Introduction to the Stock Market_6. Chart patterns_ Introduction

Lesson 6: Chart patterns. Introduction

Overview

Let’s discuss how to put on trades according to chart patterns.

First, a few facts to keep in mind:
- Chart patterns can be traded on all time frames: Intraday, Swing on
Long-term investment. If you are taking the 5, 10 or 15 min charts, you can be
trading a continuation or reversal chart pattern on an intra-day basis. If you’re
looking at a longer time frame, like the daily, weekly or even monthly, you are
looking at a long horizon, but it will still work because emotions and demand
are universal laws.
- Chart patterns must always be analyzed in the context of a trend. It’s very
important for you to see which trend is currently prevalent in the stock.

There are two types of chart patterns:

Reversal chart patterns
- symmetrical triangles
- flags
- ascending/descending triangles
- gaps

Continuation chart patterns
- head and shoulders
- wedges
- double tops/triple tops
- wolfe waves

There are more patterns, but most of them are basically variations of these, so there
is no point learning how to identify all of them, without actually knowing how to trade
them.
Like we’ve seen before, it’s more important to learn a few things and master them,
than try to be a jack-of-all-trades.

A continuation, like a symmetrical triangle, is expected to continue the trend.
In a reversal chart pattern, we expect the market to reverse the trend it’s currently in.

If you see an inverted head and shoulders in a downtrend, you’re expecting to buy,
because you’re expecting the trend to now shift from down to up.

We will go through each and every pattern:
- How to identify them
- How to put up trades using them

Always remember, it’s the money management that will save you and bring you
profits.

Breakdown

Technical traders use the price history of any asset, and the price patterns that form,
as a basis for making trading decision and analysis. This is called technical
analysis, a technique that uses the price chart of an asset as a key determinant in
forecasting where the price will go next.

Price charts are highly visual, showing where a stock price has been in the past, the
price's current trajectory, how volatile the price movements are, and whether the
stock has a lot or little interest in it.

● What Can You Learn from Charts?

Chart patterns are a field of study within the larger field technical analysis. Chart
patterns are geometric shapes created by the price movements of an asset, such
as a stock, currency, or commodity. These geometric shapes provide a context for
how the asset is moving right now, and the direction and magnitude of the price
moves that may be forthcoming.

Chart patterns are a key tool in the technical trader's arsenal. The following lessons
will cover the main types of charts patterns, including how to trade them and what
insights they provide into current and future price movements.

The size of a chart pattern, and where it occurs within a trend, provides clues as to
how big the next price move will be once the chart pattern completes. When the
price finally breaks out of the chart pattern (completion) this indicates the direction
the price is likely to continue moving. Therefore, chart patterns are useful tools for
any trader, whether they trade the patterns or use them for analytical purposes.

● Reversal Patterns VS. Continuation Patterns

Like we’ve seen, reversal pattern signal an end to the trend that was in place prior to
the chart pattern forming. For example, if the price had been trending higher and
then a reversal pattern forms and completes, the uptrend is likely over. Continuation
patterns signal the continuation of a trend. If the price is moving lower, then a
continuation pattern forms and the price breaks out (completes) in the trending
direction, then that downtrend is likely to continue.

Traders highlight chart patterns by using trendlines. Trendlines are drawn along
high and low points on the chart. These trendlines are then used to signal when the
price is breakout of, or completing, the pattern.

There is subjectivity involved in drawing trendlines, which means chart patterns are
not an exact science. One person may see a pattern someone else does not, or
draw their trendlines in a different way leading to a different pattern or breakout point.
Such differences affect the performance of trades based on the patterns. Even
though there is subjectivity, new traders should not be discouraged if they don't
immediately find trading chart patterns profitable. With practice and experience,
traders will develop skills which aid them in assessing which chart patterns to trade,
and how, and which patterns to leave alone.

There are a number of chart patterns to be aware. Each provides its own insight into
where the price could go in the future, and how far. Certain patterns can be used as
a trading strategy, with an entry point, a stop loss level which helps control risk, and
a target price for locking in gains. Traders may alter these techniques, based on their
own experience or market observations.

● The Bottom Line

Traders use chart patterns to help determine which direction the price is going, and
potentially how far it could go.

Chart patterns like head and shoulders, triangles, cup and handles, double/triple tops
and bottoms, flags pennants, rounded bottoms, and wedges all provide entry points,
stop loss levels, and profit target estimates, making them almost complete strategy.
To trade these patterns as a complete strategy, traders incorporate the patterns into
their trading plan and will also determine the proper position size to take on each
trade.

Gaps may be used as entry or exit points, depending on whether the gap signals a
continuation of the trend or a reversal, but also may be used for analysis purposes.
The insight gained from watching a chart pattern, or gap, unfold may lead to taking
advantage of another trade based on a different strategy.