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A breakout is defined as price movement above or below a predefined level. A breakout backed by a surge in volumes is considered to be more reliable to act upon. A trader trading on the basis of breakouts would consider entering a long position once price moves above a resistance level or would consider a short position after price falls below a support level.
The reason chart pattern breakouts have gained popularity is because they are easy to identify, frequent in occurrence and are the starting point for a major reversal in trend or continuation accompanied by a surge in volatility.
Most of the results obtained with technical analysis procedures do not indicate the eventual magnitude of a trend but chart patterns tend to act as an exception, since their formation provides the technical analyst with limited forecasting abilities.
Chart patterns can be over any time frame – intraday, daily, weekly and monthly. In the following section we cover some of the common chart patterns which tend to witness a spike in prices after a breakout.
Chart Patterns are broadly classified into two categories: continuation and reversal patterns
Pennant is a short-term continuation pattern. It is created when there is significant price movement in the stock, i.e. strong volume rally on the back of positive fundamental development followed by several days of narrowing price consolidation in the stock on light volumes. Finally a fresh breakout is observed in the direction of the prevailing trend with a surge in volumes once again. The duration of the pattern is usually a few weeks. The pennant is in effect a very small triangle.
The technical price target for a pennant is arrived at by computing the height of the flag pole and adding it to the eventual breakout point after consolidation.
Characteristics of a pennant
Prior Trend: To be considered a continuation pattern there should be evidence of a prior trend in existence.
Sharp Move: The first leg of the pennants is characterized by a sharp surge in price in the direction of the current trend.
Pole: The pole is the distance from the first resistance or support breakout level to the high of the pennant. The pole should ideally break a trend line or resistance level.
Pennant: A pennant is a small symmetrical triangle that begins wide and tends to converge as the pattern develops. Prices tend to consolidate during this phase.
Time frame: Pennants are short term continuation patterns that usually last from 1-8 weeks. Pennants that tend to take a longer duration are classified as symmetrical triangle.
Breakout: The breakout tends to occur in the direction of the prevailing trend. A break above resistance indicates that the previous up trend has resumed.
Volume: Heavy volume is observed during the formation of the pole and at the time of breakout. Volume tends to add credibility to the pattern.
In the above chart of Lakshmi Machine Works, we observe a pennant chart pattern. A swift surge in prices is observed on the back of positive fundamental development; prices then tend to consolidate within the triangle before eventually giving a breakout near the apex of the triangle. A bullish trade can be initiated once we get a breakout.
Cup and handle is a bullish continuation pattern where an uptrend has paused, but will resume once the pattern witnesses a breakout. To qualify as a continuation pattern, a prior trend should be in existence. The pattern derives its name from the clearly visible patter it forms on the chart. The cup is a curved U-shaped formation with the handle which is formed on the right hand side. The handle tends to have a slight downward slope. The pattern is a long term chart pattern which in some instances could take even more than an year to form.
The technical target for a cup and handle pattern is arrived at by computing the depth of the cup formation and adding it to the breakout point.
Characteristics of a Cup and Handle Pattern
Cup: The cup tends to be U shaped and tends to resemble a rounding bottom.
Handle: After the cup has been formed, there tends to be a pullback in prices that forms the handle. Sometimes this handle resembles a flag or pennant having a downward slope; other times just a short pullback. The handle represents the final consolidation/pullback before the breakout occurs and can retrace up to 1/3 of the cup's advance. The smaller the retracement is, the more bullish the formation and higher the chances of a major breakout. If the pattern is going to fail, the signal to look for is a break below the lower part of the handle.
Duration: The cup can extend from 1 to 6 months, sometimes longer on weekly charts. The handle can be from 1 week to many weeks and ideally completes within 1-4 weeks.
Volume: Ideally there should be a substantial increase in volume at the time of breakout above the handle’s resistance. Expansion in volume leads to the added confirmation.
In the above chart of Eveready Industries we witness a cup and handle formation, it tends to act as a continuation pattern. Prices tend to consolidate sideways before resuming its uptrend. A trade can be initiated once the breakout point is crossed on a closing basis maintaining the low of the handle as the stop loss.
