Back to Home

Chapter 7 Forecasting with Classic Chart Patterns

Continuation Patterns

Continuation Patterns derive their name from the fact that they generally continue in the direction of the trend. Symmetrical Triangles, Ascending & Descending Triangles, Rectangles and Flags & Pennants are the most common Continuation Patterns.

Reversal Patterns

Reversal Patterns have a tendency of reversing the trend. These consolidation patterns can signal a reversal in both uptrend as well as downtrend.

Head and Shoulder

The Head and Shoulder pattern is generally regarded as a Reversal Pattern.Volume is of great importance in the Head and Shoulder pattern. Volume generally follows the higher price on the left shoulder. However, the head is formed on diminished volume, indicating the buyers.aren't as aggressive as they once were. On the last rallying attempt, the right shoulder-volume is even lighter than on the head, signaling that the buyers may have exhausted themselves.

Head and Shoulder Formation:

Inverted Head and Shoulder

The Head and Shoulder pattern can sometimes be inverted.

Remember that:

  • The inverted left shoulder should be accompanied by an increase in volume

  • The inverted head should be made on lighter volume.

  • The rally from the head, however, should show greater volume than the rally from the left shoulder

  • Ultimately, the inverted right shoulder should register the lightest volume of all.

  • When the stock eventually rallies through the neckline, a big increase in volume should be seen.

Inverted Head and Shoulder Formation:

Symmetrical Triangles

Symmetrical Triangles can be characterized as areas of indecision. A market pauses and future direction is questioned. Typically, the forces of supply and demand at that moment are considered nearly equal.

Remember that:

  • Attempts to push higher are quickly met by selling, while dips are seen as bargains.

  • Each new lower top and higher bottom becomes more shallow than the last, taking on the shape of a sideways triangle. (It's interesting to note that there is a tendency for volume to diminish during this period.)

  • Eventually, this indecision is met with resolve and usually explodes out of this formation (often on heavy volume.)

Symmetrical Triangle Formation:

Ascending Triangles

The Ascending Triangle is a variation of the symmetrical triangle. Ascending Triangles are generally considered bullish and are most reliable when found in an up-trend. The top part of the Ascending Triangle appears flat, while the bottom part of the Ascending Triangle has an upward slant.

Remember that:

  • In Ascending Triangles, the stock becomes overbought and prices are turned back.

  • Buying then re-enters the market and prices soon reach their old highs, where they are once again turned back.

  • Buying then resurfaces, although at a higher level than before.

  • Prices eventually break through the old highs and are propelled even higher as new buying comes in.

Ascending Triangles Formation:

Descending Triangles

The Descending Triangle, also a variation of the Symmetrical Triangle, is generally considered to be bearish and is usually found in downtrends.

Unlike the Ascending Triangle, this time, the bottom part of the Descending Triangle appears flat. The top part of the triangle has a downward slant.

Remember that:

  • Prices drop to a point where they are oversold.

  • Tentative buying comes in at the lows, and prices perk up.

  • The higher price, however, attracts more sellers and prices re-test the old lows.

  • Buyers then once again tentatively re-enter the market.

  • The better prices though, once again, attract even more selling.

  • Sellers are now in control and push through the old lows of this pattern.

  • At the same time, the previous buyers rush to dump their positions.

Descending Triangles Formation:

Wedges

The Wedge formation is also similar to a Symmetrical Triangle in appearance, in that it has converging trend lines that come together at an apex. However, Wedges are distinguished by a noticeable slant, either to the upside or to the downside. As with triangles, volume should diminish during its formation and increase on its resolve.

Remember that:

  • A falling Wedge is generally considered bullish and is usually found in up-trends. However, it can also be found in downtrends. The implication is still generally bullish. This pattern is marked by a series of lower tops and lower bottoms.

  • A rising Wedge is generally considered bearish and is usually found in downtrends. They can be found in up trends too, but would still generally be regarded as bearish. Rising Wedges put in a series of higher tops and higher bottoms.

Rising Wedge Breakdown:

Falling wedge Breakout:

Flags and Pennants

Flags and Pennants can be categorized as Continuation Patterns. They usually represent only brief pauses in a dynamic stock. They are typically seen right after a big, quick move. The stock then usually takes off again in the same direction. Research has shown that these patterns are some of the most reliable Continuation Patterns.

Remember that:

  • Unlike Wedges, their trend lines run parallel.

  • "Bear" flags also have a tendency to slope against the trend. Their trend lines run parallel as well.

  • Pennants look very much like Symmetrical Triangles. However, Pennants are typically smaller in size (volatility) and duration.

  • Volume generally contracts during the pause with an increase on the breakout.

Flag Pattern Breakout:

Rectangles

A Rectangle chart pattern indicates sideways action. When the market enters in a congestion phase, it is likely to break out in the direction of the preceding trend.If two horizontal lines surround a retracement, it is a Rectangle chart pattern. Both the bullish and bearish Rectangle patterns look the same. However, they appear in different trend context.

Remember that:

  • The trend before the Rectangle chart pattern determines if the pattern is bullish or bearish.

  • A Rectangle pattern continues the prior trend.

  • Buy on break-out above the resistance line, or on pullback to the resistance line (now acting as support), after the break-out.

  • Sell on break-down below the support line, or on pullback to the support line (now acting as resistance), after the break-down.

  • Volume should increase when price breaks out of the resistance / support line

Rectangle Breakout:

Key takeaways

  • Until a price pattern has been formed and completed, the assumption should be that the prevailing trend is still operative.

  • Price patterns can be formed over any time frame. The longer the time required toform a pattern, the more substantial the ensuing price movement is likely to be.

  • Measuring formulas can be derived for most type of patterns, but these are generally minimum objectives. Prices usually extend much further.

  • Price objectives represent the minimum ultimate target and are not normally achieved in one move.

1 2 3 4 5 6 7 8 9