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10 chart patterns every trader needs to know

Chart patterns are an integral aspect of technical analysis, but they require some getting used to
before they can be used effectively. To help you get to grips with them, here are 10 chart patterns
every trader needs to know.

Why is it Important to analyze the Chart Patterns?

 Chart patterns tend to repeat themselves over and over again which helps to appeal to
human psychology and trader psychology in particular.
 If you are able to learn to recognize these patterns early they will help you to gain a real
competitive advantage in the markets.
 Chart patterns provide a complete pictorial record of all trading, and also provide a
framework for analyzing the battle between bulls and bears.

Best chart patterns

1. Head and shoulders

2. Double top
3. Double bottom
4. Cup and handle
5. Rounding bottom
6. Wedges (Rising and falling)
7. Pennant or flags (Bullish and Bearish)
8. Ascending triangle
9. Descending triangle
10.Symmetrical triangle

Types of Chart Patterns:

Chart patterns fall broadly into three categories: continuation patterns, reversal patterns and
bilateral patterns.

 Continuation patterns: These kinds of chart patterns give continuation signals of the
ongoing trend
 Reversal Patterns: These kinds of chart patterns give reversal signals
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 Bilateral Patterns: These kinds of chart patterns show uncertainty and high volatility in the
market.

1. Head and Shoulders:

 This is a bullish and bearish reversal patterns which has a large peak in the middle
and smaller peaks on the either sides.
 Head and shoulders pattern is considered to be one of the most reliable reversal chart
patterns.
 The Head and Shoulders chart pattern is a price reversal pattern that helps traders
identify when a reversal may be underway after a trend has exhausted itself. This
reversal signals the end of an uptrend. The Head and Shoulders pattern has a
distinctive appearance resembling its namesake which includes a distinct „left
shoulder‟, „head‟, „right shoulder‟ and „neckline‟ formation (see image below).
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1b. Inverse Head and Shoulders Pattern?

The Inverse Head and Shoulders (informally known as the 'Reverse Head and Shoulders pattern)
resembles the same structure as the standard formation but reversed. The Inverse Head and
Shoulders is observable in a downtrend (see image below) and indicates a reversal of a downtrend
as higher lows are created.
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How to Identify Head and Shoulders Patterns

The following list gives a simple breakdown of the key action points when identifying this pattern:

 Identify the overall market trend using price action and technical indicators (preceding
uptrend)
 Isolate the Head and Shoulders chart construction
 The distance between the „Head‟ and „Shoulders‟ should be as close to equidistant as
possible
 Delineate the neckline at the low point between both „shoulders‟ – preferably horizontal but
not obligatory

Trading the Head and Shoulders Pattern

We stated earlier that possibly the greatest advantage of this formation is that it offers precisely
defined levels. The key is a neckline due to the three reasons:

 A break of the neckline activates the pattern. Before the neckline is broken, we consider the
pattern to still be in the making.
 A neckline defines the stop loss i.e. after the breakout; any reverse move to the other side of
the neckline activates the stop loss and automatically invalidates the pattern.
 A distance between the neckline and the head is measured to calculate the take profit.

We will now use the same two examples to give you a step-by-step guide on how to trade the
head and shoulders and inverse head and shoulders patterns.

Once we have drawn the pattern and identified three key elements of the formation, we monitor
the “draft” pattern closely and wait for the bears to potentially break the neckline and activate the
formation. There are two options for the head and shoulders pattern as far as the entry is
concerned.

The first option offers you a chance to enter a short trade as soon as the neckline is broken and the
daily candle closes below the broken neckline. This option means that you can‟t miss a trade.

However, this one is also riskier as this move lower can easily prove to be a failed breakdown. In
this case, your stop-loss would be activated almost instantly.
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The second option is preferred by the majority of the trading community. It's based on an idea that
you should make an entry after the price action closes below the neckline and the breakdown is
confirmed. Accordingly, the buyers will then push the price action to retest the neckline, the so-
called “throwback”, before resuming lower.