Ascending triangle usually appears during an uptrend and is considered as a continuation pattern. Ascending triangles are always bullish patterns whenever they occur on the chart. It is also known as right angle triangle due to its shape. Ascending triangles are really a special form of symmetrical triangle with the horizontal line formed at an angle of 90 degrees. In the ascending triangle formation, the horizontal line represents overhead resistance that prevents the security from rising. It is as if a large sell order has been placed at this level, thus preventing the price from surging higher. Even though the price is not able to cross this level, the reaction lows continue to rise. It is these higher lows that indicate increased buying interest and provides the ascending triangle its bullish bias.
The technical target is arrived at by computing the vertical height of the triangle and adding this length to the breakout point. Another method is drawing a line parallel to the base of the triangle through the peak of the first rally.
Characteristics of an Ascending Triangle
Top Horizontal Line: At least 2 reaction high points are required to form the upper resistance horizontal line.
Lower Ascending Trend line: At least two reaction low points are required to form the lower rising trend line. The succeeding reaction is higher than its predecessor thus causing the lower trend line to rise and giving the patter its bullish feature.
Time frame: The length of the pattern can range from a few weeks to many months with the average pattern lasting from 1-3 months.
Volume: As the pattern develops, volume tends to contract. Volumes usually expand at the time of the breakout which gives the added confirmation.
In the above chart of Page Industries we witness an ascending triangle chart pattern. Prices tend to gradually rise during the pattern and finally succeed to give an upward breakout towards the end. Trades can be initiated within the pattern as well at the time of the breakout.
Descending triangle is a bearish continuation pattern. The pattern is usually observed in a downtrend. There are few instances the pattern is seen during an uptrend acting as a reversal pattern but is considered as a bearish pattern regardless of where it occurs. The descending triangle is also known as right angle triangle because of it shape. The horizontal line acts as a zone of support. It is as if there is heavy buying interest at this level preventing the stock from falling further. It is the lower highs along the declining trend line that signals greater selling pressure and gives the pattern its bearish feature.
The technical target is arrived at by computing the vertical height of the pattern and adding this height to the breakout point. It can also be computed by drawing a line parallel to the base of the triangle through the trough of the first correction.
Characteristics of a descending triangle
Upper Descending Trend line: At least two reaction highs are required to form the upper descending trend line. The reaction highs should be successively lower.
Lower Horizontal Line: Minimum tow points are required to form the lower horizontal line of the descending triangle pattern.
Duration: The length of the pattern can range from a few weeks to many months, with the average pattern lasting from 1-3 months.
Volume: As the pattern develops, the volumes usually reduce. When the breakdown finally occurs volumes tend to expand which acts as a confirmation signal.
In the above chart of Oil Ltd we witness a descending triangle pattern. Prices constantly face resistance along the upper descending trend line while taking support along the lower horizontal line, finally the bears win the battle with price witnessing a breakdown towards the end and resuming the original downtrend.
Bullish flag pattern is a continuation pattern in the direction of the existing trend. A flag as the name implies, the pattern looks like a flag on the chart. It is a sharp, strong volume backed rally on the back of positive fundamental development, followed by several days of sideways to lower price consolidation on much weaker volume after which a second sharp rally is observed on strong volumes. The breakout signal is generated when price breaches the upper resistance level. Flags seem to form at the halfway point of the move. Flag formation is usually reliable as patterns from a forecasting point of view; the target price is usually met.
The technical target is arrived at by computing the height of the flag pole and adding it to the eventual breakout point.
Characteristics of a Flag pattern
Prior Trend: To be considered a continuation pattern, there should be evidence of an existing trend.
Flagpole: The flagpole is a sharp surge in prices on heavy volumes. It is the distance from the first resistance break to the high of the flag. The flag pole can contain gaps.
Flag: A flag is a small consolidation zone that tends to slope against the trend i.e. if the existing trend move is up, then the flag would slope down. If the move was down then the flag would slope up. We could witness a sideways consolidation in prices as well.
Duration: Flags are short-term patterns that can last from 1 to 4 weeks.
Break Out: For a bullish flag, a break above resistance signals that the previous advance has resumed.
Volume: Maximum volume is observed during the formation of the flagpole and at the time of breakout. During the flag formation volumes tend to contract.
