Technical analysis involves the ability to identify patterns and predict future outcome. A successful trader must have a good knowledge about these patterns and their movements. Although some of the patterns look quite straightforward, they require a keen eye to point any discrepancies within their formation. Adequate filters are also required to separate correct and incorrect support breaks and prevent loss making trades. Here we look at stock chart patterns which are useful for a trader.
1. Triple Top Reversal
This is a bearish reversal of the trend when the price is unable to breach a high in three successive attempts. There is a reversal of the trend at the lower support price. After the breakout the support becomes potential resistance and the price tries to break this resistance in subsequent rallies. The volume levels decreases as the triple top reversal pattern develops. Near the peaks one might see higher volume. After the third peak there is an expansion of volume as the reversal starts. This expansion of volume can be taken as a proof of the correctness of the pattern.
Fig 1: Google’s stock attempted breakout for three times but failed. After this we see a sharp reversal in the price trend.
2. Ascending Triangle
This is a bullish formation where the uptrend is formed as a continuation pattern. They indicate accumulation of the stock. The duration of this pattern is from a few weeks to 1-3 months. Contraction of volume might be seen as this pattern develops. Before the breakout the expansion of volume confirms the trend. Volume confirmation is one of the preferred indicators for identifying patterns; however it is not always necessary.
Fig 2: Ascending triangle pattern within Google’s stock.
For current price check Google stock quote: Google (NASDAQ:GOOG)
3. Head and Shoulder
This pattern has a distinct head which is the higher peak and two lower peaks on the left and right which are approximately equal. The support is formed at the neckline. After this support is breached it becomes the resistance line. The decline in price level after breakout can be gauged by measuring the distance of the top of the head to the neckline. This will give a rough guide to the level of drop possible within the price. Generally the volume levels during the advance of the left shoulder are higher than during the formation of the head. The lower volume levels during head formation can be taken as a warning signal that a correction is soon possible. Volume increase during the decline of the right shoulder is another major signal for this trend.
Fig 3: IBM’s stock showing a head and shoulder pattern
4. Double Top
This pattern is found when two peaks are formed with a moderate trough. The support is the trough formed in between. After the breach of the breakout the prices will decline showing a sharp bearish trend. The price target can be arrived by measuring the peaks from the support line which would indicate how far the price can drop. Volume levels after the first peak are generally unimportant however the development of second peak starts with lower volume. The decline from the second peak should see an expansion in volume. Finally the breaking of the support break occurs with increased volume.
Fig 4: IBM’s Double Top pattern showing a big decline after the breakout.
5. Flag Pattern
Flags are formed when there is a sudden increase in the price level and there is a need for consolidation before the earlier trend can continue. This is a shorter term pattern lasting from 1 to 12 weeks. These sharp advances or declines are backed by heavy volume as seen in the figure below. If it is a bullish uptrend the breaking out of the resistance level signifies that the price advance has started again. The volume levels are high during the formation of the flagpole. The heavy volume levels provide confirmation and give credence to the continuation of this trend.
Fig 5: IBM’s Stock showing a classic flag pattern where the stock consolidates for a few weeks before continuing its upward move.
6. Price Channel
A stock might move within a given price channel and would not be able to breach the resistance and support lines for a long time. This leads to formation of a price channel and provides traders with a very good profit making pattern. Within a bullish trend the breakout happens when the price breaches the resistance line.
Fig 6: IBM’s stock showing a price channel for a couple of months.
7. Rounding Bottom
Rounding bottom is a long term pattern where consolidation leads to a change from a bearish trend to a bullish trend. The breakout point is at a point where the pattern moves beyond the point where the downtrend started. Ideally one should see a similar pattern within the volume levels as formed by the price movement. That is, the volume levels are high at the beginning and decline with the price level and after reaching a trough they start increasing with advancing price levels. However it is more important to have an increase in volume during the advancing of the price and near the breakout point.
Fig 7: IBM’s Stock showing a rounding bottom pattern
For current price check IBM stock quote: IBM (NYSE:IBM)
These patterns require a good amount of approximation. In most of the patterns the peaks might not match exactly or the breakout is a few points below what is predicted. Hence adjustment in trading style would need to be made in line with how the pattern is formed.