Trading Toolkits: A Beginners Guide to Classical Chart Patterns

In Technical Analysis, a transition between trends is often signaled by price patterns. A price pattern is a series of lines/curve that usually indicates the prevailing trend in the market at the time of the analysis

By
Wilfred Victor
on
April 22, 2021
Category:
Trading Toolkits


Introduction

Technical Analysis (TA) is one of two strategies common with financial market traders and analysts. The other two being Fundamental Analysis. With TA, the idea is that traders are well familiarized with the historical price pattern as an indication of what the future holds. With classical chart patterns being the most used Technical Analysis form, traders can recognize trends based on the chart’s pattern, often accompanied by price action and other TA strategies.


What is a Classical Chart Pattern?

In Technical Analysis, transitions between trends are often signaled by price patterns. A price pattern is a series of lines/curves that usually indicate the prevailing trend in the market at the time of the analysis; these are often recognizable price patterns that traders follow.


How do Classical Chart Patterns Work?

There are various types of Classical Chart Patterns popular with traders. These determine or give an insight as to what the next market move may look like. Before explaining the various chart patterns, it is pertinent to understand how the market trend is determined using TrendLines.


Trend Lines

These are key regions in the chart, often indicating the Support and Resistance zones (two key areas that every other pattern is hinged on). For instance, taking the price chart of Reef Finance paired to the USDT below.

Reef/USDT 4hr

You want to convert to a line chart to pick each candle’s opening and closing prices correctly. 

NB: Line chart shows you the Peaks (resistance) and Through (support) of your chart. SnR offers you critical areas in your chart and is often regarded as the most crucial part of Technical Analysis.

In the example above, REEF support is currently at the red line rectangle below the current price of $0.034, and the resistance level is at the $0.035612 peak level. 

Using the knowledge of S and R, we can determine the various trendlines prevalent in the market.

  • Uptrends occur where prices are making higher highs and higher lows. Up trend lines connect at least two of the lows and show support levels below the price.
  • Downtrends occur where prices are making lower highs and lower lows. Down trend lines connect at least two of the highs and indicate resistance levels above the price.
  • Consolidation, or a sideways market, occurs where the price is oscillating between an upper and lower range, between two parallel and often horizontal trendlines. The price is not making any significant moves but smaller moves yet to break out to the up or downtrends.

A Continuation Pattern signifies the temporary pause of the existing trends, typically a pattern that shows the bulls are taking a break in an uptrend market or the bears are temporarily resting in a downtrend market. After this period, the price that ensues is followed by a spike with high volume. Example of Continuation patterns include;

  • Pennants
  • Flags 
  • Wedges

A Reversal Pattern signifies the change of a prevailing trend. The pattern indicates the exhaustion of the current market trends. Often showing either the bulls or bears have run out of steam. What follows is a change of market trend and an emergence of a new trend. Example of a Reversal pattern includes;

  • Head and Shoulders
  • Double Tops
  • Double Bottoms


Flags 

This is a continuation trend pattern that shows consolidation against the direction of the longer-term trends usually occurring after a sharp price move. It looks like a flag on a flagpole, where the pole is the impulse move, and the flag is the area of consolidation.

A Bull Flag showing a solid upward continuation of the trend
Bear Flag occurring in a downtrend showing a sharp move downwards


Pennants 

These are typically variants of flags where the area of consolidation has converging trend lines that take the shape of a triangle. It is a neutral formation with the interpretation of it dependent on the context of the prevailing market. Three kinds are identified, namely;

  • Ascending Triangle
  • Descending Triangle
  • Symmetrical Triangle
Ascending Triangle showing a break out of the price to the upward side

Descending Triangle a bearish signal indicating a potential breakout of price downwards

Symmetrical Triangle typically indicating a neutral market.


Wedges

 This is a market trend that indicates loss of momentum and indicates an impending reversal of the current trend. It is drawn by converging trend lines, indicating tightening price action. The trend lines, in this case, show that the highs and lows are either rising or falling at a different rate.

Rising Wedge: Indicating the pending bearish reversal of the current bullish market

Falling Wedge pattern indicating a bullish reversal


Double Top

Characteristically M-shaped, it is a bearish signal showing the price hitting the resistance zone twice and failing. The pattern is confirmed when the price breaches the low of the pullback at the resistance point.

Bearish Double Top Signal


Double Bottom

Strong bullish reversal pattern indicating the turn of the market to the upside as the market fails to breach the support twice. It’s the opposite of the double top.

Bullish Double Bottom W shaped Reversal Pattern.


Head and Shoulder Pattern 

This is a bearish reversal pattern with a baseline (neckline) and three peaks. The pattern is confirmed when the price breaches the neckline support area.

H&S pattern

Inverse Head and Shoulder Pattern

 As the name implies, this is the opposite of the H&S pattern indicating a bullish reversal market trend.

I-H&S Pattern


Classical Chart Patterns Significance?

The longer it takes any of these patterns to form, the more the impact of the price. When confirmed, the significance of the chart patterns can result in higher gains for the trader who has already taken a position prior. Thus, understanding any of these patterns and correctly applying them to your analysis will make you a successful trader in the long and short term.


The Weakness?

Chart patterns are not a 100% fail-proof strategy and do not work in isolation. Correct risk management and applying these patterns to various other strategies will mitigate loss; failure to do so will result in loss of trade. It is very common for chart patterns to fail and break down unexpectedly. This makes them only one aspect of trading profitably.


Final Thoughts

Like with typical data types, the historical data is not a watertight strategy as the expected outcome may not be the reality. 

It is pertinent to understand your risk nature, trading personality, and application of proper risk management to protect your funds, as no strategy is 100% immune to failure.

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Wilfred Victor

Ace finds himself as a blockchain enthusiast who is focused on growing with the entire crypto sector. He is an energetic and passionate writer who believes that all things are achievable.