Technical Analysis 101: 5 Chart Patterns for Traders
Chart patterns are the shapes that form on a price chart and help to predict what prices will do next, based on their past behavior. Chart patterns are a key part of technical analysis and require a trader to be able to identify and interpret them correctly.
Different chart patterns work better for different situations, depending on the market, the volatility, and the trend. Analysts often use chart patterns with candlestick charts, which make it easier to see the previous opens and closes of the market.
In this article, we’ll review five common chart patterns that technical traders can use to identify opportunities in markets.
The head and shoulders chart pattern signals that a trend is about to change from bullish to bearish. It looks like a head with two shoulders on each side. The pattern has four parts: the left shoulder, the head, the right shoulder, and the neckline. The target is the distance from the head to the neckline, subtracted from the neckline. The daily chart of the S&P 500 (/ES) in mid-2023 displays this pattern:
The inverse head and shoulders shape is the opposite of the topping pattern. It shows that a trend is about to change from bearish to bullish. It looks like an upside-down head with two shoulders on each side. The pattern has four parts: the left shoulder, the head, the right shoulder, and the neckline. The inverse head and shoulders pattern makes higher lows, which means the price does not go as low as before.
The rising wedge (or ascending wedge) pattern is a shape that forms when price moves between two upward sloping trend lines. It is a bearish pattern that can show either a reversal or a continuation of the trend, depending on where it appears and how the trend is going. But no matter where the rising wedge is, traders should always remember that this pattern means that prices are likely to go down. The daily chart of the Nasdaq 100 (/NQ) in late-2023 displays this pattern:
The falling (or descending) wedge pattern is the opposite of the rising wedge. It is a shape that forms when price moves between two downward sloping trend lines. It is a bullish pattern that can show either a reversal or a continuation of the trend, depending on where it appears and how the trend is going. But no matter where the falling wedge is, traders should always remember that this pattern means that price is likely to go up.
The ascending triangle is a sign that the trend is going up and will continue to do so. It has a flat top line that acts as a resistance and a rising bottom line that shows higher lows. This means that buyers are stronger than sellers and keep pushing the price up. The pattern is complete when the price breaks above the top line and follows the trend. The weekly chart of the S&P 500 (/ES) in late-2022 through mid-2023 showcases this pattern:
The descending triangle is a sign that the trend is going down and will continue to do so. It has a flat bottom line that acts as a support and a falling top line that shows lower price highs. This means that sellers are stronger than buyers and keep pushing the price down. The pattern is complete when the price breaks below the bottom line and follows the trend.
The double-top pattern is a shape that shows that the market is about to go down. It has two peaks that are close in price, with a drop in between. It looks like an “M” on the chart. The drop shows that the price has trouble going higher than the peaks. After the first peak, the price goes down and then up again, but not as high as the first peak. This means that the market is losing strength and is ready to fall. The daily chart of the Australian dollar (/6A) in mid-2023 shows this pattern:
The double-bottom pattern is a shape that shows that the market is about to go up; it is the opposite of a double top. It looks like a “W” on the chart. The price goes down to a new low and then bounces back up a little bit before going down again to the same low. The price cannot go lower than the low, which means that the sellers are losing power, and the buyers are taking over. The price then goes up sharply from this point. The sign that the market is going up is when the price breaks above the high point between the two lows, called the neckline.
A rectangle is a shape that shows when a market is moving within a range that has a flat top and bottom. The top and bottom lines are the resistance and support levels, which are parallel to each other and look like a rectangle. The range, or rectangle, usually happens when investors are not sure about the future direction of a security. So, the price goes up and down within the range, without breaking out either way. The weekly chart of the Russell 2000 (/RTY) from mid-2022 to late-2023 displays this pattern:
Christopher Vecchio, CFA, tastylive’s head of futures and forex, has been trading for nearly 20 years. He has consulted with multinational firms on FX hedging and lectured at Duke Law School on FX derivatives. Vecchio searches for high-convexity opportunities at the crossroads of macroeconomics and global politics. He hosts Futures Power Hour Monday-Friday and Let Me Explain on Tuesdays, and co-hosts Overtime, Monday-Thursday. @cvecchiofx
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