In trading, no matter how experienced one is, no one can quite predict what a specific market will do at a specific time in the future with any guarantee. This is one of the reasons why a market analysis is important, as it deals with probabilities, rather than predictions. For a lot of traders, this requires them to analyze charts to find patterns that are a reflection of what people have done in the same scenarios in the past. As human behavior and price history are two concepts that have a tendency to repeat, one can easily extrapolate the probability of predictable patterns of price behavior just by examining the tracks that the prices leave on a chart.
The Blank Chart
The above chart is a blank one, and contrary to what others might say, it still provides us with some valuable insights. The above chart uses candlesticks to display price information. In August, the chart shows that the price starts an upward trend. If one were to draw a line under the major valleys, it will be straight. Since it follows the line of the trend, it’s called a trend line.
The above chart suggests that the uptrend is about to end. To know how far the price can drop, it’s necessary to look at chart patterns. The price scale seen in the chart tells us that the stock has more than doubled in value within a year. A trader who purchased the stock near the August low and sold near the March high would’ve gained tremendously.
The above chart is the same as the one before, only with some added lines. The chart almost resembles an up sloping staircase with horizontal treads. The price goes below the diagonal trendline at a few points but not for long. The price either climbs above the diagonal line or directly rests on it.
In the above chart, the period from September to November is the only time where the price has the potential to make good contact with the line above it.
Connecting Valleys
Another good way to work with chart patterns is by searching for valleys that bottom near the same price. We are using the same chart as the one we used in the connecting peaks example. The lower right inset of the above chart is an example of what we call a double bottom. There are two valleys, “E” and “F” that are both near the same price level.
Look for valleys that bottom near the same price. Draw a horizontal trendline along the valleys as seen above (B). The price rests on it and does not close below the line even though some of the lows can poke through. Thus, B is an example of the alignment of multiple valleys to form a trend line. Look for two valleys near the same price and any other valleys that can reside near the same price.
If there are multiple peaks stopping near the same price level, you can look towards valleys situated between the peaks to get a better clue about their type. These patterns can be anything such as an ascending triangle, a broadening pattern, or a triple top. On the other hand, if there are several valleys at a similar price, it can be a broadening pattern, a descending triangle, or a triple bottom.
Patterns With Curves
Patterns such as inverted and ascending scallops are all formed with curved lines. The price trends in a straight line after which it rounds over at the top. It then retraces a portion of the prior profit.
The above chart shows inverted and ascending scallops which are in the shape of an upside down bowl. A surprising quality about these setups is that they tend to get shorter as they approach a trend change. This does not happen all the time, as there are times when they can get taller.
Scallops come in four types: Ascending, Descending, Inverted and Non-inverted. You should thus check for peaks and valleys that form turns.
Other examples of patterns with curves include the rounding top and bottom as well as the cup with handle patterns. As a trader, always look for curves on the price chart. To form chart patterns, connect those curves with imaginary lines.
Connecting Peaks
You should look to spot multiple peaks at or near the same price. In the above chart pattern, a chart pattern called a double top is highlighted by the twin peaks in the upper left inset. The tops “C” and “D” both peak near the same price. If there were three peaks found near the same price, the setup could become a triple top.
Thus, in this approach, you have to carefully monitor the chart to find out peaks at or near the same price. Always begin constructing any chart pattern by visually finding peaks sharing similar prices. Here, the two peaks that top out near the same price have a possibility of forming a double-top.
The line “A” is a horizontal trendline that connects the peaks. Trendlines can slope in any direction, with some of them being curved as well. Here the price touches the top line multiple times. It does not close above the top line until after the end of the line where price catches a thermal and soars. When the price breaks out of the chart pattern and closes above the top trendline, it is known as a chart pattern breakout.
Final Thoughts
Traders who are starting out or have just started trading for a few months should always learn how to train their eyes to detect chart patterns. You can start by looking for peaks forming near the same price, which could either be double tops or triple tops. There are others which can use curves so look for peaks to round over or valleys that round up. These chart patterns are generally more difficult to spot as compared to straight lines.