Chart Patterns Explained: Recognizing Trends and Reversals
Technical analysts trade with confidence when they recognize familiar chart patterns. Identifying these patterns helps predict future price scenarios. Chart patterns are generally classified into two types: reversals and continuations.
Reversal Chart Patterns
Head and Shoulders (H&S)
Head and shoulders is popular reversal pattern, forming at the end of an upward or downward trend.
Let’s first examine the H&S as it appears at the end of an upward trend.
Chart 1: Head and Shoulders. Source: MetaTrader4
The pattern consists of three main components: two shoulders and a head, resembling a human body. Initially, prices fluctuated while forming the left Shoulder A. Buyers then pushed prices to a new high, forming the head. As the price started to decline, bulls were opening long positions. Still, their strength was insufficient to push prices to the previous high, resulting in the formation of the right Shoulder B. Usually, Shoulder B is of the same height as Shoulder A. The end of the upward trend was confirmed when the neckline connecting the two shoulders was broken. At this moment, many sell orders were triggered (the sellers stepped into the market, and stop-loss orders from long positions were executed).
A broken neckline reverses its function and becomes resistance. If the price fails to return above it, the H&S pattern becomes more pronounced, offering another opportunity for sellers to join the emerging decline. Stop orders are set above Shoulder B or above the head (for a safer, albeit more distant, stop). The price target is determined by measuring the distance between the highest high (the top of the head) and the neckline. This distance is applied to the neckline breakpoint to set the price target.
The same logic applies to the inverted head and shoulders pattern, which forms a reversal after a downtrend.
Inverted Head and Shoulders
Chart 2: Inverted Head and Shoulders. Source: MetaTrader4
The break of the neckline signals the start of an up-move. Stop orders are placed below the right shoulder or below the head (for better protection). The price target is determined by measuring the distance between the head (bottom) and the neckline, then projecting this distance to the point of the neckline break.
Chart 2 shows that the formation may only sometimes have perfectly pronounced components. When considered alone, the left shoulder and the head do not indicate a reversal. However, the right shoulder finds significant support, and the upward breakout confirms the end of the decline.
Such situations should be verified with other technical tools, like indicators. Ideally, the head will form on lower trading volumes, with the break occurring on rising volumes. This would confirm an emerging buying domination.
The neckline can be in the direction of the main trend or opposite to the primary trend. In Chart 2, it descends in the direction of the trend.
Final words about Head and Shoulders
Constructing the H&S pattern involves some subjectivity. However, this formation provides an opportunity to build a trading plan around significant turning moments. It is more commonly formed at the end of upward trends.
Double Top and Double Bottom
The name of these formations is quite descriptive. Whether it appears at the end of an upward (double top) or downward (double bottom) trend, these patterns signal a potential reversal.
Double Top
In a double top pattern, an upward trend hits a price level and corrects downward. A new upward move follows, but prices do not surpass the previous high. Gradually, sellers take control.
Chart 3: Double Top. Source: MetaTrader4
A break below the bottom (the lowest point between the two tops) confirms the pattern’s completion. This is when more conservative traders might open short positions. More aggressive traders may sell while the pattern is still in formation.
The critical moment in this pattern occurs when prices attempt to break above the previous high but fail. A reversal is more likely if this latest rise happens in lower volumes. Stop orders are best protected above the two tops.
The price target is determined by measuring the height of the range (the distance between the peaks and the low point in between) and subtracting that distance from the breakout level.
The bottom represents the last support level. A downward break occurred in this case, and the target was reached.
Identical analysis applies to the double bottom pattern.
Double Bottom
Chart 4: Double bottom. Source: MetaTrader4
After a period of decline, a bottom was formed, casting doubt on the downward trend. The bottom was unsuccessfully tested, leading to the formation of a second bottom, slightly higher than the first. This indicates strong buying interest in this zone.
Aggressive traders might look for an early buying opportunity while the second bottom still forms. More conservative traders would wait for further technical confirmation by breaking the top of the consolidation (the top between the two bottoms). In either case, the safest place for stop orders is below the two bottoms. The price target is determined by applying the height of the range to the breakpoint.
Triple Top and Triple Bottom
This pattern is similar to the “double top” and “double bottom” formations, with the main difference being the presence of a third impulse to continue the existing trend. Failure to surpass the previous two highs forms the third top. Identically, the inability to break below the two lows forms the third bottom. This indicates that the current trend is exhausted. Previous tops and bottoms have proven to be significant resistance and support levels. The most conservative price to place stop orders is above the tops or below the bottoms (for short and long positions, respectively).
