Technical analysts use chart patterns, visual representations of price movements, to forecast future stock market price trends. These patterns, divided into continuation and reversal types, are formed through the collective actions of market participants.
Continuation Patterns:
These patterns indicate that, barring a brief period of stabilization, the current trend is likely to continue. Typical patterns of continuation include:
1. Flag and Pennant Patterns:
Flag Pattern: The “flag pattern” is a technical chart pattern indicating that the current stock market trend will likely continue. It typically follows a strong price movement (flagpole), with price consolidation forming a rectangular or parallelogram flag pattern. A bearish flag pattern shows higher highs and lower lows, while a bullish flag consolidates with opposite movements. Traders look for a breakout from the flag formation in the trend’s direction, often with higher volume. Traders sometimes use the length of the flagpole to determine the possible price target when a breakout occurs.
Pennant Pattern: The pennant pattern, resembling a symmetrical triangle, forms after a sharp price movement (flagpole) in the market. This pattern suggests that the price will briefly consolidate before continuing on its previous trajectory. Converging trendlines on the pennant indicate declining price volatility. Traders look for a breakout from the triangle formation, ideally with increased volume, to confirm the trend. The measured move technique predicts price objectives after a pennant breakout, using the height of the flagpole.
2. Triangle Patterns:
Symmetrical Triangle: A symmetrical triangle chart pattern indicates market resistance as price consolidates between converging trendlines. It implies that after buyers and sellers find equilibrium, there may be a breakout in either direction. Traders wait for confirmation of the breakout by watching for volume expansion.
Ascending Triangle: An ascending triangle indicates bullish emotion, featuring an ascending support line and a horizontal resistance level. It shows that buyers are getting more aggressive as they push past resistance in anticipation of a higher volume breakout above the barrier level.
Descending Triangle: A descending triangle, which indicates a bearish emotion, has a descending resistance line and a horizontal support level. In the vicinity of resistance, sellers have sway over buyers as they wait for a larger volume breakdown below support.
Reversal Patterns:
1. Head and Shoulders Pattern:
Head and Shoulders: The head and shoulders pattern in the stock market is a bearish reversal with three peaks. The pattern indicates that bullish momentum has run its course. The neckline connects the pattern’s low points. A breakdown below the neckline confirms the reversal.
Inverse Head and Shoulders: A bullish reversal pattern in the stock market is the inverse head and shoulders pattern. There are three troughs in total: two upper troughs (shoulders) and a lower trough (head). The pattern suggests that the bearish momentum has run its course. A breakout over the neckline indicates possible higher movement and validates the reversal.
2. Double Top and Double Bottom:
Double Top: In the stock market, two successive peaks and a neckline (the trough) define a bearish reversal pattern called a double top. When the price breaks below the neckline and fails to break above the second peak, it confirms a likely trend reversal.
Double Bottom: In the context of the stock market, a double bottom is a bullish reversal pattern that consists of two successive troughs of comparable depth spaced by a high (the neckline). When the price confirms a breakout over the neckline but fails to break below the second trough, it suggests a possible trend reversal.
3. Triple Top and Triple Bottom:
Triple Top: In the stock market, three successive peaks spaced apart by small retracements define a bearish reversal pattern called a triple top. It indicates resistance at a specific price point, where each peak follows a price break that fails to rise higher. A collapse below the neckline validates the pattern, suggesting possible downward movement.
Triple Bottom: In the stock market, three successive troughs of comparable depth interspersed with small rallies define a triple bottom, a positive reversal pattern. After every dip, it indicates support at a specific price level where the price is unable to break lower. A breakout above the neckline validates the pattern, suggesting possible upward movement.
