Looking at Patterns

You have seen how we can look at the charts, and draw some straight lines, either horizontally or at an angle, which seem to have some significance when you look at future price movements. These principles can be universally applied no matter what the financial market you are betting in, and they are some of the most basic tools of technical analysis. TA has a lot more to tell us however. In this section we’ll continue to look at price movements, and in later sections will get down to more manipulation of the data.

“Stock trading charts broadly fall into two main categories; Reversal or Continuation patterns and while almost any historical stock trading chart can be found for free online, it can be difficult to identify a stock pattern during its early stages.
Reversal patterns help to highlight that a trend may be reaching its end and that prices may reverse direction. They indicate the market momentum is slowing. These technical analysis patterns include: Head and Shoulders, Inverse Head and Shoulders, Double Top and Double Bottom.
Continuation patterns are established in times of price consolidation during a trending market. They imply uncertainty and offer opportunities to get into or add to a position. When price breaks out from the congestion it is usually in the direction of the trend. These technical patterns include: Triangles, Flags, Pennants and Wedges.”

It is also good at this stage to remember that all this information is purely a guide. There are no hard and fast rules to interpreting the charts, we are just looking at what has worked in the past and seems to still work most of the time. When we say that something follows on another thing, there is usually no guarantee but just the balance of probabilities, which have been gleaned from many prior observations. Though by no means a perfect science, the results can be considered a good way to make trading decisions as long as risk management and money management techniques are followed.

With that said, we’re now going to look at the shape of the price charts to see what information that can yield. We’ve already looked at the price movement in the sense of the peaks and troughs, connecting them to give us projections, but now we look at the overall price curve shapes to see what more can be understood from them. In this section we are looking at the continuous price line chart, and you will see in later sections that we can also break down individual days, or time periods, particularly when using candlestick charting, and discover yet more patterns.

There are a couple of ways to make money by predicting price movements. First, if there is a trend you can bet on the trend continuing, say by taking a long position in an uptrend. The second and in some senses opposite idea is to predict when a trend is failing and going to reverse, and to bet in the opposite direction, usually after you have seen initial price reversal. This means there are two types of information we want to find out – firstly, what is the likelihood that a trend will continue, and secondly, what are the signs that the trend will reverse?

This is sometimes difficult because when we look at a typical chart in a trend, you will see times when the price moves against the trend. This doesn’t necessarily mean that the trend is finished, but it can do. Even in a strong trend, you will find retracements. You have to employ the tools at your command to discover whether they are simple retracements or whether they are the start of a price reversal and a trend in the opposite direction. Even this oversimplifies the situation, because you can have sideways movement and periods of consolidation.

The most important point to winning spread bets is to figure out whether the price movement is continuing or going to reverse. The actual size of the move is of lesser importance, as long as you have the right direction. Therefore when we look at the chart patterns we are most interested in whether the pattern indicates that the price direction is continuing, that is a “continuation pattern”, or whether a reversal is imminent, that is a “reversal pattern”. Bearing in mind that prices tend to continue in the same direction unless there’s a reason for them to change, you will find that most technical analysis concentrates on reversal patterns.