The concept behind double-, triple-, and quadruple tops and bottoms is straightforward: the more times a price level holds, the more significant support/resistance it becomes.
Chart 5: Resistance Zones. Source: MetaTrader4
Synchronization Across Timeframes
Chart 5 illustrates resistance levels where attempts to break through have been rejected. Eventually, the bears took control, leading to a decline.
This example illustrates the idea of synchronization across timeframes. If the primary trend has been downward over the last three years but has risen in the past three months, a double top or similar formation could provide a selling opportunity in line with the long-term price direction. Stop orders would be placed above the highs (resistance levels), and the main trend would determine the price target. This approach can achieve a satisfactory reward/risk ratio. Thus, a lower timeframe reversal pattern may initiate the continuation of the main trend.
Wedges
Wedges can act as both reversal and continuation patterns. Based on their characteristics, they are categorized into rising and falling wedges.
Rising Wedges
Rising wedges follow a pattern of increasing highs and increasing lows. However, reaching new highs becomes increasingly difficult, naturally narrowing the wedge’s boundaries. Typically, a significant move follows these periods of flattening balance between buyers and sellers.
Chart 6: Rising Wedge. Source: MetaTrader4
Chart 6 illustrates rising wedge formation. The uptrend has gradually lost strength, with new highs barely exceeding the previous ones. The break of the support line reversed price direction.
A rising wedge can also be used to set a price target. This target is determined as the base of the wedge (where the pattern formation starts) applied to the breakpoint.
Rising wedges often indicate a future decline, regardless of whether they appear as a reversal at the end of an uptrend or as a continuation of a bearish trend.
Chart 7: Continuation Wedge. Source: MetaTrader4
Chart 7 illustrates how the rising wedge has continued the downtrend. Although prices temporarily found support, the increasing lows failed to establish a basis for a significant up-move. The break in the downward direction signaled the resumption of the decline. Price targets are determined according to the rules mentioned earlier.
Falling Wedges
Chart 8: Falling Continuation Wedge. Source: MetaTrader4
Chart 8 shows a falling wedge that continues the bullish trend. It alternates between lower lows and lower highs, with each successive low barely surpassing the previous one.
When the resistance line was broken, the rise resumed. The resistance of the last top was also broken, confirming the signal’s validity. The price target can be determined as previously described. If the formation continues the primary trend (the case of Chart 8), the price target can be set against significant levels within that trend.
Chart 9: Bullish Reversal Wedge. Source: MetaTrader4
The last example shows a falling wedge as a reversal pattern at the end of a decline. Its interpretation follows the previously described logic. Falling wedges indicate a potential price increase, whether they form as reversal patterns at the end of a decline or as a continuation of a bullish trend.
Wedges are a popular and essential chart pattern. They offer a relatively straightforward method for determining entry points, stop-loss, and take-profit levels.
Continuation Patterns
Triangles
Triangles often appear as a continuation pattern, though they can also signal the start of correction. After an upward or downward movement, prices temporarily reach an equilibrium, with neither bulls nor bears in control. During these periods, a triangle pattern forms. Triangles can be symmetrical, ascending, or descending.
- Symmetrical triangles feature rising lows and falling highs.
- Ascending triangles have rising lows with highs arranged in a horizontal line.
- Descending triangles have falling highs with lows arranged in a horizontal line.
Chart 10: Symmetrical Triangles. Chart: MetaTrader4
The triangles in the chart are symmetrical, with higher lows and lower highs narrowing the movement’s boundaries. A breakout from the triangle (close above the resistance line) signals a continuation of the trend. To determine the price target, add the distance from the triangle’s base (blue line) to the breakout point.
Many traders prefer to see a break above the highest top of the triangle to confirm the continuation of the primary trend. Stop orders should be placed below the lowest point (where the pattern begins). Symmetrical triangles provide a solid foundation for building a strategy aligned with the primary trend.
Chart 11: Ascending Triangle. Source: MetaTrader4
Chart 11 shows an ascending triangle characterized by rising bottoms and horizontal tops. This pattern suggests the beginning of a bullish trend as buyers gain control at increasingly higher levels.
However, in practice, ascending triangles can also form before a decline. Therefore, a triangle break must occur to confirm the direction of future prices. Many traders analyze volumes to determine if the break is supported by increased trading activity.
