Chart Patterns

What Is a Chart Pattern?

Chart patterns are frequently used to indicate shifts between upward and downward trends. These patterns are formed by connecting trendlines or curves to display recognizable price movement patterns.

A reversal pattern occurs when the price pattern signals a change in the direction of the trend. In contrast, a continuation pattern happens when the existing trend briefly pauses before continuing. There are various patterns that traders use—here's an overview of how these patterns are created and some popular examples.

KEY TAKEAWAYS

• Patterns form unique shapes on a chart due to security price movements and serve as the basis for technical analysis.

• By connecting shared price points, like closing prices, highs, or lows, patterns are identified during a particular time frame.

• Technical analysts aim to recognize these patterns to predict the future price direction of a security.

• Patterns can range from straightforward trendlines to more complex formations like double head-and-shoulders.

Trendlines in Technical Analysis

Understanding trendlines and how to draw them is important when identifying price patterns, as they help technical analysts find support and resistance areas on a chart. Trendlines are straight lines created by connecting a series of falling peaks (highs) or rising troughs (lows).

An upward-angled trendline, or an uptrend, appears when prices have higher highs and higher lows. This uptrend line is formed by connecting the rising lows. On the other hand, a downward-angled trendline, or a downtrend, appears when prices have lower highs and lower lows.

Different opinions exist on which part of the price bar should be used for drawing trendlines. However, the body of the candlestick, not the thin wicks, often represents the majority of price action and may be a more accurate point for drawing trendlines. This is especially true for intraday charts with "outliers" or data points that fall outside the normal range.

For daily charts, many chartists use closing prices instead of highs or lows. This is because closing prices show the traders and investors who are willing to hold a position overnight or during weekends and holidays. Trendlines that have three or more points are generally considered more valid than those with only two points.

• Uptrends happen when prices have higher highs and higher lows. Up trendlines join at least two lows, displaying support levels below the price.

• Downtrends take place when prices have lower highs and lower lows. Down trendlines connect at least two highs, showing resistance levels above the price.

• Consolidation, or a sideways market, is when the price moves within a range between two parallel, often horizontal, trendlines.