Every technical analyst feels confident when recognizes a chart pattern that has encountered many times before. Discovering a familiar configuration creates expectations about the future price changes. Traders build their trading plan on this forecast. Patterns can be categorized as reversals and continuations. Below we will describe their more common representatives.

Reversal Chart Patterns

Head and shoulders

This is the most popular reversal pattern. It is formed at the end of an upward or downward trend. Let’s first look at head and shoulders as the end of an upward trend.

Chart 1: Head and Shoulders. Chart: MetaTrader4

Chart 1: Head and Shoulders. Chart: MetaTrader4

Three main components make up the model – two shoulders on which the head rests (analogous to a human body). Prices have shown some fluctuations while forming the left shoulder A, but buyer pressure has subsequently sent the pair to a new high. The subsequent decline was used by bulls to open long positions. But their strength was not enough to test the high and as a result the second shoulder B was formed. Usually shoulder B is at the height of shoulder A. Confirmation of the end of the upward trend comes when the neckline connecting the two shoulders is broken (the head is cut off).  Many traders will open their short positions at this point.

It is common for the broken neckline to be tested in its new capacity of a resistance. In the event of failure to rebreak, the formation will take on an even more definitive appearance while offering another opportunity to join the emerging decline. Stop orders can be placed above the right shoulder B or above the head itself (a safer but longer stop). The price target is equal to the distance between the highest high (top of the head) and the neckline. This distance should be applied to the neckline break point to determine the price target.

The logic is identical for the inverted head and shoulders pattern. It comes after a downward trend and builds a reversal formation.

Chart 2: Inverted Head and Shoulders. Chart: MetaTrader4

Chart 2: Inverted Head and Shoulders. Chart: MetaTrader4

The break of the neckline is considered the beginning of an uptrend. The stop may be below the right shoulder or below the head (more safe). The price target is determined by the distance between the head (bottom) and the neckline. It is projected to the point of the neckline break. In this case, the target is reached.

Chart 2 shows that the formation will not always have perfectly pronounced components. The left shoulder and the head do not portend a reversal when considered alone. However, the right shoulder is consolidating and the upward breakout has confirmed the end of the decline.

In practice, situations such as the one on the chart should be traded in sync with other technical tools such as indicators. It would be better for the head to form on lower trading volumes and the break to occur on rising ones. This would confirm a lack of selling interest and a nascent buying interest.

The neckline could be in the direction of the main trend or against it. In Chart 2, it is descending in the direction of the decline. If it were ascending, the neckline break would occur after the previous highs have been overcome. They are important resistances and their break gives further confirmation of the strength of the bulls.

As can be seen, the construction of the H&S carries its share of subjectivism. At the same time, this formation provides an opportunity to build a trading plan around moments of significant potential. It is formed more often at the end of upward trends and for many yields better results in these cases.

Double top and double bottom

The name of this formation is eloquent. Whether it appears at the end of a rise or decline, this pattern is a harbinger of a reversal. In the double top variant, the upward trend has reached certain levels, followed by a period of price fluctuations and a certain decline. A new upward impulse has followed. The prices reach but fail to break the top. At this point, the sellers take control of the situation.

A break of the formed bottom (the lowest level between the two tops) confirms the completion of the pattern. This will be the time for more conservative traders to open short positions. More aggressive market participants would sell while the formation is still being built, before the actual confirmation of the break comes.

In practice, the key moment is when the attempt to reach new high fails. If this latest rise occurs on lower volumes, a reversal seems very likely. The stop orders will be best protected above the two tops.

Chart 3: Double Top. Chart: MetaTrader4

Chart 3: Double Top. Chart: MetaTrader4

The price target is determined by the distance between the tops and the bottom in between (the height of the range). The bottom is the last support. In this case, the downward break has occurred and the target has been met. The logic is identical for the double bottom pattern.

Double bottom

Chart 5: Double bottom. Chart: MetaTrader4

Chart 5: Double bottom. Chart: MetaTrader4

After a period of decline, a bottom was formed. It remains intact for a certain interval of time, which puts the downward trend in doubt. However, the bottom is tested, but unsuccessfully. As a result, a second bottom is formed, which in this case is even slightly higher than the previous one. This is an indication of the strength of the buyers in this zone.

The more aggressive traders would look for an early buying opportunity (while the second bottom is in the process of formation). The more conservative ones would wait for further technical confirmations and a break of the top of the consolidation (the top between the two bottoms). In either case, the safest position to place the stop is below the two bottoms. The price target is the height of the range applied to the break point.

Triple top and triple bottom

The interpretation is similar to the “double top” and “double bottom” patterns. The main difference is the presence of a third impulse to continue the existing trend. Failure to overcome the previous highs/lows is a sign of the end of the existing trend. Conservative traders place stop orders above the tops and below the bottoms, respectively.

The idea of double, triple, quadruple, etc. tops and bottoms is obvious – the more times a level is tested and holds, the more importance it is.

Chart 6: Resistance Zones. Chart: MetaTrader4

Chart 6: Resistance Zones. Chart: MetaTrader4

On Chart 6, we can see resistance levels at which attempts to rise have been limited. Eventually, the bears took control and a decline ensued.

