● What Are Chart Patterns?
Technicians have identified a variety of chart patterns that occur. These patterns or formations represent the more subjective aspects of technical analysis; even if you're skeptical about these patterns, they're still useful to learn about, if for no other reason than other people are looking for the same patterns. A note on patterns: There are endless numbers of chart patterns out there. This guide will only detail widely-accepted, common ones. Keep in mind that this is not an exact science. The patterns you will see follow general guidelines, but aren’t rigidly defined. For now, just try to understand the basics of each one.
● Gap Patterns
Sometimes good or bad news will come out when the stock market is closed, creating a severe imbalance of buyers or sellers. The result is that when the stock finally opens for trading, it will jump up or down, leaving a hole in the chart. Technicians call this occurrence a gap.
In Figure 2.3 below, we see Amazon.com’s (AMZN) stock gap up when it surprised the public with better than expected earnings.
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Fig 2.3 Click to Enlarge (May need to disable pop up blocker).
Amazon released their good earnings news after the stock market closed, creating a huge imbalance of buyers the following morning. When the stock finally opened for trading, it gapped up.
Gaps are important for two reasons:
(1) They’re a strong sign of strength or weakness, and (2) they tend to get filled. Gaps are usually caused by either really good or really bad news, so they’re usually significant patterns.
● Flag and Pennant Patterns
Flag and pennant patterns are continuation patterns, meaning that after they occur, usually price continues to move in the same direction as the prevailing trend. They represent temporary congestion within stock trends. If a flag and pennant pattern occurs, and the price successfully breaks out of it, then it can be taken as confirmation that the trend has continued.
Fig 2.4 Click to Enlarge.
As you can see in figure 2.4 above, the NASDAQ continued up from January to July 1995. Within the trend, there were periods of congestion called flags and pennants.
You may be unclear about the difference between flags and pennants. Well…so are most people. It doesn’t really matter whether something is a flag or a pennant. The two are interchangeable from a practical standpoint. The important thing to know is that they are good times to enter a trend, and if they fail, they can mark the end of a trend.
● Triangle Patterns
Some traders refer to triangles as “coils” because the trading action gets tighter and tighter until the market breaks out suddenly and powerfully. What happens is that buyers and sellers become more and more unsure about where the stock is going until, finally, the stock moves significantly, releasing all the stored energy like a coiled spring .
There are three types of triangle patterns: Ascending triangles, descending triangles, and symmetrical triangles.
● Ascending Triangles
An ascending triangle is a triangle that has a flat top with a rising bottom. It is generally regarded as a bullish pattern.
Fig 2.5 Click to Enlarge.
Above we sellers maintaining steady resistance at the flat top of the triangle, yet buyers were becoming more and more aggressive, creating an upward bottom for the triangle. Buying pressure finally broke through the sellers’ resistance at the top of the triangle.
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