In the above chart of Oberoi Realty we observe a flag chart pattern. Prices witness a swift rise on the back of positive fundamental development followed by price consolidation for nearly two weeks before eventually witnessing a breakout in the direction of the prevailing trend. A bullish trade can be initiated at the time of the breakout by maintaining the low of the consolidation zone as the stop loss.
A Falling Wedge is a generally considered bullish pattern and is usually found during up-trends. The pattern can also be found in downtrends; however the implication is still generally on the bullish side. A falling wedge represents a temporary interruption of a rising trend. This pattern is marked by a series of lower tops and lower bottoms. It is so named because the pattern is in the form of a wedge pointing downwards with the price appearing to fall lower. The chart pattern is formed by price action, which is contained within a converging and descending trend line. The pattern appears when there is profit booking in an uptrend. The wedge and the pennant are very similar, since both consist of converging trend lines that move in a contra trend direction. The difference is that the breakout point of a pennant forms very close to or event at the apex whereas for the wedge the two projected lines would meet way in the future. Wedges take a longer time to form as compared to pennants.
The technical target: For upward breakouts, the highest point of the wedge is considered the technical target.
Characteristics of a falling wedge
Prior Trend: For the pattern to qualify as a reversal pattern there must be a prior trend in existence to reverse.
Upper Resistance Line: It takes at least two reaction highs to form the upper resistance line, ideally three. Each successive high should be lower than the previous highs hit.
Lower Support Line: At least two reaction lows are required to form the lower support line. Each reaction low should be lower than the previous lows.
Break Out: A breakout signal is generated when price moves above the pattern’s upper resistance levels. For additional confirmation a trader could wait till prices move above the previous resistance high.
Time frame: The pattern usually takes 2-8 weeks to form.
Volume: While volume is not particularly important on rising wedges, though it is an essential factor to confirm a falling wedge breakout. Without an expansion of volume, the breakout will lack conviction and could be vulnerable to failure.
In the above chart of 3M India Limited we observe a wedge pattern breakout. It is similar to a pennant but the time taken for pattern formation is slightly longer. The pattern is traded with a bullish bias at the time of the breakout.
Rectangle is generally considered as a continuation pattern, the pattern acts as a sideways consolidation during a trend. Prices tend to consolidate between two parallel lines known as support and resistance. The success rate of the pattern is not high and the exact direction of the breakout is known once we get a clear breakout signal. The pattern can be successfully traded by buying at the support zone and selling at the resistance or by trading once a breakout signal is generated. There are instances where the rectangle pattern tends to act as a reversal pattern as well. A rectangle pattern formed at the top of a trend is known as distribution pattern and one formed at bottom is known as an accumulation pattern.
The technical target for a rectangle is arrived at by computing the width between the two parallel lines and adding or subtracting it from the breakout point based on the direction of the breakout.
Characteristics of a Rectangle
Prior Trend: For the pattern to act as a continuation pattern a prior trend should be in existence.
Support/Resistance: Prices tend to fluctuate between these two parallel lines. Minimum of two contact points should be formed along the support and resistance lines respectively. Although not a prerequisite, it is preferable that the high and low points alternate.
Volume: Volume tends to contract at the start of the pattern and expands at the time of breakout. The expansion in volume at the time of breakout tends to provide added confirmation.
Time Frame: Rectangles can extend from many weeks to a few months. If the pattern is less than 3 weeks, it is usually considered a flag pattern. The longer the prices consolidate in a sideways range more significant and less probability of it being a false breakout.
Breakout Direction: During the period of formation , there is no way of knowing in advance which way the prices will ultimately break; therefore it should always be assumed that the prevailing trend is in existence until a reversal has been proved. Speculating the breakout direction with a rectangle pattern formation could be a risky trade.
In the above chart of LIC Housing Finance we witness a rectangle chart pattern. In this case, prices tend to consolidate between the two parallel lines before finally managing to give a breakout on the upside breaching its resistance level and managing to continue its original uptrend.
Double Bottom is a reversal chart pattern and is the mirror image of a double top formation. The pattern is made up of two consecutive troughs separated by a peak in between. The pattern is generally observed during a downtrend.
The technical target is arrived at by computing the low point of the pattern and adding it to the breakout point
Characteristics of a double bottom
Prior Trend: For the pattern to act as a reversal pattern a prior downtrend should be in existence.
