A Fidelity Investments Webinar Series

Identifying Chart Patterns

with Technical Analysis

BROKERAGE: TECHNICAL ANALYSIS

 BROKERAGE: TECHNICAL ANALYSIS

Techniques for
Trading Patterns

Understanding Construction
Patterns and of Common
Their Limits Chart Patterns

Agenda

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Understanding
Patterns and
Their Limits
 BROKERAGE: TECHNICAL ANALYSIS

Defining Patterns

•A pattern is bounded by at least two trend lines (straight or curved)

•All patterns have a combination of entry and exit points

•Patterns can be continuation patterns or reversal patterns

• Patterns are fractal, meaning that they can be seen in any charting
period (weekly, daily, minute, etc.)
•A pattern is not complete or activated until an actual breakout occurs

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 BROKERAGE: TECHNICAL ANALYSIS

The Limits of Patterns

Keep in Mind
Some of our human tendencies can be
dangerous for investors.
• See patterns where there aren’t any
•Believe “market lore,” technical and fundamental, without evidence

• Look backwards rather than forward

• Stick with original price targets of patterns after conditions have

changed

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Techniques for
Trading Patterns
 BROKERAGE: TECHNICAL ANALYSIS

Techniques for Trading Patterns

• Breakouts
• Entry Stops
•Protective Stops

•Retracements

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 BROKERAGE: TECHNICAL ANALYSIS

Breakouts
Violation of Trend Line,
Support or Resistance, or
previous reversal point
It signifies that a change
in buyer and seller
behavior and signals Resistance Breakout
the beginning or end
of a trend.

Price

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 BROKERAGE: TECHNICAL ANALYSIS

Confirmation Filters

Types of Filters
Confirmation • Intrabar
•Multiple closes
Filters
Apply a confirmation filter to • Time
determine whether a breakout •Percentage or point
has taken place.
• Money

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 BROKERAGE: TECHNICAL ANALYSIS

Entry Stops
Entry Stops
Buy stop orders are used to
enter trades once the price
breaks out.

Resistance Breakout

Trend Line Breakout

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 BROKERAGE: TECHNICAL ANALYSIS

False and Failed Breakouts

False Breakout
Price breaks out but almost
immediately returns back
through its breakout price. Breakout False Breakout (return
Resistance through breakout level)
Line
Failed Breakout

Failed Breakout
(Trap)
False breakout occurs and
the price then breaks out in
the opposite direction.
Trend Line

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 BROKERAGE: TECHNICAL ANALYSIS

Protective Stops
Protects Capital
Determines the amount of
capital risk before entry

Types of
placement
Breakout
Resistance Line

• Filters, such as percent,

points, or money
Trend line, support or
• resistance level with filter
Protective Stop

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 BROKERAGE: TECHNICAL ANALYSIS

Trading False Breakouts Using Protective Stops

Example

False Breakout Protective sell stop and sell

• Enter on breakout short entry stop

• Place protective stop

outside breakout bar
opposite from breakout
direction
•
Place entry stop at same Failure
level (called a “stop and
reverse” order)
• If price continues in
direction of breakout, profit
from breakout entry
• If breakout is false, profit
from stop and reverse

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 BROKERAGE: TECHNICAL ANALYSIS

Retracements
Counter Trend
Correction
Retracement (pullback)
Types

• Pullback (on breakout down)

• Throwback (on breakout up)

Waiting for Trend Line Breakout

• Don’t always occur
• Performance can suffer
when they do

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Construction of
Common Chart
Patterns
 BROKERAGE: TECHNICAL ANALYSIS

Common Chart Patterns

Multi-Bar Candlestick Short-Term

Patterns Patterns Patterns
Horizontal Congestion
• Doji • Pennant/Flag
• Double and Triple • Harami • Gaps
Tops/Bottoms • Hanging Man/Hammer • Pipe Bottom
• Rectangles • Shooting Star/Inverted • Narrow Range
Hammer
Triangles • Engulfing
• Symmetrical • Dark Cloud/Piercing
•
Ascending and Descending
•
Wedges
Other
• Head and Shoulders
• Cup and Handle

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 BROKERAGE: TECHNICAL ANALYSIS

Horizontal Congestion: Double Top

Characteristics:
Double Top
Double Top
(breakout down)
• Two successive peaks separated
by an opposite reversal point
Resistance Line
Either rounded or pointed peaks
•
that are usually at roughly the same
price (resistance level) Entry Pullback

Breakout
Price must break out of middle Support
•
reversal point Line Breakout

Price

Calculate target price:

Taking the height from the highest peak to the trough and
then subtracting the amount from the breakout price to the
downside.

