower trendline of the pattern, you should enter a short position in the security as it indicates a bearish reversal in the security.
Profit Target: The profit target for this pattern should be the immediate support level in the security. The profit target can also be based according to the risk-to-reward ratio of the market participants.
Stop Loss: The lower trendline of the candlestick pattern should be the trigger for stop-loss while trading using this pattern. One should place a stop loss a few points above the upper trendline line of the pattern.
(source: TradingView)
Important Chart Patterns #5 – Double Top Pattern
A double top is a bearish reversal pattern that is formed when the price of the security reaches a high two consecutive times that are separated by a pullback in the centre which is the baseline/support level of the pattern.
This pattern indicates that the bullish momentum is weakening and there might be a potential trend reversal in the security.
Trading using the Double Top pattern:
Entry: When the price of the security breaks below the support line of the pattern which is separating the two highs, you should enter a short position in the security as it indicates a bearish reversal in the security.
Profit Target: The profit target for this pattern should match the distance between the highest point in the pattern and its support level. When the price matches the calculated distance, one can book profits from the trade.
Stop Loss: The support line of the chart pattern should be the trigger for stop-loss while trading using this pattern. One should place a stop loss a few points above the support line of the pattern.
(source: TradingView)
Important Chart Patterns #6 – Double Bottom Pattern
The double top is a bullish reversal pattern that is formed when the price of the security reaches a low two consecutive times that are separated by a pullback in the centre which is the baseline/resistance level of the pattern.
This pattern indicates that the bearish momentum is weakening and there might be a potential trend reversal in the security.
Trading using the Double Bottom pattern:
Entry: When the price of the security breaks above the resistance line of the pattern which is separating the two lows, you should enter a long position in the security as it indicates a bullish reversal in the security.
Profit Target: The profit target for this pattern should match the distance between the lowest point in the pattern and its resistance level. When the price matches the calculated distance, one can book profits from the trade.
Stop Loss: The resistance line of the chart pattern should be the trigger for stop-loss while trading using this pattern. One should place a stop loss a few points below the resistance line of the pattern.
(source: TradingView)
Important Chart Patterns #7 – Flag and Pole Pattern
A flag and pole pattern is a bullish continuation pattern formed when there is a sharp upward move in the price of security followed by consolidation within a small range. The consolidation is again likely followed by a strong uptrend in the market.
Trading using the Flag and Pole pattern:
Entry: When the price of the security breaks above the consolidated price which has formed a flag pattern, you can enter a long position in the security, as the breakout indicates the continuation of the existing trend.
Profit Target: The profit target for this pattern should match the height of the pole pattern that is formed before the small consolidation. When the price matches the calculated distance after the breakout, one can book profits from the trade.
Stop Loss: When the price of the security moves a few points below the consolidated flag pattern, one should exit the trade from the security.
(source: TradingView)
Important Chart Patterns #8 – Inverted Flag and Pole Pattern
An Inverted flag and pole pattern is a bearish continuation pattern formed when there is a sharp downward move in the price of security followed by consolidation within a small range. The consolidation is again likely followed by a strong downtrend in the market.
Trading using the Inverted Flag and Pole pattern:
Entry: When the price of the security breaks below the consolidated price which has formed a flag pattern, you can enter a short position in the security, as the breakdown indicates the continuation of the existing trend.
Profit Target: The profit target for this pattern should match the height of the pole pattern that is formed before the small consolidation. When the price matches the calculated distance after the breakout, one can book profits from the trade.
Stop Loss: When the price of the security moves a few points above the consolidated flag pattern, one should exit the trade from the security.
(source: TradingView)
Important Chart Patterns #9 – Head and Shoulder Pattern
A head and shoulder pattern is a bearish reversal pattern that is formed when the price of the security forms three peaks that are separated by a pullback which forms the neckline for the pattern.
The middle peak formed in this pattern is the highest compared to the peaks beside it. This pattern indicates that the buyers have been exhausted after trying to push the price up and are overpowered by sellers in the market. When the price breaks below the neckline of the pattern, it is an indication of a bearish reversal in the market.
Trading using the Head and Shoulder Pattern
Entry: When the price of the security breaks below the neckline of the pattern which is separating the three peaks, you should enter a short position in the security as it indicates a bearish reversal in the security.
Profit Target: The profit target for this pattern should match the distance between the highest point in the pattern and its neckline. When the price matches the calculated distance, one can book profits from the trade.
Stop Loss: The neckline of the chart pattern should be the trigger for stop-loss while trading using this pattern. One should place a stop loss a few points above the neckline of the pattern.
(source: TradingView)
Important Chart Patterns #10 – Inverted Head and Shoulder Pattern
An Inverted head and shoulder pattern is a bullish reversal pattern that is formed when the price of the security forms three lows that are separated by a pullback which forms the neckline for the pattern.
The centre low formed in this pattern is the lowest compared to the lows beside it. This pattern indicates that the sellers have been exhausted after trying to push the price down and are overpowered by buyers in the market. When the price breaks below the neckline of the pattern, it is an indication of a bullish reversal in the market.
Trading using the Inverted Head and Shoulder Pattern
Entry: When the price of the security breaks above the neckline of the pattern which is separating the three lows, you should enter a long position in the security as it indicates a bullish reversal in the security.
Profit Target: The profit target for this pattern should match the distance between the lowest point in the pattern and its neckline. When the price matches the calculated distance, one can book profits from the trade.
Stop Loss: The neckline of the chart pattern should be the trigger for stop-loss while trading using this pattern. One should place a stop loss a few points below the neckline of the pattern.
(source: TradingView)
In Closing
As we conclude this article, it should be noted that while the above-mentioned patterns give you an idea about the potential direction of security and help you place suitable trades, there is no guarantee that these patterns will work every time. Along with the chart patterns, one should also use other technical tools like indicators to get a better conviction of your analysis using the chart patterns.
Written By – Aaron Vas
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