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Chart Patterns


Introduction to Chart Patterns

Introduction to Chart Patterns - picture of three stock chart sheets showing various chart patterns with a pen on top and glasses to help spot trends for traders and investors to profit from a trade

Chart patterns are essentially nothing more than organized stock price behavior that is displayed visually on a stock chart. These chart patterns basically show the relationship between the supply and demand for a company's stock. While a stock chart will at first glance seem to display a large amount of random price behavior, closer examination will reveal a variety of organized stock price behavior.

There are numerous chart patterns, some of which are quite obscure and only occur occasionally, while others are easily recognized and occur more frequently.

The astute stock investor looking for these chart patterns on a stock chart can make an informed decision about a proposed investment, such as whether a short-term trade would be more appropriate compared to a long-term investment or whether it is appropriate to add to an existing position or even reduce an existing position.

Chart patterns are popular with investors who time their entry. They also provide a convenient method of locating proposed short-term trades, as trades taken from chart patterns generally provide a more reliable outcome than merely randomly entering a trade.

Trading from chart patterns is a popular

strategy with stocks traders

Some chart patterns are used to determine the extent and direction of a major movement in price while other chart patterns are used to determine when a major movement in price has ended. The chart patterns that are easily recognized and occur more frequently are the most useful patterns for stock investors and traders.

The use of chart patterns provides a visual conformation of the trending nature of a stock. The primary reason for using chart patterns is to trade with a trending stock rather than trading a stock that is merely randomly fluctuating about. The popular phrase "The trend is your friend" is the basis for chart pattern trading.

Too many beginner stock investors and would be traders approach short-term investing with nothing more than hope and ambition. They have no systematic approach and will typically sell a profitable position prematurely and hold on to a losing position in the hope that it will trade back up to their purchase price so that they can sell it and at least get their money back. Needless to say that such an approach will do nothing but lose money and will cause a significant amount of emotional distress.

Chart patterns provide short-term investors and traders with a systematic approach which can be used that at least provides a rational basis for selecting when to enter a trade and when to exit.

Chart patterns are normally drawn on daily bar charts, but they can also be drawn on line charts and candlestick charts. The chart patterns can also be seen on weekly and even on monthly charts which provides a very long-term view.

The chart patterns that will be covered are the patterns that occur more frequently and are reasonably easy to see on a stock chart. For those investors and traders who are new to chart patterns, it is easier to view the pattern when lines are drawn on the chart to highlight the pattern. Once the beginner gains experience, the drawn lines can be omitted.

Support and Resistance

These occur naturally on the stock charts

Chart Patterns - picture of a stock trader holding an image of a chart which shows a  bottoming pattern to provide support and move upwards to give resistance

Support

Support is simply a general stock price level where prices have a tendency of falling to and rebounding off that price level which repeats several times over a period of weeks to months.

Price support levels occur naturally due to the behavior of market participants such long-term stock investors, short-term investors, speculators, stock traders and short sellers. The support levels come about from a variety of reasons which generally include:

Price support levels:

  • Market participants who bought the stock which subsequently rallied, earned a nice profit and are more than happy to buy the stock again if the price falls back to the same general price where they originally bought the stock.
  • Market participants who attempted to buy the stock but their orders where not filled as the stock's price rallied are angry that they missed the move. Should the stock price drop back to their original order price, they will make not make the same mistake and will make sure their orders are filled this time.
  • Market participants who short sold the stock which then rallied but they did not exit at any stop-loss, are more than eager to exit their shorts (buy back the stock) should the price drop back to their short entry price level.
  • Market participants who originally sold their stock only to then see it rally will be keen to buy back their position should the stock's price drop back to their original selling price.

When all of these market participants seek the same general price level, then a price support is formed. There are two basic types of support levels which form on a stock chart. The first type is when stock prices essentially trade sideways in a narrow congestive range before rallying and then subsequently falling back to that level. The second type occurs when a stock rallies and falls back to the same level, and repeats this several times.

An example of a support level is shown below in Chart 1.

Chart 1. Support level which held

chart pattern - support  and resistance; chart showing stock in strong uptrend pulled back to support and bounced up

Basically two things can happen with the support level. The first one is that the stock price continues to bounce up off this support level and then rallies (as shown above in Chart 1.). The second is that the stock price drops through the support level, which generally indicates that the stock price will probably continue downward - at least for the short-term.

A support level does not guarantee that prices will rebound up from that level, but usually price falls are at least temporally paused. If stock prices do fall straight through a support level, then the prices decline is often dramatic.

Resistance

Resistance is the opposite of Support and is simply a general stock price level where prices have a tendency of rising to and rebounding off that price level which repeats several times over a period of weeks to months.

Price resistance levels occur in a manner similar to support levels and occur naturally due to the behavior of market participants. The resistance levels come about from a variety of reasons which generally include:

Price resistance levels:

  • Market participants who short sold the stock which then declined in price earned a nice profit and are keen to short sell the stock again if the price rallies back to the same general price where they originally short sold the stock.
  • Market participants who attempted to sell their stock holdings but their orders where not filled as the stock's price declined. They are angry that they missed out on selling their stock at the higher prices. Should the stock price rally back to their original sell order price, they will make sure their orders are filled this time.
  • Market participants who bought the stock which then declined, but they did not exit at any stop-loss, are more than eager to sell their stock should the price rally back to their entry price level in order to break even.