18
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Horizontal Congestion: Double Bottom

Characteristics: Double Bottom

(breakout up)
• Two successive troughs separated
by a peak
Breakout
Either rounded or pointed troughs Breakout
• Resistance line
that are usually at roughly the same
price (support level)
Entry
Price must break out of Throwback
•
middle peak
Double Bottom
Support line
Price

Calculate target price:

Taking the distance from the troughs to the peak and then
adding that amount from the breakout price to the upside.

19
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Horizontal Congestion: Triple Top

Characteristics: Triple Top

(breakout down)
• Three distinct peaks at roughly the Triple
Top
same price level separated by two
Resistance line
intermittent troughs
Breakout occurs when price exceeds Pullback
•
the extreme of the intermittent Breakout
trough or a trend line connecting
those points Support line

Entry Breakout
Price

Calculate target price:

Take the height from the highest peak to the lowest trough
in the pattern. Then subtract that amount from the lowest
trough in the pattern to generate a price target.

20
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Horizontal Congestion: Triple Bottom

Characteristics: Triple Bottom

(breakout up)
• Three distinct troughs at roughly the
same price level separated by two
intermittent peaks at any level Entry Breakout
Breakout
Breakout occurs when price exceeds Resistance line
•
the extreme of the intermittent peaks
or a trend line connecting those
Throwback
points
Best performance may be after a Triple
Bottom
Support line Price
• sustained decline*
An average performance, but watch
for failures*
• Calculate target price:
Take the height from the highest peak to the lowest trough
in the pattern. Then add that amount to the highest peak in
the pattern to generate a price target.

21
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Horizontal Congestion: Rectangles

Characteristics: Rectangle
(entry up, breakout up) Resistance Zone
• Trading range with support and
resistance levels bounding price Entry Throwback
action Support Zone
Shortfall Breakout
Slight tilt, similar to horizontal Breakout
•
channel Resistance line

Often has many false breakouts*

•
Support line
Things to consider:
Price
•
‐ Confirm a breakout
‐ “Shortfall” often indicator of eventual
breakout direction Calculate target price:
Take the height from the resistance line to the support line. Then
• Best occurrence may be bottom either add that amount to the resistance line to generate a price
breaking upward* target for an upside breakout, OR subtract that amount from the
support line to generate a price target for a downside breakout.

22
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Triangle: Symmetrical

Characteristics: Symmetrical Triangle

(breakout up)
• Bounded by a downward sloping
upper trend line and an upward
sloping lower trend line. Each bound Throwback

is a straight trend line Breakout

Prices must touch each bound at Target Line

•
least twice. Many false breakouts. Entry
Moderately successful in
performance Cradle
Price

• Things to consider:
‐ Confirm a breakout
Calculate target price:
• Best occurrence may be upward Take the height from the highest peak in the pattern to the
breaking out –above average for lowest trough in the pattern. Then either add it (for upward
all patterns* breakouts) to the breakout price or subtract it (for downward
breakouts) from the breakout price to generate a price target.

23
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Triangle: Ascending

Characteristics: Ascending Triangle

(breakout down)
• Bounded by a horizontal upper trend
line and an upward sloping lower Pullback
Resistance line
trend line. Each bound is a straight Target
trend line Line
Entry
Prices can break in either direction,
•
but more commonly upward*
Support line
Breakout usually occurs in pattern. Breakout
Uptrend Line
• About average failure rates but many
small false breakouts* Price

Post breakout performance average

• on upside but above average on Calculate target price:
downside* Take the height from the highest peak in the pattern to the
lowest trough in the pattern. Then either add it (for upward
breakouts) to the breakout price or subtract it (for downward
breakouts) from the breakout price to generate a price target.

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*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Triangle: Descending

Characteristics: Descending Triangle

(breakout down)
• Bounded by two trend lines; the
lower is horizontal and the upper
Resistance line
slopes downward
Downtrend
Prices can break in either direction Line Pullback
• Entry
but most commonly downward*
Above-average performance on Support line
Breakout Down
• upside break; retracements occur Breakout
often*
Price

Calculate target price:

Take the height from the highest peak in the pattern to the
lowest trough in the pattern. Then either add it (for upward
breakouts) to the breakout price or subtract it (for downward
breakouts) from the breakout price to generate a price target.