Lows: Both the lows should be reasonably alike and occur at nearly the same level. If the depth of second trough is shallower than the first it is considered a bullish sign.
Volume: High volume is observed at the low points (accumulation) as well at the time of breakout.
Time frame: The pattern usually takes between 4 weeks to a few months. The double bottom formation takes more time to form than a double top formation.
In the above chart of Ambuja Cement we witness a double bottom chart pattern. In this case the second trough is higher than the first which is considered a bullish sign. The pattern tends to act as a medium to long term trend reversal pattern. A bullish trade can be initiated once the neckline is breached.
Triple Bottom pattern is considered as a reversal pattern; it tends to occur after a long downtrend. The triple bottom occurs when the price of the stock forms three distinct lows, at around the same price level, before giving an upward breakout and reversing its downtrend.
The technical target is derived by measuring the vertical depth of the pattern and applying this length to the breakout point.
Characteristics of a Triple Bottom
Prior Trend: A downtrend or long trading range should be in place for Triple Bottom to occur.
Three Lows: All three lows should be reasonably alike and occur at nearly the same level.
Volume: High volume is observed at the low points (accumulation) as well at the time of breakout.
Time frame: The pattern usually takes a few months before a reversal is witnessed. The triple bottom formation takes more time than a triple top formation.
In the above chart of TV18 Broadcast we witness a triple bottom formation. Prices face resistance on three successive occasions near the neckline before finally witnessing a breakout. The pattern is a trend reversal pattern and as can be seen in the above chart, it is witnessed at the bottom of a downtrend.
Inverse head and shoulder is a bullish reversal pattern and is usually observed after a downtrend. The pattern contains three successive troughs with the middle trough commonly known as the head, being the deepest and the two outside troughs (shoulders) being shallower. Ideally, the two shoulders would be equal in height and width. The reaction highs in the middle of the pattern can be connected to form resistance, or a neckline.
The technical target for an inverse head and shoulder pattern is arrived by adding the difference between the neckline and the lowest level reached in the formation to the breakout point.
Characteristics of an inverse head and shoulder
Prior Trend: For the inverse head and shoulder to act as a reversal pattern there should be a prior downtrend in existence.
Left Shoulder: While in a downtrend, the left shoulder forms a trough that marks the low point of the current trend. The reaction high of the decline usually remains below any longer trend line.
Head: After making a bottom, the high of the subsequent advance forms the second point of the neckline. The head forms the low point of the pattern.
Right Shoulder: Bears push prices lower again, but this time prices fail to make a new low. This low is always higher than the head and usually in line with the low of the left shoulder. This is a bullish sign as the bulls start to gain control.
Neckline: The neckline forms by connecting reaction highs off of the left shoulder and the head which is extended further. The neckline can slope up, slope down, or be horizontal.
Volume: Volume plays an important role in the confirmation of an inverse head and shoulder pattern. Volume tends to decline during the correction phase and tends to expand during the advance.
Neckline Break: The inverse head and shoulder pattern is complete only once the neckline is comprehensively breached. Breakout must occur with an expansion of volume which tends to provide added conviction.
In the above chart of Pidilite Industries we witness an inverse head and shoulder chart pattern. A bullish trade can be initiated when price breaches the neckline. In the above example the price outburst has been backed by a surge in volumes which tends to provide the trader added confirmation.
The symmetrical triangle is usually considered a continuation pattern but there are instances when a symmetrical triangle acts as trend reversal pattern as well. Continuation or reversal, the direction of the next major move can only be identified after a valid breakout. A symmetrical triangle is composed of series of two or more rallies and reactions in which each succeeding peak is lower than its predecessor. It is among the most common chart patter and also among the most unreliable pattern. The more times the lines forming the symmetrical triangle have been touched or approached, the greater the probability that their breakout will be a valid.
The technical target for symmetrical triangle is arrived at by computing the vertical height of the triangle at its widest point and adding it to the breakout point.
Characteristics of a symmetrical triangle
Trend: In order to qualify as a continuation pattern, a prior trend should exist. The trend should be at least a few months old and the bullish symmetrical triangle marks a consolidation period before continuing its prior trend.
Volume: Volume diminishes during the formation of the symmetrical triangle before the breakout where volumes tend to surge.
