Chart pattern analysis consists of a set of pre-defined patterns formed by moving market prices. Chart patterns are used by traders and analysts to identify potential entry and exit points in the markets.
While the idea of pattern recognition may seem strange, it's based on carefully tested methods which underline their usefulness to traders. Importantly, patterns are factors to consider when calculating where to enter, set stop-loss orders, and where to set your profit targets. These factors are, of course, some of the key things that all traders will wish to consider when managing their overall portfolio.
Our Next Generation platform has several chart types on offer including the popular line, bar (OHLC) and candlestick charts. The best chart for you depends on how you like your information displayed and your trading level. You can find out more from our video on different chart types and their best uses.
Line charts are the simplest type of charts in financial markets. There is no high or low point specified, unlike bar and candlestick charts, and they are instead based on lines drawn directly between closing prices. This chart type is commonly utilised in reports and presentations to show general price movements, however they often lack granular information when compared to other trading chart options.
Bar charts or OHLC charts (open high low close chart), unlike line charts show both the opening and closing price, as well as the highs and lows for the specified period. As opposed to a line, the data is more in depth and uses a single vertical bar. The top of the bar represents the highest price achieved for the specified time frame and the bottom of the bar the lowest price. Additionally, a horizontal bar extends to the left of the bar which denotes the opening price and a short horizontal bar to the right which signifies the closing price. The direction of a trade can be seen from the colour of the bar. A green bar indicates that the closing price was higher than the open, however red indicates that the opening price was higher than the close.
Candlestick charts are very similar to bar charts but are more popular with traders. Like bar charts the candlestick’s highest wick is the highest price in that period and the lowest wick is the lowest price. The candlestick body represents the difference between the opening and closing price, which can help to indicate price movements. The candlestick is green or red subject to a bullish or bearish movement respectively. A bullish movement is an uptrend, whilst a bearish movement shows a downtrend. Find out how to read the bear and bull markets effectively here.
Many chart patterns can be represented best on candlestick charts, as candlestick charts have their own set of chart patterns alongside the ones outlined in this article. For in-depth analysis on candlestick charts and their specific patterns, see our introduction to candlestick charts and our candlestick charts pattern guide.
In this article we take a look at five influential stock chart patterns that can be a powerful addition to your strategy, no matter which approach you take to trading the markets.
The double top is a simple yet effective chart pattern that most commonly indicates that an upward trend may be losing momentum. It occurs when a stock hits a price level but meets resistance and falls back down from it (see highlighted area in chart). When the price moves back up but fails to break the previous high, it forms the influential double top pattern. The double top pattern is considered complete when the price falls back and breaks the previous low, indicating further weakness. The target being the 'height' of the pattern projected down from where it breaks that low.
The double bottom is the opposite of a double top and applies to a falling market. In a double bottom, the falling price hits a low point and then bounces back up. The price turns lower again but doesn't break through that previous low. It's when the price rallies and pushes through the previous high that the double bottom is completed. The target can then be perceived as the height of that double bottom, projected from that breakout point (see second arrow in accompanying chart).
Like the classic cliché 'the trend is your friend', chart followers look to identify a trend in a particular stock and jump on board with the intention of riding that move further. But of course trends don't last forever and a trendline break can be another influential stock pattern. Trendlines are drawn underneath rising lows in an uptrend (indicating buying demand) and above falling highs in a downtrend (indicating selling pressure). A break in this level, as indicated by the blue circle in the accompanying chart, is an indication that a change of trend could be on the cards, often prompting traders and investors to adjust their positions accordingly.
The head and shoulders pattern is similar to a double top, but is made up of three highs (a peak, followed by a larger peak and then a small peak again, hence the name head and shoulders). Typically in a head and shoulders pattern, the second peak should be the largest, indicating the head, followed by a lower high in the third peak. The chartist will draw a smaller trendline under the recent lows, referred to as the 'neckline'. It is when this trendline is broken and price moves lower that the head and shoulders pattern is said to be complete, and the target is for a move lower still – equal to the height of the 'head' in the pattern. Head and shoulders are reversal patterns that are used to indicate a possible change in sentiment from a bullish to a bearish market or vice versa.
Not all patterns suggest that the stock you are following is about to reverse direction. Some can signal that the market is just pausing, before continuing its original direction. One of the most common continuation patterns is the triangle. It gets its name because the stock trades in a tighter and tighter pattern, carving out the shape of a triangle on the chart. The assumption behind these patterns is that when it breaks, it will continue the direction of the prior trend. So in an uptrend, the triangle is expected to break upwards, giving a signal to buy, and vice versa if the stock was in a downtrend before the pattern formed.
Symmetrical triangle
Symmetrical patterns consist of at least two lower highs and two higher lows. If a trendline is drawn connecting the highs, and a separate trendline is drawn connecting the lows, the lines should have matching gradients Like a triangle, these lines get tighter and tighter until they converge and then continue to move in the same direction as before.
Ascending triangle
Ascending triangles are generally considered bullish and an indication that a previous uptrend will continue. In an ascending triangle, the top part of the trendline is flat, while the bottom trendline slopes upwards.
Descending triangle
Opposite to an ascending triangle, the descending triangle is a bearish formation and typically signals a continuation during a downtrend. Descending patterns can sometimes be found at the end of an uptrend and could signal a reversal in price.
Chart patterns can sometimes be quite difficult to identify on charts when you’re a beginner and even when you’re a professional trader. Luckily, we have integrated our pattern recognition scanner as part of our innovative Next Generation trading platform. Our pattern recognition scanner helps identify chart patterns automatically saving you time and effort.
The pattern recognition scanner collates data from over 120 of our most popular products and alerts you to potential technical trading opportunities across multiple time intervals.
Using popular patterns such as triangles, wedges and channels, coupled with our bespoke star rating system, the pattern recognition scanner updates every 15 minutes to continuously highlight potential emerging and completed technical trade set-ups.
See our chart pattern analysis video for more information on how to identify chart patterns.