When all of these market participants seek the same general price level, then a price resistance is formed. There are two basic types of resistance levels which form on a stock chart. The first type is when stock prices essentially trade sideways in a narrow congestive range before declining and then subsequently rallying back to that level. The second type occurs when a stock declines and rallies back to the same level, and repeats this several times.

An example of a resistance level is shown below in Chart 2.

Chart 2. Resistance with upside breakout

chart pattern - support  and resistance; chart showing stock chart hitting resistance and trading through in an uptrend with daily bars

There are two outcomes that can occur with a price resistance level. The first one is that the stock price continues to rebound down off the resistance level. The second is that the stock price rallies through the resistance level, which generally indicates that the stock price will probably continue to rally - at least for the short term (as shown above in Chart 2.).

A resistance level does not ensure that prices will rebound back down from that level, but usually any rallies are at least temporally slowed. If the stock price does break through the resistance level, then the stock may well undergo a significant rally.

Trading Range

A Trading Range occurs when the stock price is essentially trading sideways, with the stock price repeatedly bouncing off a lower and upper limit, and the stock price is contained within these limits. The Trading Range is generally in a relatively tight range and the lower and upper price limits are the Support and Resistance levels.

An example of a trading range is shown in below in Chart 3.

Chart 3. Trading Range

chart pattern - support  and resistance; chart showing stock bounded in trading range and then breaks out to the upside

There are two outcomes that can occur with a trading range. The first is that the stock price rallies through the resistance level, which generally indicates that the stock price will probably continue to rally - at least for the short term (as shown above in Chart 3.). The second is that the stock price breaks down through the support level, which generally indicates that the stock price will probably continue downward - at least for the short-term.

Volume

When a stock breaks through a support or resistance level or breaks out of a trading range, the move can be dramatic, especially if accompanied by an increase in volume. The increase in volume tends to be more significant with a breakout through a resistance level to the upside than it is with a breakdown through a support level to the downside.

Basically, a stock can fall quite easily in price without much interest from the market, but when a stock has the potential to significantly increase in price it attracts a lot of interest from the market. Therefore volume increases are more important with price increases than they are with price declines.

Chart Patterns - picture of a stock chart trending upwards with daily candle bars with a trend line plotted underneath to give support for the trader

Trend Lines

Traders love trend lines

Stock prices tend to spend a large amount of time moving in a fairly ordered manner, rather than aimlessly gyrating about. These price movements alternate between upward moves and downward moves. Quite often these movements will continue in a particular direction for quite some time before reversing, which can be for several months and even years. These upward moves are known as an uptrend and the downward moves are known as a downtrend. These trends are a characteristic that are displayed by all stocks and is a natural pricing behavior of the stock market.

Uptrend

A trend continues with only minor interruptions until it finally ends. Any stock trader would ideally like to enter their position as close to the beginning of an uptrend as possible and exit their position as close as possible to the end of an uptrend. The concept behind trend-lines is to identify when a new uptrend has begun and stay with that trend until it appears that the uptrend has ended.

Trend-lines can be found with short-term trends, medium-term trends and long-term trends.

An example of a short-term uptrend is shown below with a daily bar chart.

Chart 1. Uptrend short-term Trend-line

chart patterns - Trend Lines; chart showing stock with short term uptrend line and down trend line for stock code TYL

An example of a medium-term uptrend is shown below in Chart 2.. The chart below also shows how the medium-term uptrend contains several short-term uptrends.

Chart 2. Uptrend medium-term Trend-line

chart patterns - Trend Lines; chart showing stock with medium term uptrend and numerous short term trends located with in the chart uptrend line

The most clearly discernible characteristic of an uptrend is the succession of higher relative highs and higher relative lows. The relative high is a minor high and a relative low is a minor low in an uptrend irrespective of the time frame. Generally each minor top is higher than the preceding minor top and each minor bottom is higher than the preceding minor bottom in an uptrend.

A trend-line is constructed by drawing a straight line connecting the relative lows. Since the relative lows are increasing in price, the trend-line will slope upwards and highlights the uptrend. At least two relative lows are required to draw a trend-line, but three or more relative lows will increase the reliability of the trend-line.

When the stock price of an uptrending stock trades below the trend-line, it signals that the uptrend may have ended. This does not necessarily mean that a new downtrend has begun since stocks will often pause for a while in an uptrend and then may actually continue with a new uptrend. Thus an uptrending stock can have numerous trend-lines, each which was interrupted by a short pause before the next uptrend begins.

Downtrend

For the most part, a downtrend is simply the inverse of an uptrend, but from an investing point of view a downtrend is limited in the amount that the price can move (since a stock price can not fall below zero). Whereas an uptrend has no upper limit as to how high a stock's price can go. In a downtrend, the absolute maximum possible price movement is 100% (the price paid for the stock), however with an uptrend the movement can be anything greater than 100% and stocks can rally a couple of hundred percent in a short period of time. In the long term, stocks can increase in price many thousands of percent. This means that most uptrends are longer than the majority of downtrends. This is especially true for the long-term trends and to a lesser extent for the medium-term and short-term trends.