Duration: The symmetrical triangle can extend for a few weeks or many months. If the pattern is less than 3 weeks, it is usually considered a pennant.
Breakout: The ideal breakout point occurs 1/2 to 3/4 of the way through the pattern's development or time-span. A break before the 1/2 way point might be premature and a break too close to the apex or after the apex may be insignificant.
Breakout Direction: The future direction of the breakout can only be determined after the break has occurred. Even though a continuation pattern is supposed to breakout in the direction of the long-term trend, this is not always the case.
Breakout Confirmation: For a break to be considered valid, it should be on a closing basis. Breakout backed by a surge in volumes tends to give added confidence.
In the above chart of Bharti Infratel, we observe a bullish symmetrical triangle. Prices move back and forth within the pattern before witnessing a breakout towards the apex of the triangle. The pattern should ideally be traded once the breakout has occurred since the direction of the breakout is not clear.
The Rounding Bottom is a reversal chart pattern that tends to act as consolidation period where the sentiment turns from a bearish bias to a bullish bias. The chart pattern looks similar to a cup and handle pattern but without the handle. The pattern can take a considerably long time in formation. Rounding bottoms are fine examples of gradual change over the demand /supply balance that slowly picks up momentum in the direction opposite to that of the previous trend.
Technical targets for rounding bottom formation are arrived at by computing the depth of pattern and adding it to the breakout point.
Characteristics of a Rounding bottom
Prior Trend: A downtrend or long trading range should be in place for rounding bottom to occur.
Breakout: Bullish confirmation comes when the pattern breaks above the resistance point that marked the beginning of the decline at the start of the pattern.
Volume: It tends to be high at the beginning of the decline gradually declining towards the bottom and rising once again towards the advance. Volume levels tend to track the shape of the pattern. Rise in volumes at the time of breakout tends to provide added confirmation.
Time: The pattern takes anywhere between few months to a few years to form. Due to the duration of the pattern it’s a slightly difficult pattern to trade on.
In the above chart of Magma Fincorp, we witness a rounding bottom formation. Volume tends to dry up during the formation of the pattern with a spurt in price and volumes seen towards the end of the pattern. It is a difficult pattern to trade as the exact point of breakout is difficult to predict.
Double Top formation is a trend reversal chart pattern. The pattern is usually observed at the top and acts as a distribution pattern. Double top pattern is characterized by a rally to a new high followed by a slight pullback in prices and a then a second rally to new highs. Selling pressure is witnessed as the stock forms fresh highs indicating the dominance of sellers. The stock trends lower over the course of next few weeks. A reversal in trend is confirmed once the key support levels are broken. The peaks should ideally be separated by about a month or more. If the peaks are to close, it could just represent normal resistance rather than a major change in trend. The main characteristic is that the second top that is formed is with distinctly less volume than the first.
The technical target for double top pattern is arrived at by computing the vertical height of the first top and subtracting it from the breakdown point once the reversal has occurred.
Characteristics of a Double top
Prior Trend: As with any reversal pattern, there must be an existing trend to reverse. In the case of the double top, an uptrend of several months should be in place.
First Peak: The first peak should mark the highest point of the current trend.
Trough: A correction is witnessed after the peak. Typically the correction ranges 10-15%.
Second Peak: The second peak is formed after a time frame of 1-3 months. The peak is formed on the back of low volumes and faces resistance at its previous high.
Decline from Peak: The subsequent decline from the second peak usually witnesses an expansion in volume as the bears take over.
Trend Reversal: A trend reversal is indicated once the support zone is breached; the breakdown of the support zone is usually accompanied with a surge in volumes.
In the above chart of Persistent Systems we observe a double top chart pattern. The pattern tends to act as a distribution pattern with the stock witnessing selling pressure as it tries to surge higher. Finally the bears manage to take control towards the end and prices crack below the neckline.
Triple Top is a distribution pattern and is an extension of the double top formation. The pattern consists of three distinct tops rather than two. The pattern is formed when bulls try to take the stock higher on three successive occasions but face resistance at roughly the same resistance zone and ultimately price breaks down breaching its support zone.
The technical target for a triple top formation is arrived at by computing the vertical length of the high point of the pattern from support line and then subtracting it from the support line once the breakdown occurs. No triple top formation is complete until the stock falls through the neckline i.e. the support level.
