Standard patterns on technical analysis are those shapes that use to appear on graphs, and indicate some future trends and moves on the assets behavior. Graphs are nothing more than a “memory” of the assets and a picture of the investors’ sentiment in a certain period of time. Thus, the probability of this sentiment to be repeated in the future is huge, then some shapes within graphs repeat over and over, giving some hints on price moves. Technical analysis never gives you a 100% sure of a move, but gives you some indication on what to be expected, and get profits.
There are two types of standard shapes: continuation patterns and reversal patterns.
Triangles are quite common on the technical analysis. It represents a temporary balance between buyers and sellers, or a consolidation. It is formed by a support line and a resistance line, and both converge drawing a triangle. If prices move up beyond the line, an upward trend is likely to happen, otherwise, if prices break the bottom line, a downward trend can be expected. Triangles use to be realiable.
Explanation of the shape is that sellers are in a hurry to sell their shares, while buyers still believe that prices may go up a bit more. This way, the balance between them becomes more and more narrow as time goes by, until a break happens to any direction. There are three types of triangles: symmetrical, ascending and descending.
The symmetrical triangle may appear in both upward and downward trends, and does not cause any change in trend. As it reflects a completely even scenario between buyers and sellers, this pattern is considered extremely reliable, statistically. Look the illustration below:
The graph shows a convergence and balance for MPLU3 shares. The more points the line touches, the more reliable the pattern shall be. In the illustration above, the support line is touched three times and the resistance line twice, which indicates that a break is near. You can set the level that the price will reach the length of the triangle. Simply calculate the height of the triangle (distance between rows, starting from the first point) and project this distance from the point where the price breaks the triangle, indicating the minimum objective where the price will come. It is important to remember that the disruption of the triangle should always follow the trend. For example, if prices are in an upward trend, and a triangle appears, one should expect prices to break up. Otherwise, if the trend is not followed, the pattern will be probably invalidated.
Ascending triangles use to show up during upward trends and do not cause any reversal. Projections are strongly reliable and demonstrate a lateral recovery within the uptrend. The triangle has an horizontal line as resistance and an oblique line as support. Look the illustration below:
A zig-zag happens inside the triangle, with the line touching both the resistance and the support three times each. To find the target price for an ascending triangle, the same procedure used for the symmetrical triangle must be applied, calculating the height from the first point and project it from the point where the disruption of horizontal resistance occurred. Above, we can see a breakout on the resistance, and the following price increase equivalent to another projected triangle.
The descending triangle is the opposite from the ascending one. It appears with downward trends and again its projections are very reliable. They appear in downtrends and not cause changes in trend. Their projections have a high reliability, and demonstrate a lateral recovery within the downtrend. They come with a straight support line and an oblique resistance line. Look at the illustration below:
A zig-zag occur inside the triangle – the bottom line is touched multiple times, while the upper line is touched four times. To find the target prices, use the same procedure as the other triangles, calculating the height from the first point and project it from the point where the disruption of horizontal resistance occurred. In the illustration above, we can notice a breakout at the support line, with prices dropping quickly to a much deeper trough.
Rectangles, as the name suggests, are squared and straight patterns that appear in both positive or negative markets, and do not reverse trends, besides presenting high reliability. The rectangle comprises two parallel line – support and resistance. Look the graph below:
Usually the breakout will happen depending on the trend in course, indicating a continuing trend. To find where prices will be after the breakout, one must find the rectangle’s height and project it as of the break. In the illustration above, we can see the breakout happened at the support, and thereafter prices dropped the equivalent to a rectangle’s height.
A wedge is similar to a triangle, however here both lines – support and resistance – point in the same direction. When an upward trend is in course, both lines are falling. When the trend is down, the two lines are ascending.
Prices will oscillate within this formation very quickly and almost reach the end of the triangle, ie the vertex before break formation. If prices break down, prices tend to fall. If break up, prices tend to rise.
Flags are just like a channel, as a inclined rectangle. If the trend is positive, the flags will be descending, and if the trend is negative, the flag is ascending.
In the flag above, prices rise to an upward trend. Thereafter, there is a correction, where prices fall. However, after correction, the prices increase again. When prices break out the superior line, buying moves are recommended. The flags can also predict downward trends.
Pennants are similar to triangles, but they are quicker, smaller and don’t show too many zig-zags. Also, the break happens close to the vertex.
The last three illustrations, the wedge, the flag and the pennant, may show both trends (up and downward) and do not lead any reversal. All of them are quite common and are not very reliable. Thus, these patterns just say whether the investor is correctly interpreting the markets or not.
When prices reach peaks or troughs, one can see the prices are losing momentum and a reversal is coming. The moments that anticipate these moves show particular patterns which may confirm and indicate the investor whether a change is happening or not. They are:
This is one of the most known patterns. It seems like the shoulders and the head of a person. That shows a peak (left shoulder), followed by a higher peak (the head), and a third peak (right shoulder), in a height similar than the first peak.