Except for bear markets, most medium-term and short-term downtrends tend to be fairly short and some uptrends only pause before new uptrend begins.

An example of a medium-term downtrend containing several short-term downtrends is shown below in Chart 3.

Chart 3. Downtrend Trend-lines

chart patterns - Trend Lines; chart showing stock with medium term down trend and several short term trends pointing downwards as the stock declines in price over the last year

A downtrend is a succession of lower relative lows and lower relative highs irrespective of the time frame. A trend-line is constructed by drawing a straight line connecting the relative highs. Since the relative highs are declining in price, the trend-line slopes downwards which highlights the downtrend. As a minimum, two relative highs are required to draw a trend-line. Three or more relative highs increase the reliability of the trend-line.

When the stock price of a downtrending stock trades above the trend-line, it signals that the downtrend may have ended and that the stock may either pause or start a new uptrend. Should the stock pause, a new trend will eventually develop which can be either an uptrend or a resumption of the downtrend.

Summary

Stocks have a natural tendency to move significantly, whether that move is up or down in price. Although not all stocks move all of the time, they do tend to spend most of the time either rallying or selling down in price. Trend-lines give the stock investor or trader a visually cue as to the trending nature of a particular stock.

Most stock investors and traders would agree that it is much easier to buy a stock than it is to decide the best time to sell the stock. The minor fluctuations within an uptrend tend to shake a lot of stock traders out of their position prematurely.

Trend-lines provide the stock trader with a visual picture of the trend which makes it easier to form an objective opinion as to when it's appropriate to sell their stock. Stock investors seeking to reduce their exposure can also make go use of trend-lines which will allow them to ride an uptrend towards its top.

Reversal Patterns

Catch the start of a new uptrend

Chart Reversal Patterns - picture of a stock chart which has sold down and rebounded back up with an arrow pointing to give the stock trader confidence that the price movement is a reversal pattern

The stock chart provides a visual cue as to when a trend may be ending. A penetration through a trend-line gives the first sign that this may be happening. However, trends will often not simply reverse direction to start a new trend heading the other way. It is quite common for a stock to trade in a congestion area before a new trend forms in the opposite direction. These congestion areas tend to occur several times as the trend progresses, with the final congestion turning out to be the completion of the broad price movement in that direction.

These final congestion areas show up on stock charts as patterns that a stock investor or trader can use to their advantage and they occur at the ends of both uptrends and downtrends.

The more common reversal patterns cited in the technical analysis literature are discussed in the following sections.

Double Top

The Double Top is a fairly common reversal pattern for an uptrending stock. The stock makes the first relative high and pulls back. The stock then trades back up but only manages the reach the first relative high before trading back down again.

An example of a Double Top is shown in Chart 1.

Chart 1. Double Top pattern

chart reversal patterns - chart showing the double top chart pattern for traders to profit with the target and neckline for technical analysis

The second relative high does not necessarily need to be at the exact same price level as the first relative high. To be considered a Double Top, it is acceptable if the second relative high is somewhere near the first relative high. The horizontal line drawn at the relative low is referred to as the neckline. When the stock trades down through the neckline it confirms that current uptrend has ended. This does not mean that a new downtrend has started as the stock may well trade in congestion before a new trend is established and the new trend direction could even be upwards rather than downwards. The Double Top is considered a reversal pattern once the neckline is penetrated since the new trend direction is more commonly downwards, at least for the short-term.

The profit target as shown in Chart 1. is a minimum price movement that the stock will usually decline once the neckline is penetrated. The profit target is determined by the distance from the Double Top to the neckline which is then subtracted from the neckline. Short-term stock traders such as swing traders frequently use these profit targets by short selling the breakdown through the neckline and exiting at the profit target.

The Double Top signals that the current uptrend has ended but does not confirm that a new downtrend has begun. Construction of a trend line confirms that a new trend has begun.

The time frame between the two tops is generally a minimum of several weeks and is often several months. Tops that are only a couple of days apart are meaningless and are not considered to be a Double Top. Also the neckline needs to be a meaningful distance below the tops as the pullback from the first high must be a genuine pullback and not just the lows of a narrow trading range. Generally a minimum distance of 10% is considered acceptable.

The Double Top tends to be quite effective with stocks that are trading at new all-time highs. It is also effective for stocks that have rallied strongly even though they may not be trading at a new all-time high. However, the Double Top is as that effective for stocks that are not trending strongly or for stocks that are trading in a broad consolidation range.

Double Bottom

The Double Bottom is basically the inverse of the Double Top. The stock makes the first relative low and then rallies but is soon sold back down again towards the first relative low. The stock then rallies back up a second time.

An example of a Double Bottom is shown in Chart 2. with a weekly chart.

Chart 2. Double Bottom pattern

chart reversal patterns - chart showing the double bottom chart pattern with the profit target and neckline for stock traders

The horizontal line drawn at the relative high is the neckline. When the stock trades up through the neckline it confirms that current downtrend has ended. The Double Bottom is considered a reversal pattern once the neckline is penetrated since the new trend direction is more commonly upwards.