Characteristics of a Triple Top
Prior Trend: For the triple top to act as a reversal pattern, an uptrend or long trading range should be in existence.
Three Peaks: The peaks tend to act as resistance zones and prevent prices from surging higher, then tend to be reasonably well spaced and similar in dimension.
Volume: As the triple top develops, volume tends to decline during the surge and increase during the correction phase indicating that the bears are in control. After the third high, an expansion of volume is observed on the subsequent decline and continues to expand as price breaches the support level i.e. the neckline of the pattern.
Trend reversal: The Triple Top is not complete until a support level is breached. The correction low points are connected to form the support line.
Time frame: The triple top takes a few months for the pattern formation.
In the above chart of Fortis Healthcare, we witness a triple top chart pattern. The pattern tends to act as a long term reversal pattern. Prices try to surge higher on three consecutive occasions but are met by selling pressure. A trader can initiate a sell trade when the neckline is breached.
Head and Shoulder is a famous chart pattern that implies a likely reversal of the current trend. It is probably one of the most reliable chart patterns. The head and shoulder pattern is easy to spot on the chart. It is characterized by three peaks with the middle peak (head) being the highest peak and along with two other peaks known as shoulders on either side. The shoulders are of roughly equal height but less than that of the head. The lows of these peaks are connected with a trend line, commonly known as the neckline of the pattern.
The technical target is arrived at by computing the vertical height of the head from the neckline and subtracting it from the neckline once the breakdown occurs.
Characteristics of a Head and Shoulder
Prior Trend: For the head and shoulder to act as a reversal pattern there should be a prior uptrend in existence.
Left Shoulder: While in an uptrend, the left shoulder forms a peak that marks the high point of the current trend. However the new highs are short lived and prices retreat towards the trend line.
Head: From the low of the left shoulder, prices advance once again this time surpassing the previous highs and form the high point of the pattern. After peaking selling pressure is witnessed, this once again drags prices towards the trend line.
Right Shoulder: The bulls push prices higher again, but this time fails to make new highs. This is a very bearish signal; because bears took control and did not allow the bulls to make a new high or even an equal high. The decline from the peak of the right shoulder should break the neckline.
Neckline: The neckline is formed by connecting the two correction points i.e. of the left shoulder and head which is then extended further. The neckline can slope up, slope down or be horizontal.
Volume: Volume plays an important role in the confirmation of a head and shoulder pattern reversal. Volume tends to decrease during the formation of the peaks i.e. the highest volume is observed during the formation of the left shoulder and tend to decrease as pattern develops. Volumes tend to surge again during the correction from the right shoulder and as prices breakdown from the neckline. Volume expansion is an additional confirmation not a necessary condition.
Neckline Break: The head and shoulder pattern is complete only once the neckline is comprehensively breached.
In the above chart of JP Associates, we witness the formation of a Head and Shoulder chart pattern. A bearish trade can be initiated once the neckline is breached. The pattern is observed at the top of an uptrend.
Rounding Top is a top reversal pattern. It is a mirror image of the rounding bottom pattern. The pattern is formed when there is a sharp rally to a new high on strong volume, several weeks of light trade with limited upside progress in prices, forming an inverted U shaped pattern, followed by a sharp move lower with a rise in volumes. It is difficult to obtain breakout points for rounding top and bottoms since they tend to develop slowly and do not offer any clear support resistance levels on which to establish a potential benchmark.
Technical targets for rounding top formation are arrived at by computing the height of pattern and adding it to the breakout point.
Characteristics of a Rounding top
Prior Trend: For a rounding top to act as a reversal pattern a prior uptrend should be in existence.
Breakout: occurs when prices break below (Go from above to below) the support of the pattern; Support is the lowest low that there is during the Pattern.
Volume: It tends to be high at the beginning of the advance, gradually declining towards the top and rising once again towards the advance. Volume levels tend to track the shape of the pattern. Rise in volumes at the time of breakout tends to provide added confirmation.
Time: The pattern takes anywhere between few weeks to a few months. It is a long term pattern.
In the above chart of Castrol, we witness a rounding top pattern. It is a chart pattern where in the shares gets transferred from the informed traders to the uninformed traders, there is gradual displacement of shares.