On the left shoulder, the market runs within an upward trend, creating a consistent peak. After that, there is a correction, where prices drop a little bit with lower trading volumes. Right after, markets soar again, reaching a peak higher than the first one, although trading volumes stay lower, which makes prices to drop once more, forming the “head”. In a third step, prices are again adjusted and the right shoulder appears – in the same landing than the first shoulder, but with less trading happening. Then prices retreat, returning to the levels of the first shoulder. The right shoulder is then formed. If penetration of the neckline, the prices will have a significant drop. Sometimes, prices start to fall, but return to the neckline before the sharpest decline. The reliability of this pattern is high.
This pattern behaves just like the regular shoulder-head-shoulder, but this time pops up after a downward trend. Thus, it comprises a change from a downward to an upward trend.
The reversed shoulder-head-shoulder is formed by three different troughs: the left shoulder, the head, and the right shoulder. The first troughs is smoothier, with a slight decreased followed by a pullback. Then, prices suffer a stronger decrease, to react again right after, forming the head. A third move happens and prices drop a little more again, but quickly bounce back and the last shoulder appears. If prices break the neckline, is a strong signal that prices will start to rise, reversing the downward trend.
Double tops and bottoms
Double tops and bottoms lead to reliable interpretations of graphs, pointing to a change on basic trends. It consists of two peaks at the same level, acting as a resistance, and a background that separates them, also known as valley.
The more distant the two tops are and the slower they are formed, the stronger will be the pattern. If prices break through the line of the valley, is a strong indication that they will fall. Occasionally, a pullback may occur, but it occurs at a low volume. Patterns like these may last days or even months, and lead to a complete reversal on trends. Tops usually appear after an upward trend and bottoms after downward trends, forming a figure exactly the opposite of the double tops.
Triple tops and bottoms
Three peaks or troughs are formed at the same level, with two “valleys” or “hills” between them.
This pattern is quite similar to a double top or bottom pattern, but is more reliable. In it, there is a level of congestion pricing, where the line of the valley is broken, prices will have strong evidence of decline.
Cups and handles
Cups and handles represent a gradual change of trends, in which pricing levels are too low or high, and can’t sustain the current trend, heading to a reversal.
Both cups and handles are long term patterns, and take at least three months long, as prices detach from their original trending line and draft an almost horizontal move, to end by breaking through resistance or support lines and reverse the trend. On cups, trending volumes follow the pricing formation, but in handles, the volume does not have a typical training.
On technical analysis, gaps are areas in the graphs where empty spaces appear – which means no trading activities have been registered. Thus, there is a gap not filled in the chart. Gaps are usually related to relevant happenings, such as news or quarterly reports, when opening prices are much higher or lower than closing prices of the last trading session. Gaps may also appear without any particular occurrency, just by investors feel that prices will move to some particular direction, so that before the opening of trading, most of them have already taken their positions(purchase or sale). Thus, the price is slightly pushed up or down, causing a jump in prices.
For any gap, the trading volume must be observed. If the volume is high, the gap may lead to a breakout on supports or resistances. Besides, most gaps vanish relatively quick, which is not a rule however, where it may take years for this to happen. When a gap is closed, that implies trading was resumed at the level of the gap, covering the empty space in the graph.
There are three different types of gaps: runaway, breakaway and exhaustion.
They usually emerge in the end of a pattern, when prices break supports or resistances, exposing a trending move.
In the graph above, the gap emerges after a drownward trend, in which a big candle stick is formed, followed by a gap, and prices keep soaring, but before that a pullback appears.
They appear amid a strong pricing change, and pricing mostly sails in the same wind of the gap. As they spot out in a middle of a trend, they also help the investor to confirm an hypothesis if the trend continues its steady trajectory.
Such gaps emerge from up or downward trends, reinforcing the strength of these trends, which are hardly closed. It acts as support in an upward trend and as resistance in a downward trend.
Exhaustion gaps indicate the limits for a trending move. After an upward trends, they can show up right after a huge price hike. After a downward trend, it pops up after a deeper price fall.
That happens when unexperienced investors try to take advantage of recent ups and downs. When an asset shows a huge hike, such investor notice it afterwards, and place all bets trying to grab some profits himself. However, once all investors with such profile already made their purchases, no one else is willing to buy, so a halt may occur before prices start falling down.
The reversal island. is highly reliable, but very seldom in graphs. There is two types of island reversals: the high island and the low island.
High reversal island
They usually come after a hiking trend, causing a reversal. The prices keep rising and a gap is formed. Thereafter, one or two bars more occur, and then a downward gap. Hence their name – the bars stand isolated, as islands.
This move represent a moment of panic amid the investors, forming a gap. However, after some trading sessions, the opposite happens, and sales gain momentum, making prices to form a new gap, but a downward gap this time.
Low reversal island
It has the same concept than the high reversal island, but happens after a downward trend, leading to a reversal.
Here, prices drop sequentially, so in a desperate moment of the sellers, a gap is formed. Some time after that, the opposite happens, and buyers come back, heading to an upward gap and to a trend reversal.