The profit target as shown in Chart 2. is a minimum price movement that the stock will usually increase once the neckline is penetrated. The profit target is determined by the distance from the Double Bottom to the neckline which is then added to the neckline.

As for the Double Top, the time frame between the two bottoms is generally a minimum of several weeks and is often several months. Also the distance from the neckline to the bottoms should be a minimum of 10%.

The Double Bottom is quite effective with stocks that are trading at new all-time lows and can also be effective for stocks that have had a significant sell down. The Double Bottom is however not that effective for stocks that are not trending strongly or for stocks that are trading in a broad consolidation range.

Head and Shoulders Top

The Heads and Shoulders Top is a reversal pattern for an uptrending stock that signals the end of a major uptrend. This is a fairly rare pattern in its strict form as presented in the technical analysis literature.

With this pattern, the stock makes the first relative high and pulls back. The stock then trades back up to make a new second relative high, but then trades all the way back down to the preceding pullback's low. The stock then rallies again but falls short of the second relative high which was the highest peak.

An example of a Heads and Shoulders Top pattern is shown in Chart 3 with a weekly chart.

Chart 3. Head and Shoulders Top pattern

chart reversal patterns - chart showing the head and shoulders top reversal chart pattern with the profit target and neckline for stock traders

The first relative high is referred to as the Left-shoulder, the second and highest relative high is referred to as the Head and the third relative high is referred to as the Right-shoulder.

The horizontal line drawn connecting the two relative lows is referred to as the Neckline. Ideally the neckline is horizontal, but it is far more common for the two relative lows to be at different price levels even though the pattern is more reliable when the slope of the neckline is moderate rather than excessive.

When the stock trades down through the neckline it confirms that current uptrend has ended. This does not mean that a new downtrend has started as the stock may well trade in congestion before a new trend is established and the new trend direction could even be upwards rather than downwards. The Heads and Shoulders Top is considered a reversal pattern once the neckline is penetrated since the new trend direction is more commonly downwards.

The profit target as shown in Chart 3. is a minimum price movement that the stock will usually decline once the neckline is penetrated. The profit target is determined by the distance from the Head to the neckline which is then subtracted from the neckline.

The Heads and Shoulders Top signals that the current uptrend has ended but does not confirm that a new downtrend has begun. Construction of a trend line confirms that a new trend has begun.

The time frame between the three tops is generally a minimum of several weeks and is often several months. Tops that are only a couple of days apart are meaningless and are not considered to be a Heads and Shoulders Top. Also the neckline needs to be a meaningful distance below the tops as the pullback from the first high must be a genuine pullback and not just the lows of a narrow trading range. Generally a minimum distance of 10% is considered acceptable.

The Heads and Shoulders Top tends to be quite effective with stocks that are trading at new all-time highs and for stocks that have rallied strongly even though they may not be trading at a new all-time high. The Heads and Shoulders Top is however not that effective for stocks that are not trending strongly or for stocks that are trading in a broad consolidation range.

Head and Shoulders Bottom

The Heads and Shoulders Bottom pattern is basically the inverse of the Heads and Shoulders Top that signals the end of a major downtrend. With this pattern, the stock makes the first relative low and then rallies but is soon sold back down again and makes a new lower relative low. The stock then rallies all the way back up to the first relative high and is sold down again but this time the relative low is only around the first relative low.

An example of a Heads and Shoulders Bottom is shown in Chart 4. with a weekly chart.

Chart 4. Head and Shoulders Bottom pattern

chart reversal patterns - chart showing the head and shoulders bottom pattern with the profit target and neckline with both shoulders for stock traders

The horizontal line drawn connecting the two relative lows is the Neckline. Ideally the neckline is horizontal, but it is far more common for the two relative highs to be at different price levels even though the pattern is more reliable when the slope of the neckline is moderate rather than excessive. When the stock trades up through the neckline it confirms that current downtrend has ended. The Heads and Shoulders - Bottom is considered a reversal pattern once the neckline is penetrated since the new trend direction is more commonly upwards.

The profit target as shown in Chart 2. is a minimum price movement that the stock will usually increase once the neckline is penetrated. The profit target is determined by the distance from the Head to the neckline which is then added to the neckline.

As for the Heads and Shoulders Top, the time frame between the three bottoms is generally a minimum of several weeks and is often several months. Also the distance from the neckline to the bottoms should be a minimum of 10%.

The Heads and Shoulders Bottom is quite effective with stocks that are trading at new all-time lows and can also be effective for stocks that have had a significant sell down. The Heads and Shoulders Bottom is however not that effective for stocks that are not trending strongly or for stocks that are trading in a broad consolidation range.

V Top

The V Top is a reversal pattern for an uptrending stock and is fairly common pattern that occurs. With this simple pattern, the stock typically trades up strongly on the last leg of an uptrend. Usually with this chart pattern, the stock's price increase accelerates upwards away from the trend line and can give the impression that a new steeper trend has formed. The uptrend can also take on the appearance of a parabolic curve. The end to this last steep uptrend phase can lead to a dramatic reversal.

An example of a V Top is shown in Chart 5.