In the example, the ascending triangle acted as a continuation pattern. Alternatively, if the resistance line (the horizontal line connecting the highs) had been broken to the upside, it would have confirmed a reversal, prompting traders to seek buying opportunities.
Chart 12: Descending Triangle. Source: MetaTrader4
Chart 12 illustrates a descending triangle as a reversal formation. This pattern typically suggests a continuation to the downside, with consecutive lower highs indicating sellers’ strength. However, in this case, buying interest prevailed around the support levels (the series of horizontal lows), leading to a trend reversal. This once again highlights the importance of the breakout direction in predicting the future movement of the currency pair.
The examples show that predicting a chart pattern’s outcome is not always possible. Therefore, chart patterns should be used alongside other analytical techniques. Triangles often form at low volumes, with a significant trading activity accumulating during the breakout.
The relatively intuitive approach to constructing triangles and determining entry, stop, and profit levels allows traders to build their trading plans around these formations.
Trend-following traders commonly exploit triangles. Symmetrical and ascending triangles indicate a continuation of the upward trend, while symmetrical and descending triangles suggest temporary consolidation in a downward trend before the decline continues.
Flags and pennants
Flags and pennants are continuation patterns that appear after a sharp upside or downside price movement. They represent a temporary balance between buyers and sellers before the trend resumes. Flags are rectangular, while pennants are triangular. The names come from the rapid price change forming a pole with the flag or pennant attached to it.
Chart 13: Bearish Flags and Pennants. Source: MetaTrader4
Chart 13 shows a series of flags and pennants within a downtrend. Bearish flags form a rising price channel – a series of higher lows and parallel highs. This is a corrective move that is usually realized on lower volumes.
The same can be said for the pennant– an inherently symmetrical triangle. Similar to flags, the likelihood of a trend continuation in pennants rises when these patterns form during periods of low trading volume.
Chart 14: Ascending Flag and a Pennant. Source: MetaTrader4
Chart 14 depicts an ascending flag and a pennant. The flag forms a channel opposite the main trend, with lower lows and lower highs. A break of the resistance line signals an uptrend resumption. The height of the pole, projected to the breakpoint, determines the price target. The stop can be placed below the flag’s lowest low.
A pennant is also visible on the chart. After a false continuation breakout, the trend reversed. The false breakout is also known as a “bulls trap.” False signals are an inevitable part of trading chart formations.
Flags and pennants act as a temporary pause before a distinct rise or fall. The pennant in this example has the characteristics of a triangle, as it has been forming for a long time.
Flags and pennants are often used in intraday trading. The pole of the pattern frequently results from unexpected news, leading to a quick and substantial price change. Formations like flags and pennants form during the subsequent consolidation period. These moments of correction or consolidation offer good risk-adjusted trading opportunities.
Rectangles
Rectangles confine price changes within two parallel horizontal lines of support and resistance, forming a sideways price channel. At least two bottoms and two tops are needed to construct this pattern.
Extended price action inside these boundaries indicates a balance between bulls and bears. Predicting the future price direction is challenging. Rectangles can appear as a continuation or as a reversal pattern. The breakout from the rectangle is considered indicative of the future direction of the trend.
Chart 15: Rectangle. Source: MetaTrader4
To determine the price target after a break, measure the height of the rectangle and apply it to the breakout point. The most robust protection for short positions is above the tops (resistance line). After a downward breakout, the support line becomes resistance, allowing sellers to place short but risky stops above it.
If the breakout is upward, conservative stop orders should be placed below the bottom of the rectangle. Shorter stops can be positioned below the rectangle’s upper line, which, after the breakout, is a support.
Many traders prefer to trade within the rectangles, buying near the support line and selling near the resistance.
Rectangles are attractive trading formations because of their simplicity and the intuitive way of defining entry, stop-loss, and take-profit levels. However, additional tools may be necessary to reduce the number of false signals.
Conclusion
Chart formations play a significant role in technical analysis. However, they involve nuances and subjectivity in both construction and interpretation. Real-life patterns may not always align with textbook examples. Therefore, chart patterns should be used with other analytical tools for greater accuracy.
Volumes often serve as a confirmation indicator when trading price patterns. Breakouts supported by high trading volumes have good prospects for success. Using momentum and other indicators near the breakpoint can further verify signals.
Trend-following traders widely use continuation formations to join the main trend at good reward/risk ratios. Reversal patterns also have significant potential, but trading against the primary trend is challenging.
Some chart patterns share continuation and reversal characteristics, adding complexity to the analysis.
