“Price movement is random, chart patterns exist in variety. How do we study on it?”
Well, the best answer to this question I had come across is this one by Jessie Livermore:
“All through time, people have basically acted and reacted the same way in the market as a result of: greed, fear, ignorance, and hope. That is why the numerical formations and patterns recur on a constant basis.”
Chart formations basically are the result of human emotion. Human nature never changed. This is the reason why history repeated itself.
Although there are many charts present in different patterns, seem like no idea how it is going to move. Actually, different charts can be simplified and concluded in 2 general types. In this session, we are going to discuss about these 5 chart types.
A. Reversal formation
Every stock price reversal is ultimately the result of one of the following: distribution or accumulation. Some of the most trusted reversal patterns are:
Bearish reversal
1. Head and Shoulders
Appear at market top as a bearish reversal pattern.
Formation
Price forms a left shoulder, head and right shoulder pattern.
Neckline, a straight line which connects the right and left shoulder.
Volume decrease gradually from left shoulder to right shoulder.
Neckline is a strong support level, an important line to watch at when price drop to this level. A sharp increase in volume on the break below neckline is another important confirmation on this reversal pattern. Head & Shoulders reversal pattern formed at 2008.
2. Double Top
Appear at market top as a bearish reversal signal
Look like a letter “M”
Formation
Form a left peak and right peak.
Neckline, a line which connect the lowest points of both peak.
Volume at second peak much lower than the first peak.
Neckline is a strong support level, an important line to watch at when price drop to this level. A sharp increase in volume on the break below neckline is another important confirmation on this reversal pattern. Lower high formed at second peak indicate a stronger reversal signal.
3. Rounding Top
Appear at market top as a bearish reversal signal.
Higher lows formed at left side.
Lower highs formed at right side.
Volume at middle curve are the lowest, while both side of curve have higher volume.
Bullish reversal
1. Inverted Head and Shoulders
Appear at the market bottom as a bullish reversal signal.
Formation
Price forms an inverted left shoulder, head and right shoulder pattern.
Neckline, a straight line which connect the right and left shoulder.
Volume increase gradually from left shoulder to right shoulder.
Neckline is a strong resistance. A breakout at neckline indicates a strong bullish signal. Increase in volume during the breakout is another confirmation of the reversal.
2. Double Bottom
Appear at market bottom as a bullish reversal signal
Look like a letter “W”
Formation
Form a left valley and right valley.
Neckline, a line which connects the highest point of both valleys.
Volume at second valley much higher than the first valley.
Neckline is a strong resistance level, an important line to watch at when price stand nearby this level. A sharp increase in volume on the break above neckline is another important confirmation on this reversal pattern. Higher low formed at right valley indicated a stronger reversal signal.
3. Rounding Bottom
Appear at market bottom as a bullish reversal pattern
Lower highs formed at left side.
Higher lows formed at right side.
Volume at middle curve is the lowest, while both side of curve have higher volume.
B.Correction formation
Stock price take a pause and rest of varying durations. A pattern is considered complete when the pattern has formed and then "breaks out" of that pattern. Here are some of the common correction formations:
Triangle
Formation
At the start of its formation, the triangle is at its widest point, the range of trading become narrows as it moves in sideway
Upper trend line links all the highs, while lower trend line link all the lows
Volume decrease gradually as the price movement become inactive.
Consists of 3 types
-Ascending triangle
-Descending triangle
-Symmetrical triangle
There are 2 lines to pay attention; upper trend line is a critical resistance level, while lower trend line is a vital support level. Any breakout on these 2 lines will indicate the further movement.
1. Ascending Triangle
Selling pressure getting less as price trade from a wide to a narrow range. Sellers are observing and they not willing to sell off their stock with lower price.
Volume decreased along the trading pattern but higher lows are formed due to only a little buying volume already can digest the selling pressure and push the price up.
A strong resistance exists at upper trend line.
2. Descending Triangle
Buying pressure getting less as price trade from a wide to a narrow range. Buyers are observing and they not willing to buy stock with higher price.
Volume decreased along the trading pattern but lower highs are formed due to low buying pressure. So, only a litter selling volume already can push the price down.
A strong support exists at lower trend line.
3. Symmetrical triangle
Buyers are more willing to buy at lower price, while sellers more willing to sell at higher price.
Buyers and sellers both are observing the situation. So, transaction volume is getting low along the triangle pattern.
When symmetrical triangle occurs, it means buy pressure and sell pressure are the similar for that particular period. The direction of future trend will not be known until the breakout happens.
Box
Formation
A strong resistance level exists on the top of box
A strong support level exists on the bottom of box
Any breakout happens on the top or bottom of box will indicate further movement. Sharp increase in volume during the breakout is another factor to determine its movement’s momentum
1. Bullish box
When the price breaks out the top limit of the box, it is called a bullish box. Bullish box is a strong indication of up trend. The longer the term stock in a box, the stronger the up trend after it breaks up.
2. Bearish box
When the price breaks out the bottom limit of the box, it is called a bearish box. Bearish box is a strong indication of down trend. The longer the term stock in a box, the stronger the down trend after it breaks up.
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