Chart 5. V Top chart pattern

chart reversal patterns - chart showing the V top reversal chart pattern for stock traders to profit in an uptrend

The most effective method to determine the likelihood that this last steep trend phase may have ended is to draw a second minor trend line along the lows of the bars of this steep trend. A penetration of the trend line will generally signal that the uptrend has ended.

This does not mean that a new downtrend has started as the stock may well trade in congestion before a new trend is established and the new trend direction could even be upwards rather than downwards. But if the trend does reverse which is the more common outcome with the V Top, the decline is usually quick and swift. There is usually a significant drop in price before the first bounce rally occurs. Stock investors buying stocks at V Tops is one of the major sources of investor losses.

The time frame of the last steep trend phase generally ranges from a couple of weeks up to a month or even two.

Determining the top of a V Top tends to be quite difficult if not impossible, but being aware of their existence can at least allow the stock investor or trader to exit a position with a considerable profit when the trend line is penetrated. While the stock may continue to rally some more after a trend line break, it is better to book a sizable profit rather than run the risk of destroying the profit should the stock trend reverse and sell down violently.

V Bottom

The V Bottom is basically the inverse of the V Top and is a common reversal pattern which occurs quite frequently in a downtrending stock. With this simple pattern, the stock typically trades down strongly on the last leg of a downtrend. Usually the selling intensifies which gives the impression that a new steeper downtrend has formed. The downtrend can also take on the appearance of an inverted parabolic curve. The end to this last steep downtrend phase can lead to a dramatic reversal.

An example of a V Bottom is shown in Chart 6.

Chart 6. V Bottom chart pattern

chart reversal patterns - chart showing the V bottom reversal chart pattern in a downtrend to bottom and reverse back up

The most effective method to determine the likelihood that this last steep trend phase may have ended is to draw a second minor trend line along the highs of the bars of this steep trend. A penetration of the trend line will generally signal that the downtrend has ended.

This does not mean that a new uptrend has started as the stock may well trade in congestion before a new trend is established and the new trend direction could even be downwards rather than upwards. However, if the trend does reverse which is the more common outcome with the V-Bottom, the rally is usually quite dramatic. There is usually a significant gain in price before the first pullback occurs.

The time frame of the last steep trend phase generally ranges from a couple of weeks up to a month or even two. The V Bottom is frequently the last desperate selling spree by nervous investors.

Triple Tops and Bottoms

These are simply Double Tops and Bottoms that did not penetrate their necklines, or if they did penetrate their necklines the stock traded back to make another relative high or low. Stocks that form more than two tops or bottoms are often in a trading range from which they can breakout either to the upside or downside at any time.

Bottom Base Patterns

When a downtrend ends it does not necessarily reverse into a new uptrend but may form a broad base that can last for months and even a year or more. These broad base patterns are often characterized by short rallies and declines that typically hit a resistance level and a support level. Once the stock breaks out of broad base, the stock can rally significantly.

Sometimes these broad bases actually curve upwards like a bow and are referred to as Rounding Bottoms. These tend to be more difficult to trade as there is no definite resistance level for the stock to break through but the rising relative highs and lows may be sufficient to locate a trend line.

Chart Consolidation Patterns - picture of a stock trader examining a chart with technical analysis to spot the consolidation pattern to provide a profitable trade in an uptrend

Consolidation

Patterns

Pauses in the trend

A consolidation pattern is simply a pause in a stock's trend which allows the trend to continue further. These pauses can last from several weeks to several months. While consolidation patterns occur with any stock they are especially beneficial to stocks that are in strong trends. Without a consolidation phase, the trend becomes increasingly vulnerable to a trend reversal.

The consolidation phase also allows a stock investor or trader to enter a new position or add to an existing position with the anticipation of a continuation of an uptrend. Consolidation patterns can also occur as trend reversals and it is the direction of the breakout from the pattern that determines whether it is a continuation or a reversal of the trend.

The more common continuation patterns cited in the technical analysis literature are discussed in the following sections.

Symmetrical Triangle

The Symmetrical Triangle occurs quite frequently and is essentially a trading range that is contracting. The upper boundary (which is a resistance) is a short-term trend-line that is sloping downward. The lower boundary (which is a support) is a short-term trend-line that is sloping upwards. The stock price repeatedly bounces off these upper and lower trend-lines and is contained within these limits.

The Symmetrical Triangle is illustrated below in Chart 1. with a weekly chart.

Chart 1. Symmetrical Triangle

Consolidation - stock chart showing the Patterns symmetrical triangle in an uptrend with daily bars for traders

The completion of the pattern occurs when the stock breaks out of the contracting trading range, which can be in either direction. The breakout usually occurs before the upper and lower trend-lines converge together. The time period that the stock remains in the trading range varies from a couple of weeks to a couple of months. The longer consolidation periods lead to moves that are more significant.

The profit target as shown in Chart 1. is a minimum price movement that the stock will usually increase once the upper boundary line is penetrated. If the lower boundary is penetrated then the price movement will usually move down by a minimum distance. The profit target is determined by the distance from the first Relative High to the first Relative Low of the Symmetrical Triangle pattern. This distance is then added to the breakout point for an upside breakout or subtracted from the breakdown point for a downward breakout. Short-term stock traders such as swing traders frequently use these profit targets by trading the breakout and exiting at the profit target.

