Study of Chart Patterns

1 Introduction
Irrespective of the kind of charts that you use, there are frequently patterns which are formed which signal a major
or minor move, a continuation or reversal. Apart from the major patterns that are covered here, another specialised
area is that of candlestick patterns. They offer a more granular view of whats happening around the overall chart
patterns that we see first. You may think that chart patterns are subjective, and yes they are; many call studying
chart pattern as an art and for that many analysts do not focus heavily on them. Irrespective, whether you do or not,
you should be aware of what they mean.

2 Patterns on a Chart
Chart patterns signal to traders that the price of a security is likely to move in one direction or another when the
pattern is complete.
There are two types of patterns in this area of technical analysis: reversal and continuation. A reversal pattern
signals that a prior trend will reverse on completion of the pattern. Conversely, a continuation pattern indicates that
the prior trend will continue onward upon the pattern's completion.
The difficulty in identifying chart patterns and their subsequent signals is that chart use is not an exact science. In
fact, it's often viewed as more of an art than a science. While there is a general idea and components to every chart
pattern, the price movement does not necessarily correspond to the pattern suggested by the chart. This should not
discourage potential users of charts - once the basics of charting are understood, the quality of chart patterns can
be enhanced by looking at volume and secondary indicators.

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There are hundreds of thousands of market participants buying and selling securities for a wide variety of reasons:
hope of gain, fear of loss, tax consequences, short-covering, hedging, stop-loss triggers, price target triggers,
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fundamental analysis, technical analysis, broker recommendations and a few dozen more. Trying to figure out why
participants are buying and selling can be a daunting process. Chart Patterns put all buying and selling into
perspective by consolidating the forces of supply and demand into a concise picture. As a complete pictorial record
of all trading, chart patterns provide a framework to analyze the battle raging between bulls and bears. More
importantly, chart patterns and technical analysis can help determine who is winning the battle, allowing traders and
investors to position themselves accordingly.
In many waves, Chart patterns are simply more complex versions of trend lines. It is important that you read and
understand the materials on trendlines given in the previous sub section.
Chart pattern analysis can be used to make short-term or long-term forecasts. The data can be intraday, daily,
weekly or monthly and the patterns can be as short as one day or as long as many years. Gaps and outside
reversals may form in one trading session, while broadening tops and dormant bottoms may require many months
to form.

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Some of the common patterns are described here. Please refer to the references to get more details on the patterns
described here.

2.1 Symmetric Triangles:

Symmetrical triangles can be characterized as areas of indecision. A market pauses and future direction is
questioned. Typically, the forces of supply and demand at that moment are considered nearly equal. Attempts to
push higher are quickly met by selling, while dips are seen as bargains. Each new lower top and higher bottom
becomes more shallow than the last, taking on the shape of a sideways triangle. (It's interesting to note that there is
a tendency for volume to diminish during this period.) Eventually, this indecision is met with resolve and usually
explodes out of this formation (often on heavy volume.) Research has shown that symmetrical triangles
overwhelmingly resolve themselves in the direction of the trend. With this in mind, symmetrical triangles in my
opinion, are great patterns to use and should be traded as continuation patterns.

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2.2 Ascending Triangles:

The ascending triangle is a variation of the symmetrical triangle. Ascending triangles are generally considered
bullish and are most reliable when found in an uptrend. The top part of the triangle appears flat, while the bottom
part of the triangle has an upward slant. In ascending triangles, the market becomes overbought and prices are
turned back. Buying then re-enters the market and prices soon reach their old highs, where they are once again
turned back. Buying then resurfaces, although at a higher level than before. Prices eventually break through the old
highs and are propelled even higher as new buying comes in. (As in the case of the symmetrical triangle, the
breakout is generally accompanied by a marked increase in volume.)

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2.3 Volume
After looking at the various chart patterns explained so far, you'll notice that consideration has been given to
volume. Simply put, volume is the number of contracts traded over a period of time. And since even the most
reliable of patterns will fail sometimes, volume can be used as another tool in determining what's happening within
the market and more specifically what's happening within the pattern.

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It is believed that volume should increase in the direction of the price. If the prevailing trend is up, volume should be
heavier on the up days and lighter on the the down days. If the trend was down, volume should be heavier on the
down days, with lighter volume on the up days. This makes sense because in an uptrend there should be more
buyers than sellers, and in a downtrend there should be more sellers than buyers. If volume should start to diminish,
it could be a warning that the trend could be losing steam and that a consolidation or perhaps a reversal could be
ahead. If the trend was up, and now we're seeing more volume on dips than on rallies, it should be an alert that
buying pressure is waning and sellers are becoming more aggressive. The reverse would be true in a downtrend. If
volume starts to shrink on the sell-offs and picks up on the rallies, once again, it could be a sign that the trend is in
trouble, and buyers are starting to assert themselves. When volume moves in the opposite direction of the price,
this is called divergence.
One of the reasons why volume has a tendency to diminish during periods of indecision is for just that reason.
During periods of sideways movement, often traders will avoid a market, preferring to commit their funds once a
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clear-cut breakout is seen. However, while it's typical for volume to diminish during these times, volume can give
clues as to possible future direction by measuring the level of conviction of the buyers and the sellers. Seeing if
there's heavier volume on the up days or on the down days could be useful in getting positioned during a sideways
move or a formation of a pattern. The idea being that if there's more volume on the up days than the down days, the
buyers are probably the more aggressive and the market should more than likely breakout to the upside. The
reverse being true if the volume is heavier on the down days, with the market likely to breakout to the downside.
So while it seems as if chart patterns, volume and technical analysis in general all have some forecasting
abilities, none are foolproof. Used together, they can be quite helpful in your trading and investing, but should be
looked at more as helpful hints as to a markets bias, more than anything else.

2.4 More Patterns

Please see below the diagrams:

Descending triangles
Head and Shoulders
Wedges
Flags and Pennants

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Rectangles

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