25
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Triangle: Wedge
Characteristics:
Rising Wedge
(breakout down from climax peak)
• Bounded by two trend lines, each
headed in the same direction; Price Climax
Pullback
must touch a trend line at least five
times (3 times on one and 2 times on
the other) before a breakout
Often occur following a panic Breakout
•
(declining wedge) or bubble Entry
(rising wedge)
Price

• Performance in both types is below

average, and retracements are
very common* Calculate target price:
For downward breakout, the lowest trough in the pattern is the
price target. For upward breakouts, take the height from the
highest peak in the pattern to the lowest trough in the pattern
and add that amount to the breakout price for a price target.

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*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Head and Shoulders: Top

Characteristics:
Head

• Three peaks with center peak higher

than the other two Left Shoulder
Right Shoulder
Shoulders should be at approximately Breakout
•
the same level and the head higher
Line connecting the two throughs
• between the peaks is called Neckline
the “neckline”

• Pattern is only complete on breaking

Target
the neckline
Target is the distance from the head to
•
the neckline projected from the neckline
This is a standard pattern for tops and
• has one of the lowest failure rates

27 *Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Head and Shoulders: Bottom (Inverse)

Characteristics:

• Inverted but otherwise Head and Shoulders Bottom

identical to a top pattern (breakout up)
except not as profitable*
Price

Breakout Breakout

Neckline
Neckline

Entry Throwback

Left Shoulder
Left Shoulder Right Shoulder Right
Shoulder
Head
Head

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*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Cup and Handle (also “Saucer”)

Characteristics: Rounding Bottom

(breakout up)
• Pattern consists of a rounded bottom
(not a “V” bottom), two “lips” at each Price Breakout
end, and a “handle” (similar to a flag
Entry Breakout Lip
pattern) from the handle
Pattern is complete with breakout
• Lip
above both lips
Throwback
Often have a throwback Breakout
Down
• The pattern’s performance ranks Cup or Bowl
Handle

•
about average for bottom patterns*
Calculate target price:
Take the height of the right cup lip to the bottom of the
cup, then add that amount to the breakout price.

29
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Trading with Patterns

Wedge
= Buy
= Stop
= Exit Wedge

Triangle

Triangle

Rectangle

*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
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 BROKERAGE: TECHNICAL ANALYSIS

Best Multi-Bar Patterns

Upward Signals Downward Signals

• Descending • Flag
Triangle • Head and
• Rectangle Shoulders top
• Pipe Bottom • Island Reversal

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 BROKERAGE: TECHNICAL ANALYSIS

General Information about a Candlestick

Characteristics:
• Traditionally, candlestick patterns are reversal patterns, meaning they
are used to identify when a trend is ending

• Candlestick patterns are often used with longer-term trends, thus,

upward reversal patterns after a correction in a longer upward trend
show the best performance, and vice versa for downward reversal
patterns in a long downward trend
Be careful not to act on a perceived candle pattern until the pattern
•
has formed and is activated by a breakout in a certain direction

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 BROKERAGE: TECHNICAL ANALYSIS

Doji
Characteristics:
Doji
• A one-candle pattern formed when the open
and close are the same price, and the high
and low are roughly equidistant from the open
and close
Extremely common
•
Indicates indecision in the marketplace and
•
thus is a possible warning of price change

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*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Harami
Characteristics:
Harami
• A two-candle pattern of a large body of either Top Bottom
color followed by a small body of the opposite
color; The second body is completely within
the body of the large body and is called a
“spinning top”

• Although common belief is that the haramiis

a reversal pattern, many report that is has the
potential of breaking either way

• A variation that has a dojiinstead of a spinning

top as the second candle has equally average
performance and random breakout*
Candle body can
be Black or White

34 *Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Hanging Man and Hammer

Characteristics:
Hanging Man —Hammer

• One-candle patterns differentiated by the color Top Bottom

of the body. Each pattern has a high that
coincides with either the opening or closing
price

• Hanging man, thought to be a continuation

pattern, actually breaks in either direction
randomly with a slight upward bias. Its overall
performance is below average*
Hammers occur relatively frequently but have
•
below-average performance*