The Symmetrical Triangle can be a continuation pattern where the trend resumes the original trend direction after the breakout from the pattern, or it can be a reversal pattern. Which direction the trend will assume can not be determined before the breakout. Symmetrical Triangles that occur in strongly trending stocks generally lead to bigger moves and are more reliable than if they occur in a stock that is not trending strongly or for stocks that are trading in a broad consolidation range.

Ascending Triangle

The Ascending Triangle is not as common as the Symmetrical Triangle but its presence is sufficient to warrant a discussion. The Ascending Triangle is essentially a combination of a trading range and a symmetrical triangle. The upper boundary (which is a resistance) is a short-term resistance level. The lower boundary (which is a support) is a short-term trend-line that is sloping upwards. The stock price repeatedly bounces off these upper and lower boundaries and is contained within these limits.

The Ascending Triangle is illustrated below in Chart 2.

Chart 2. Ascending Triangle

Consolidation - stock chart showing the Patterns ascending triangle in an uptrend with profit target for traders

The completion of the pattern occurs when the stock breaks out of either the upper resistance level or the lower up sloping trend-line. The breakout usually occurs before the upper resistance level and the lower trend-line converges together. The time period that the stock remains in the trading range varies from a couple of weeks to a couple of months. Longer consolidation periods lead to moves that are more significant.

Ascending Triangles that occur in strong uptrends are more reliable than if they occur in a stock that is not trending strongly or for stocks that are trading in a broad consolidation range.

The profit target as shown in Chart 2. is a minimum price movement that the stock will usually increase once the upper horizontal boundary line of the Ascending Triangle is penetrated. The profit target is determined by the distance from the first Relative High to the first Relative Low. This distance is then added to the upper boundary line for an upside breakout.

With an up trending stock, the upper boundary of the Ascending Triangle is a resistance level that has paused the upward movement of the stock. However, the rising lows of the pattern show that the market is becoming increasingly aggressive and a breakout to the upside generally leads to a continuation of the uptrend.

Descending Triangle

The Descending Triangle is the opposite of the Ascending Triangle. The Ascending Triangle is also not as common as the Symmetrical Triangle but its presence is sufficient to warrant a discussion. The Descending Triangle is essentially a combination of a trading range and a symmetrical triangle. The upper boundary (which is a resistance) is a short-term trend-line that is sloping downwards. The lower boundary (which is a support) is a short-term support level. The stock price repeatedly bounces off these upper and lower boundaries and is contained within these limits.

The Descending Triangle is illustrated below in Chart 3.

Chart 3. Descending Triangle

Consolidation - stock chart showing the Patterns descending triangle in a downtrend with daily bars for traders

The completion of the pattern occurs when the stock breaks out of either the upper down sloping trend-line or the lower support level. The breakout usually occurs before the upper trend-line converges with the lower support line. The time period that the stock remains in the trading range varies from a couple of weeks to a couple of months. Longer consolidation periods lead to moves that are more significant.

Descending Triangles that occur in strong downtrends are more reliable than if they occur in a stock that is not trending strongly or for stocks that are trading in a broad consolidation range.

The profit target as shown in Chart 3. is a minimum price movement that the stock will usually decline once the lower horizontal boundary line of the Descending Triangle is penetrated. The profit target is determined by the distance from the first Relative High to the first Relative Low. This distance is then subtracted from the lower boundary line for a downside breakout.

With a down trending stock, the lower boundary of the Descending Triangle is a support level that has paused the downward movement of the stock. However, the declining highs of the pattern show that the market is becoming increasingly pessimistic towards the stock and a breakout to the downside generally leads to a continuation of the downtrend.

Rectangles

The Rectangle pattern is essentially a trading range formed by an upper boundary (which is a resistance) and a lower boundary (which is a support). The stock price repeatedly bounces off these upper and lower boundaries and is contained within these limits.

The Rectangle pattern can be horizontal or it can slope upwards or downwards. A sloping Rectangle can slope with the trend or against it.

An example of a horizontal Rectangle pattern is illustrated below in Chart 4.

Chart 4. The Rectangle pattern

Consolidation - stock chart showing the rectangle Patterns in an uptrend with daily bars for traders to profit from

The completion of the Rectangle pattern occurs when the stock breaks out of the trading range, which can be in either direction. A breakout to the upside in an up trending stock with a horizontal or down sloping Rectangle generally leads to a significant move upwards. Similarly, a breakout to the downside in a down trending stock with a horizontal or up sloping Rectangle generally leads to a significant move downwards.

The profit target as shown in Chart 4. is a minimum price movement that the stock will usually increase once the upper boundary line is penetrated. The profit target is determined by the distance from the Relative Low preceding the Rectangle to the Relative High of the Rectangle. This distance is then added to the last Relative Low of the Rectangle.

The time period that the stock remains in the trading range varies from a couple of weeks to a couple of months. Longer consolidation periods lead to moves that are more significant. The Rectangle is similar to the Flag chart pattern but the Flag has a narrow consolidation range whereas the Rectangle is characterized by short rallies and declines as shown in Chart 4. above.

