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CHART PATTERNS

Chart 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 decisions.

Market 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.

TREND LINE
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 areas.
Trend Line

RESISTANCE LEVELS
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.
Resistance Levels

RETRACEMENT LINES
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.
Retracement Lines

HEAD 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 formation.
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” formation.
Double Top and Bottom

TRIANGLES
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:

Symmetrical triangle
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.

Ascending Triangle
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.
Ascending Triangle

Descending Triangle
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.
Decending Triangle

Flag and Pennants
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.

Flag and Pennants

 

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