construction is the first step of market analysis practice,
after forming the chart an analyst identifies the various
patterns and shapes to forecast the future direction or trend
of the market. The chart is simply the price data of the market.
Although, the price change is the expectation about the future
trend, it’s the traders who decide the exact timing
for its buying and selling, therefore, charting helps in identifying
those signals. In other words, market participants according
to their understanding of the markets make buying and selling
doesn’t generally move in a straight line in any direction,
market moves are characterized by a series of ups and downs
(zigzags). These zigzags resemble a series of successive waves
with fairly obvious peaks and troughs. It is the direction
of these peaks and troughs that constitute the market trend.
A trend line constructs two points. If successive low points
approach but do not break through this line, it can be taken
as a correct interpretation of the direction of the trend.
One of the basic concepts of a trend is that a trend in motion
will tend to remain in motion. As long as the trend line is
not violated, it can be used to determine buying and selling
A resistance level is a price range characterized by increased
selling pressure. If the market is in a downtrend, and previously
established congestion area in that up-trend is an area of
resistance; or in a down trending market, any previous high
will be an important resistance. Once a resistance level is
penetrated on the topside, it becomes the nearest level of
support to a subsequent incline.
Retracement lines are used to predict potential levels of
retracement following a market move. Retracement lines are
constructed by identifying the two extremes of a market retracement.
The centerline is then drawn at the 50% level: a value mid-way
between the two extremes. The other lines are drawn at the
Fibonacci ratios 38.2% and 61.8% of the market move. It is
proven that after a big move market retraces, a trader uses
these numbers to calculate the possible retracement.
AND SHOULDER FORMATION
Head and Shoulder is probably the best known most reliable
of all major reversal patterns. Most of the other reversal
patterns are just variations of the head and shoulder and
do not require extensive treatment.
In this situation a major up trend of ascending peaks and
troughs gradually begin to lose momentum. The up trend then
levels off for a while. During this time the forces of supply
and demand are in relative balance. Once this distribution
phase has been completed, support levels along the bottom
of the horizontal trading range are broken and a new downtrend
is established. The new downtrend now has descending peaks
and troughs. The opposite is the inverted head and shoulder
DOUBLE TOP AND BOTTOM
A much more common reversal pattern is the double top and
bottom. It is the most frequently seen and the most easily
recognized. Both figures below show the top and bottom variety
of this formation. For obvious reason, the top is often referred
to as an “M” formation and the bottom as a “W”
Triangles are usually continuation patterns, but sometimes
act as reversal patterns. Although triangles are usually considered
intermediate patterns, they may occasionally appear on long-term
charts and take on major trend significance. The minimum requirement
for a triangle is four reversal points. Remember that it always
takes two points to draw a trend line, therefore, in order
to draw two converging trend lines, each line must be touched
twice. There are three types of triangles:
The symmetrical triangle is usually a continuation pattern.
It represents a pause in the existing trend after which the
original trend is resumed. In the following chart, the prior
trend was up and that suggests that the chances of breakage
of this triangle is on the upper side, if the trend would
have been down the trend would have had a bearish implication.
This type of triangle has a flat top, while the lower line
is rising. This line indicates that buyers are more aggressive
than the sellers are and considered as a bullish pattern and
is usually resolved with a break out on the upside.
This type of triangle has a flat bottom, while the upper line
is falling. This line indicates that sellers are more aggressive
than the buyers are and considered as a bearish pattern and
is usually resolved with a break out to the downside.
The flag and pennant formations are quite common. They are
usually treated together because they are very similar in
appearance, tend to show up at about the same place in an
existing trend, and have the same volume and measuring criteria.
The flag and pennant represent brief pauses in a dynamic market
move. In fact, one of the requirements, for both the flag
and the pennant is that a sharp and almost straight-line move
that precedes them. They represent situations where a steep
advance or decline has gotten ahead of itself and where the
market pauses briefly to “catch its breath” before
running off again in the same direction.