The Rectangle pattern can be a continuation pattern where the trend resumes the original trend direction after the breakout from the pattern, or it can be a reversal pattern. Which direction the trend will assume can not be determined before the breakout. Rectangles that occur in strongly trending stocks generally lead to bigger moves and are more reliable than if they occur in a stock that is not trending strongly or for stocks that are trading in a broad consolidation range.

High Momentum Stocks

The high powered moves that every trader would love to trade

Chart Patterns - High Momentum Stocks; picture of a stock in a momentum move upwards shown as an animated line with an arrow pointing upwards with the trader pointing to the arrow with a pen

These are the high flying stocks that bull markets are made off, with their stock prices making a relentless climb upwards which far exceeds any rational analysis. Some of these stocks actually have a solid fundamental basis, but the extraordinary price rises do not even come close to any fundamental increase in the stock's valuation. Then there are the rest, these stocks can climb even faster and higher than the fundamentally sound stocks but they do not even make any money. In fact, most actually loss money consistently and they merely promise that in the future they will (eventually) make a profit.

There is no other type of stock which can make more money (and lose more money) than a stock that made a high momentum move. Every bull market attracts a new crowd that is willing to take a punt on a stock that promises quick and easy riches that are beyond any sane investor's imagination.

While these high momentum stocks can rise at unbelievable rates, unfortunately when the party is over, the price can drop at the blink of an eye and the magnitude and speed of the fall is nothing short of spectacular. For any investor or trader still holding such a stock will see their invested capital diminish to next to nothing.

So why would any investor even bother investing in such a high risk stock. Once these stocks make their move they are already priced way above any rational valuation, thus making them a ridiculously high risk investment. However, they can be extremely profitable to trade for those that know how to.

High momentum stocks have certain common characteristics which skilled stock traders use to their advantage. Trading these high momentum stocks is extremely popular with swing traders and position traders. Stock investors seeking a short-term investment and beginner stock traders can also make good use of these characteristics which will be covered in the following sections.

The Pullback

The Pullback is not a pattern as such but is a characteristic of high momentum stocks. While they occur with any stock, the Pullback has a special significance with a stock that has risen quickly in price. This is due to the fact that all rapid increases in prices lead to profit taking, which is normal and allows the steep uptrend to continue. The Pullback on steep price increases tends to be quite orderly whereas a reversal will typically just trade down rather than consolidate.

An example of the Pullback is shown below in Chart 1. with a weekly chart.

Chart 1. Pullback with price target

chart patterns- high momentum stocks; chart showing a stock that has pulled back in an uptrend and rallied again due to high momentum movement

The Pullback with a high momentum stock tends to be fairly brief and typically lasts from around five to ten bars before the strong trend resumes. Ideally the highs of each bar are lower than the preceding bar within the pullback. Thus the Pullback simple gets its name since the prices are temporality retreating.

The profit target as shown in Chart 1. is a minimum price movement that the stock will usually increase once the Pullback is completed. The profit target is determined by the distance from the Relative Low preceding the pullback to the Relative High of the Pullback. This distance is then added to the Relative Low of the Pullback. Short-term stock traders such as swing traders frequently use these profit targets by trading the continuation of the Pullback and exiting at the profit target.

Profits targets are commonly used by stock traders

to exit at least a portion of their stock

The steep uptrend will likely continue once the stock trades above the high of the preceding day. The Pullback has two basic variants. The first one is when the highs of the pullback days are only gradually declining. This pattern rarely leads to a dramatic reversal should the upside move not eventuate, since the stock is probably still consolidating some more. The second variant is when the highs of the pullback days decline significantly. With this variant, should the stock not breakout to the upside there is no distinction between a failed pullback and a sharp reversal. The stock may well just keep selling down and the top of the pullback turned out to be the ultimate top of the steep uptrend.

Thus the first variant is the safer pullback to trade, however the second variant occurs more frequently and can be easily traded with a rigorous stop-loss strategy.

Flags

The Flag is a short consolidation pattern that can form with stocks where the price has risen very quickly. When a high momentum stock pauses rather than sharply reverses, this is a good sign that the market is not yet finished with this stock despite that fact that prices have risen sharply in a short period of time.

With a Flag pattern stock prices trade in a narrow channel that is either horizontal or slopes downward. An example of the Flag is shown below in Chart 2.

Chart 2. Flag pattern with price target

chart patterns- high momentum stocks; chart showing a flag pattern formed with a high fast moving stock in an uptrend for stock traders to profit from

The Flag pattern gets its name from the resemblance of a flag on a flagpole since the pole can form in just a day or two. However it is far more common for the pole to form over several weeks.

The profit target as shown in Chart 2. is a minimum price movement that the stock will usually increase once the Flag is completed. The profit target is determined by the distance from the Relative Low preceding the Flag to the Relative High of the Flag. This distance is then added to the Relative Low of the Flag.

While the Flag pattern is forming, it may resemble a Pullback that is not immediately resuming its upward climb. Stock prices can trade in this narrow channel for a week or two and occasionally for up to a month. Eventually the stock will breakout of this channel and with an upside breakout the move will typically be significant. The move can be either upwards or downwards, even though a downward move is usually fairly sedate as the stock is probably still consolidating. While reversals are violent, the Flag is not a common reversal pattern.