This particular example presents the idea of synchronization between price direction from different time periods. The point is this: if we define the main trend as downward, looking at the last 3 years, but see some rise in the last 3 months, a double top or similar formation would provide a selling opportunity in the long-term direction. Stops would be above the highs (resistance levels) and the price target would be determined by the main trend. A satisfactory risk/reward ratio could then be achieved. Thus, in practice, a reversal pattern may be in sync with the main multi-year trend.

Wedges

Wedges can be both a reversal and a continuation pattern. According to their graphic representation, they are divided into rising and falling.

Rising wedges are formed when a series of rising lows are accompanied by a series of new highs. But reaching new highs is increasingly difficult, with the natural limits of the movement gradually narrowing. Usually, a significant move follows such periods of a flattening balance between buyers and sellers.

Chart 7: Rising Wedge. Chart: MetaTrader4

Chart 7: Rising Wedge. Chart: MetaTrader4

The chart shows just such a plot. The rise has gradually begun to lose strength. The new highs hardly exceed the previous ones. The break of the support line and the last low have ended the rise. The trend has reversed.

The rising wedge can also be used to set a price target. It is equal to the distance from the base of the wedge – where the first low and high started the pattern formation. This value is applied to the break point.

Chart 8: Continuation Wedge. Chart: MetaTrader4

Chart 8: Continuation Wedge. Chart: MetaTrader4

Chart 8 shows how the rising wedge has emerged as a continuation of the downward movement. Temporarily, prices have met support. However, the rising lows have failed to create a basis for significant increases. The break in the downward direction has signaled the recovery of the decline. The principle for setting a price target is the same. Rising wedges more often portend a future decline, whether they come as a reversal or a continuation pattern.

Chart 9: Falling Continuation Wedge. Chart: MetaTrader4

Chart 9: Falling Continuation Wedge. Chart: MetaTrader4

Chart 9 shows a falling wedge as a continuation of the bullish trend. It alternates lower lows with lower highs. Each successive low barely overcomes the previous one. The corrective nature of the wedge has gradually lost its strength.

When the resistance line was broken, the rise resumed. At these levels, the last top was also broken, which gives further confirmation of the signal’s veracity. The price target can be determined in the manner already presented. When the formation is a natural continuation of the existing trend, the price target could be set against important levels for that trend.

Chart 10: Bullish Reversal Wedge. Chart: MetaTrader4

Chart 10: Bullish Reversal Wedge. Chart: MetaTrader4

The last example presents a falling wedge as a reversal pattern. It comes at the end of a decline. Its interpretation follows the logic already described. Falling wedges portend a rise – whether they are formed as reversal patterns at the end of a decline or as a continuation of the bullish trend.

Wedges are a popular and important chart pattern that offers a relatively straightforward methodology for determining an entry point for opening a position, as well as stop-loss and take-profit orders. Of course, like almost everything in TA, those choices are highly subjective.

Continuation patterns

Triangles

This pattern more often appears as a continuation, although it often marks the beginning of a reversal.

After a period of upward or downward movement, the prices are temporarily in an equilibrium position. Neither the bulls nor the bears take control. In these periods, the triangle is formed. Its construction can be symmetrical, ascending or descending.

In symmetrical triangles, a series of rising lows and falling highs are present. In an ascending triangle, rising lows are observed, but the highs are arranged in a horizontal line. The descending triangles present falling highs, and the lows are arranged in a horizontal line.

Chart 11: Symmetrical Triangles. Chart: MetaTrader4

Chart 11: Symmetrical Triangles. Chart: MetaTrader4

The triangles in the chart are symmetrical – higher lows and lower highs narrow the boundaries of the movement. The breakout of the triangle (the red trend line of resistance in the example) is considered to be a signal for the continuation of the trend. The distance from the base of the triangle (blue line) is added to this break point to determine the price target.

A number of traders would also prefer to see a break of the last top (inside the triangle) to additionally confirm the continuation of the main trend. Stop orders should be placed below the lowest bottom – where the configuration begins its construction. Symmetrical triangles create very good prerequisites for building a strategy in the direction of the main trend.

Chart 12: Ascending Triangles. Chart: MetaTrader4

Chart 12: Ascending Triangle. Chart: MetaTrader4

An ascending triangle can be seen in Chart 12. Its bottoms are getting higher and the tops are forming at almost identical levels. Logic suggests the beginning of a bullish trend because, as can be seen, the buyers manage to take control higher and higher.

In practice, however, ascending triangles are often formed before a decline. The difficulty of predicting the future direction is part of the challenges of technical analysis. Trading positions should be opened once a triangle break has occurred. Many traders analyze volumes – the energy required for a significant future move after the break.

If the resistance line (the horizontal line connecting the highs) in the example had been overcome, the reversal would have been confirmed and traders would have looked for buying opportunities.

