As you likely already know, our favorite chart pattern to execute a trade off is a bull flag. It has worked for us countless times and it indicates that the trend could continue in the future. However, it is important to understand all of the major chart patterns technical traders utilize.
Flags can be categorized as continuation patterns. They represent brief pauses in stocks looking to take a breather after a run. They are typically seen after fast, big moves. The stock then usually takes off again in the same direction once necessary consolidation has occurred. The technical buy point is when price penetrates the upper trend line, or resistance of the flag area. You want to see this occur as volume is expanding. The same goes for a bear flag, just flipped. The technical sell point is when price penetrates support as volume is expanding.
The Cup & Handle is consolidating and correcting action of a stock after a major advancement. Generally a stock will have a powerful move higher, then go through a market correction (creating the ‘left’ cup). The stock will sell off in this correction at about 30% off the first high point.
As the stock comes back to test the old highs, it will incur selling pressure by the people who bought near the old highs (creating the ‘right’ cup). This selling pressure will cause the stock to drift in a sideways fashion, with a bit of a bias to the downside (creating the handle).
This handle is about 5% below the old high point. If it is much lower than this, be weary, as this may be a broken stock which contains a higher risk for failure.
The technical buy for the Cup & Handle is as it emerges to new highs at the top of the handle (as it breaks the ‘right cup’). This is one of the most reliable patterns to look for and they usually have very powerful breakouts.
The Flat Base is a pattern that is categorized by going horizontal for a period of time. Very powerful advances on generally tight risk can lead to very favorable gains with this pattern. You look for volume drying up as the stock predominantly stays around the same level.
Draw a trend line across the top of the formation. The technical buy is when the stock rips through the trendline on expanding volume. The stock has to close above the trendline in order to hold the trade overnight.
4.) Symmetrical Triangle
Symmetrical Triangles can be categorized as areas of indecision. It is easy to get “chopped up” in these names if you enter early because it may look like a ‘long’ one minute and then a ‘short’ the next. It is getting tighter and tighter as buyers are meeting sellers, and one force is going to have to win the battle sooner or later.
In an uptrend, you tend to look at it as a bullish symmetrical triangle, while in a downtrend, it’s a bearish symmetrical triangle.
These are one of our favorite patterns to trade because you usually know whether you’re right or wrong very quickly. Stocks generally explode out of these patterns as the forces of buying and selling finally pick a direction creating a momentum move. For example, if it breaks higher, the buyers will drive it up, while the shorts covering their position (by buying the stock) cause the momentum to continue further.
The Wedge is similar to a symmetrical triangle in appearance, in that they have converging trend lines depicting them. The main difference is that wedges are generally distinguished by a noticeable slant, either rising or falling.
A falling wedge is generally considered BULLISH and is usually found in uptrends. It can also be found in downtrends. The pattern is marked by a series of lower tops and lower bottoms.
A rising wedge is generally considered BEARISH and is usually found in downtrends. It can also be found in uptrends. They’re categorized as a series of higher tops and higher bottoms.
6.) Ascending/Descending Triangle
The Ascending/Descending Triangle is a variation of the symmetrical triangle.
Ascending Triangles are considered bullish and are generally found in uptrends. The top of the triangle appears flat while the bottom part of the triangle has an upward slant.
Descending Triangles are considered bearish and are generally found in downtrends. Conversely to the Ascending Triangle, the bottom part of the triangle appears flat, while the top part has a downward slant.
7.) Channels
Channels can be regular, Sideways/Rectangular Channels, Descending Channels, or Ascending Channels.
A Sideways channel is considered a continuation pattern. If it is in an uptrend, you should be bullish on the channel & vice versa.
- Head & Shoulders / Inverse Head & Shoulders
The Head & Shoulders is generally regarded as a reversal or topping pattern. It is most often seen in up-trends and is also most reliable in up-trends.
Sellers come in at the first high, (creating the left shoulder) and some downside follows. Buyers soon return and ultimately push through to new highs, only to have downside follow shortly after (creating the head). Buying again re-emerges and the stock rallies once again but fails to take out the previous high. After it cannot take out the previous high, downside follows (forming the right shoulder). Soon after, the neckline is taken out to the downside, igniting the pattern.
You see a momentum move to the downside because traders will short through that area along with those who were long who had stops placed there.
Volume is very important in this pattern as you should see the greatest volume in forming the left shoulder. It is important to see the head formed on lighter volume and the right shoulder on the lightest volume, indicating the buyers are out of gas. The pattern is complete when the stock breaks the neckline.
Inverse Head & Shoulders is virtually the same exact pattern but flipped. It is typically seen in downtrends. All the principles concerning the volume are the same as well, just flipped. You want to see greater volume in the rallies back to the neckline as you go from left shoulder to head to right shoulder. You want to see volume really expand in that right shoulder and eventually through the neckline to ignite the trade.
Do you have balls?
Post your favorite chart pattern in the Chart Reading Group chat and find 3 stocks that are forming that pattern on their daily (or even better weekly) chart and formulate a game plan for each of them!