The Flag is similar to the Rectangle. The difference is that a Flag consolidates in a narrow range whereas the Rectangle is characterized by short-term rallies and declines.

Pennants

The Pennant is basically a Flag pattern but the upper and lower boundaries slope and converge together much like the Symmetrical Triangle pattern. The two differences with a Pennant and a Triangle is that the Pennant has a rally leading up to the consolidation and second the Pennant trades in a very narrow range whereas the symmetrical triangle is characterized by short-term rallies and declines.

An example of the Pennant is shown below in Chart 3. with a weekly chart.

Chart 3. Pennant Pattern with price target

chart patterns- high momentum stocks; chart showing a pennant pattern in a strong uptrend for stock traders to make a profitable trade from

The profit target as shown in Chart 3. is a minimum price movement that the stock will usually increase once the upper boundary line is penetrated. The profit target is determined by the distance from the Relative Low preceding the Pennant to the Relative High of the Pennant. This distance is then added to the lower boundary at the breakout point for an upside breakout.

Similar to the Flag pattern, while the Pennant is forming it may resemble a Pullback that is not immediately resuming its upward climb. Stock prices can trade in this small triangle for ten or more bars. Eventually the stock will breakout of the sloping boundaries and with an upside breakout the move will typically be significant. The move can be either upwards or downwards, even though a downward move is usually fairly sedate as the stock is probably still consolidating. While reversals are violent, the Pennant is not a common reversal pattern.

Chart Patterns - High Momentum Stocks; picture of an animated graphics depicting a rocket ship blasting high into space for a momentum move that reassembles a strong stocks price advance

The beginning of a High momentum move

Sometimes the start of a high momentum move can be anticipated while other times there are no clues at all.

Some of the clues are provided by the stocks trading volume. A stock that breaks out through a broad resistance level with a strong close on high relative volume often leads to a significant move. While this does not guarantee a high momentum move, the upside potential is generally significant. A breakout with a wide range day that closed strongly on high volume is even more significant. Also significant is a day that gapped up through the resistance level, especially on high volume with a strong close. This type of gap is referred to as a Breakaway Gap.

Some stocks gradually increase the rate that the uptrend is climbing at and the stock continuously climbs higher up from the trend-line. The trend-line actually needs to be curved to keep up with the stock's price increase.

High momentum moves often start when the stock is already at an all time high. This is one of the reasons it is difficult to get on board at the start of the move, since the stock's price is typically already overvalued. Other times the stock breaks out of a broad base that had formed with a stock that was heavily sold down some time ago.

Runaway Gaps

These upside gaps appear when the trend is well and truly under way. In fact for many stock investors and traders the stock seems like it is topping out as the trend is becoming increasingly steep. However, the stock defies their reasoning and merely pauses rather than reversing. The common pausing patterns formed are the Pullback, Flag and Pennant. When the trend resumes, it is fairly common for the stock to gap up out of the pausing pattern to resume the significant uptrend. These upside gaps that occur with a high momentum stock that has already made a substantial move are known as Runaway Gaps.

Exhaustion Gaps

As the high momentum move continues, usually with an increasing steepness to the uptrend, the stock encounters some more upside gaps but may now also encounter some downside gaps.

There is really no way to know in advance whether these gaps are actually Exhaustion Gaps or just some more Runaway Gaps. The only possible clue is that with the high momentum move most gaps tend to be upside gaps rather than downside gaps. However, downside gaps only occur sometimes when the uptrend finally reverses.

The Reversal

All good things must come to an end and this is especially true for a stock with a high momentum move since it is now so ridiculously overvalued. Any little thing that would give investors reason to believe that the market may lose interest in this stock will see a flood of aggressive sell orders that will drive the stock's price down hard.

The reversal is often characterized by a single spike high day or maybe two days. These can even occur with a gap up leaving investors and traders to believe that the stock's price has further to climb since gap ups have been common with the dramatic advance in the stock's price up until now.

The one day reversal is the most dramatic reversal that occurs. Basically the stock simply trades straight up with the last day frequently being a wide range day and the stock then simply reverses and trades straight down. Sometimes this reversal day is a gap up and the following day gaps down leaving a single bar isolated at the top. When this occurs, the pattern is referred to as an Island Reversal. An Island reversal can also consist of several bars which are isolated at the top of the uptrend.

Other reversals involve the stock trading erratically at the top. The stock may gap down one day, gap up the next day only to gap down the following day before finally selling down. Some stocks may even form a double top with spike days where the stock actually made an attempt to trade back up but was overcome by selling pressure and subsequently was sold down hard.

About the only high momentum stocks that do not reverse sharply are those stocks that have a strong fundamental basis for the move (even though the move was overdone). These stocks may decline in a more orderly fashion over a period of time.

As a general rule, no stock can indefinitely sustain an ever increasing stock price without a suitable increase in the company's fundamental valuation. Since these high momentum moves occur in a relatively short period of time, even a fundamentally sound company can not keep up with such a relentless price climb and as such a significant correction occurs when the high momentum move finally ends.

While trading these high momentum stocks can be extremely profitable, the stock trader or short-term investor needs to be vigilant as the steep uptrend will typically end with little warning and any open profits can quickly turn into losses.

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