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*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Shooting Star and Inverted Hammer

Characteristics: Shooting Star and

Inverted Hammer
• A one-candle inverted hanging man or hammer Top Bottom
pattern. Hammers by themselves have white
bodies and shooting stars have black bodies

• As a one-candle pattern, the shooting star has

Either Can Be
average performance. The same is true for the Black or White
single inverted hammer*

36
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Engulfing
Characteristics:
Engulfing

• A two-bar pattern in which the second bar Top Bottom

body completely engulfs the first bar body*

• A bottom engulfing pattern, with a short black

body followed by a tall white body, is thought
to be an upward reversal pattern and actually
has very good performance on a downward
breakout in a downward trend*

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*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Dark Cloud Cover and Piercing Line

Characteristics:
Dark Cloud Cover
and Piercing Line
Top Bottom
• The dark cloud cover is a two-bar pattern where
the second bar closes higher than the first and
is black versus white in the first bar

• The piercing line is the opposite of the dark

cloud cover in that the second bar is white and
lower than the first bar which is black

• The dark cloud is thought to be a downward

reversing pattern
• The piercing line pattern is thought to be an
upward reversing pattern*

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*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Pennant/Flag
Characteristics:

Flag and Pennant

• Pennant and flag patterns are
in upward trend Flag Pennant
variations of the same pattern
These patterns are often preceded by
• a steep, sharp price change, up or
down, and form a short consolidation Price
that appears like a triangle or flag.
Generally, the pattern slopes slightly
in the direction opposite from the
trend
The breakout in either direction is
• often followed by a move that equals
the earlier steep, sharp price change Calculate target price:
into the pattern Take the height from the start of the "flag pole” to the
highest peak in the pennant. Add that amount to the
bottom of the pennant for an upward price target.

39
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Gaps
Characteristics

• Definition –no trading (gap)

at specific prices

• Gaps can be considered

“up” or “down”
Gaps are caused by
•
appreciable changes
in supply and demand
from one close to the
following open

Gap Up

40
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Gaps
Characteristics

• Gaps are generally profitable on

breakouts from patterns, trends,
support or resistance

• A method of trading a gap is the

“explosion gap pivot.” It assures Breakout
that the gap is valid

• After the gap, wait for

“throwback.” If throwback “covers”
the gap, no action. If the
throwback stops, this is called the
“pivot low.” Place buy entry above
high of the gap bar
“Pivot” is the lowest level of the
Gap Pivot
PivotLoLow

•
post-gap breakout
Protective stops initially placed at
•
gap low and then below pivot low
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*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Two-Bar Reversal Button or Pipe Bottom

Two-Day Reversal Bottom

Characteristics: (or Pipe Bottom)
• Two bars and occurs at the end of a large

trend, up or down trend. Ideally, the first bar,

in a bottom pattern, closes at the low, and the

second bar closes in the upper half of the range.
• Bar ranges are larger than preceding
It is more reliable in weekly data
bar ranges
Action occurs on breakout through second bar
•

Calculate target price:

Take the height from the taller of the two bars to the lower
of the two bars. Add that amount to the taller of the two
bars to get a price target.

42
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Volatility Patterns
Characteristics:
Inside Bar
• Dull activity is known as “low volatility.” New
trends often begin from periods of low volatility Buy next bar
at opening
One way to look at volatility is to observe the above inside
• bar close
relationship between price bars
“Range” is the spread between high and low in
• a price bar
If a bar is followed by a bar with less range,
volatility is declining; the second bar is called a
• “narrow range” bar Sell next bar
When this second bar’s range is contained at opening
below inside
bar close
•
within the range of its preceding bar, it is called
an “inside bar.”

43
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.
 BROKERAGE: TECHNICAL ANALYSIS

Narrow Range
Characteristics:
NR4
• One low volatility pattern is called a “Narrow
Range” pattern and consists of a bar with a Range on day 4 less
range narrower than its preceding bars than days 1-3
The graph shows a four-bar, Narrow Range
•
pattern (NR4) with four bars, the fourth bar
having a narrower range than the preceding Buy
three bars
The breakout occurs on a break above or below
• the high or low of the narrow range

Sell

44
*Source: Technical Analysis: the Complete Resource for Financial Market Technicians, 2 nd ed.