Chart 13 below shows an example of a descending triangle as a reversal formation. This chart pattern creates expectations of a continuation of the downtrend. The consecutive lower highs are representing the power of the sellers. But in this case, buying interests have prevailed around the support levels (the series of horizontal lows) and the trend has reversed. Again, the direction of the breakout is indicative of the future of the currency pair.

Chart 13: Descending Triangle. Chart: MetaTrader4

Chart 13: Descending Triangle. Chart: MetaTrader4

The examples purposely demonstrate the idea that it is not always possible to predict the outcome of a chart pattern. It is for this reason that they should be used in parallel with other methods of analysis and under strict risk rules. Triangles are often formed at low volumes that increase significantly during the breakout. Such a plot signals the potential and strength for a new significant price change.

The relatively intuitive approach to constructing the triangle and determining entry, stop and profit levels allows traders to build their trading plan around these formations.

Triangles are more commonly exploited by trend-following traders. In the upward direction, the symmetrical and ascending triangles portend a continuation of the trend. In the downward direction, the symmetrical and descending triangles form a temporary consolidation before the decline continues.  

Flags and pennants

Flags and pennants are continuation formations that appear after a sharp price movement in a particular direction. They represent a temporary flattening in the balance between buyers and sellers before the trend resumes. Flags have a rectangular shape, while pennants are triangles. The analogy in their names comes from the fact that the rapid price change forms a pole on which the flag or pennant is hooked.

Chart 14: Bearish Flags and Pennants. Chart: MetaTrader4

Chart 14: Bearish Flags and Pennants. Chart: MetaTrader4

The chart shows a series of flags and pennants within a decline. Bearish flags form a rising price channel – a series of ever higher lows and parallel ever higher highs. This is a corrective move that is usually realized on lower volumes.

The same can be said for the flag – an inherently symmetrical triangle. When it is formed in the course of a distinct move (a steady pole) at low trading volumes, the probability of trend continuation increases.

Chart 15: Ascending Flag and Pennant. Chart: MetaTrader4

Chart 15: Ascending Flag and Pennant. Chart: MetaTrader4

Chart 15 shows the ascending flag and pennant. The flag forms a channel opposite to the main direction – a series of lower lows and lower highs. A break of the resistance line signals a resumption of the rise. The price target for these formations is defined by the height of the pole (the initial impulse). This distance is projected to the break point. The stop may be located below the lowest low of the flag.

A pennant is also visible on the chart. It has made one false continuation breakout, then it has collapsed. It is likely that many of the bulls were looking for an opportunity to enter the main upward trend during the break and made losses.

Flags and pennants are usually associated with shorter periods of consolidation. They are a temporary pause in the middle of a distinct rise or fall. The above flag has the characteristics more of a triangle as it has been forming for a long time.

Flags and pennants are often used in intraday trading. Their pole is often the result of news that leads to a quick and substantial price change. In the subsequent consolidation period, similar continuation chart patterns are formed. These moments of partial correction or consolidation offer good risk-adjusted opportunities for traders.

Rectangles

Rectangles limit price changes within two parallel horizontal lines of support and resistance. In practice, this pattern can be seen as a sideways price channel.

At least two bottoms and two tops are needed to construct it. The bulls and bears have balanced in a particular price zone. At this point, it is difficult to predict where the prices will go. Sometimes rectangles appear as a continuation of the main trend or as a reversal pattern. The breakout is considered indicative of the future direction.

Chart 16: Rectangle. Chart: MetaTrader4

Chart 16: Rectangle. Chart: MetaTrader4

The distance between the two parallel lines is applied to the break point to determine the price target. The strongest protection for short positions in this case would be above the highs (above the resistance line). However, many would look for appropriate levels to place shorter stop orders. After the downward breakout, the support line begins to act as resistance. Relatively short but very risky stops can be positioned above it.

If the break was in the upward direction, the more conservative stop-orders would be positioned below the bottom of the rectangle. Shorter stops could be placed somewhere below the upper trend line of the rectangle, which would become support after the breakout.

The clear methodology for constructing a rectangle and the intuitive way of setting stop-loss and take-profit levels make them an extremely attractive trading formation. At the same time, such consolidations can generate a series of false signals. The use of additional analysis tools would improve efficiency in position selection.

In conclusion: price formations are an extremely popular method of technical analysis. Their construction and interpretation have their nuances and carry a dose of subjectivism. As the above examples show, in real life the pattern will not always be completely identical to the one described in a book.

Price patterns should be applied together with other analysis methods to confirm the signals generated. Volumes are often used as an additional indicator. In practice, the formations represent a period of consolidation before the trend continues or reverses. They often form at low volumes and the subsequent breakout comes at higher ones. The use of momentum and other indicators towards the break point can further confirm the signal.

Patterns will not always live up to expectations. False breaks or missed targets are part of the game. In this sense, the decision to open a position should follow a clear money management strategy.

Continuation formations are a widely used analysis tool by trend-following traders. In many cases, they allow the participation in the direction of the main trend at a good risk/reward ratio. Reversal patterns also have huge potential, but the main problem is that trades are made against the main trend.

Some formations share characteristics of a continuation and a reversal pattern, which is an additional challenge for analysts.   

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