Price Patterns

16 Jan

The Japanese Candlestick charting technique is one of the most useful tools for spotting these price patterns and trends. Here is a technical swing trading strategy which analyses key support and resistant levels for entry and exit of our trades.

Support and Resistance

Price patterns are created using support and resistance levels and help give us a clearer understanding of what’s going on in the stock. Support and resistance are like the floor and ceiling of a room. Support being the floor, resistance the ceiling. Entering as close to these levels as possible allows for the least amount of risk to be taken on during the trade. These are both psychological and technical price levels that will help you get the most out of every trade!

Defining the Trend

Before defining the patterns, we must discuss what it means to be in a trend. While quite subjective to interpretation, an uptrend is a series of higher highs and higher lows and a downtrend is a series of lower highs and lower lows. We will discuss the most common price patterns below.

When looking at price patterns, there are two categories they are divided into, continuation patterns and reversal patterns. The price patterns discussed here can be used across any timeframe, although historically the longer the time frame the more accurate. Here are a few of the most common price patterns.

Continuation Patterns:

  • Ascending Triangle

  • Descending Triangle

  • Bull Flag

  • Bear Flag

Reversal Patterns:

  • Head and Shoulders

  • Inverse Head and Shoulders

Let’s go through the price patterns one by one and look at the features that make up the pattern.

Ascending Triangle

The ascending triangle is identified by its relatively flat upper resistance boundary and rising lower boundary. The upper boundary should be touched 2-3 times in order for it to be an actionable triangle. This pattern is a bullish continuation where the bulls are showing strength and the bears are finding it hard to drive prices lower. A target price is gauged using the different in price from the flat ceiling and low point of the triangle. With a ceiling of $31 and low of $24, a 6 point price target can be estimated from the break of the resistance level.

Descending Triangle

The descending triangle is a bearish continuation pattern with a chart mirroring the ascending triangle to the downside. While triangles are classified as continuation patterns, they can be reversal patterns if occurring in the context of the opposite trend. (ie: descending triangle in an uptrend, or ascending triangle in a downtrend).

Bull Flag

The bull flag formation is a bullish continuation pattern which usually follows a breakout and is now consolidating before making its next move higher. During this consolidation, prices should not retrace more than 50% of the flag “pole.” A Fibonacci Retracement can be used to accurately measure these levels. Typically the consolidation period will consist of lower volume, once volume increases that is usually a sign of the next breakout.

Bear Flag

The bear flag formation is a bearish continuation pattern where the underlying experiences a sharp drop in price then consolidates or chops sideways before its next move lower.

Head and Shoulders

The head and shoulders formation is comprised of a small rally, large rally, and another small rally, usually occurring at the top of an uptrend. This forms two shoulders and a head. The neckline is the support level at which the stock rallies and pulls back to. When a rally sells off before making a new high, it is a sign that a head and shoulders pattern is forming. The target price can be estimated by taking the different of the high and low of the pattern and projecting it down from the neckline.

Inverse Head and Shoulders

The inverted head and shoulders pattern is the opposite of the head and shoulders pattern, it is a bullish reversal pattern. The head in this case usually acts as the bottom of a downtrend and is often times in the form of an inverted hammer. Once the neckline is broken with increasing volume a move to the upside should follow.

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