Thus, you should place the entry when the throwback occurs. Of course, the price action can still
return above the neckline, however, the chances are smaller than with the first option. The
limitation of the second option is that the price action can simply resume lower without
performing a throwback i.e. a retest of the neckline is not guaranteed
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2. Double Top:
 A double top is another bearish reversal pattern that traders use a lot.
 The double top pattern entails two high points within a market which signifies an
impending bearish reversal signal. A measured decline in price will occur between
the two high points, showing some resistance at the price highs. After retracing a
portion of the first peak, the market rallies back towards the high of the first peak
however; strength in the market is waning and is unable to sustain a break above the
first peak.

How to Identify Double Top Patterns

 Identify the two distinct peaks of similar width and height

 Distance between peaks should not be too small - time frame dependent
 Confirm neckline/support price level
 Use other technical indicators to support double top bearish signal, such as moving averages
and oscillators
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Trading the Double Top Pattern

We will now look at two different ways to trade the double top.

 The first way to trade this pattern is to look for the neckline that is marked on the chart
below. Once the price breaks through the neckline, you can then enter the market with a sell
order.
 The chart below shows the neckline being broken by the price – this is where short traders
can enter the market.
 The stop loss is placed above the double top. If the price trades beyond this point, the
pattern has failed and you do not want to be in the market any longer.
 The profit target is measured by taking the height of the actual pattern and extending that
distance down from the neckline.
 The chart below demonstrates the stop loss (red) and take profit levels (green):

Trading the double top pattern: method two

The second way to trade the double top pattern is to wait for the price to trade below the
neckline (broken support) and then look to place a sell order on the retest of the neckline as
resistance (broken support now becomes resistance). The stop loss would go above the new
resistance area and the profit target would remain the same as in the first example.

3. Double Bottom:
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 The double bottom chart pattern is found at the end of a downtrend and resembles the
letter "W"(see chart below). Price falls to a new low and then rallies slightly higher
before returning to the new low. Unable to push price to a new lower low to continue the
downtrend, sellers give up and price bounces sharply from this area. The bullish
confirmation is specified by a break in the key price level situated at the high point
between the „bottoms‟ resistance level (neckline).
 A double bottom is a bullish reversal pattern, because it signifies the end of a downtrend
and a shift towards an uptrend.

How to Identify Double Bottom Patterns:

Step-by-step guide to identifying the double bottom pattern on a chart:

 Identify the two distinct bottoms of similar width and height

 Distance between bottoms should not be too small - time frame dependent
 Confirm neckline/resistance price level
 Use other technical indicators to support double bottom bullish signal such as moving
averages and oscillators
 Be wary of trading against strong trends
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4. Cup and handle Pattern:

 The cup and handle pattern is a continuation pattern that occurs after a preceding bullish
or bearish trend. This formation provides traders with some distinctive features. The
„cup and handle‟ term translates to the bar chart pattern. The cup presents as a bowl
shape whilst the handle is depicted as a downward slanting period of consolidation.
 A cup and handle is a bullish reversal chart pattern which resembles a cup and handle
where the cup is in the shape of a “U” and the handle has a slight downward drift.

How to identify Cup and Handle pattern

 The cup and handle pattern is considered to be a bullish continuation pattern therefore,
identifying a prior uptrend is essential. This can be done using price action techniques or
technical indicators such as the moving average.
 The cup should form more of a „U‟ shape as opposed to a „V‟ with the high points on either
side of the cup being approximately even.
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 The handle resembles a consolidation generally in the form of a flag or pennant pattern.
This should be downward sloping but does consolidate sideways in some instances similar
to a rectangle pattern.
 The breakout signal can occur in different ways depending on the trader‟s preference. Some
trader‟s look at the resistance level taken from the horizontal between the highs of the cup.
Once this breaks that level, entry will be confirmed. Other traders use a break of the handle
trend line as a long entry point.

How to trade with the cup and handle pattern

Trading with the cup and handle pattern differs slightly when using it to trade and equities.
The volume function is often used in stock trading as a spike in volume indicates the
breakout which confirms the entry signal.
trading does not normally use this function, and instead involves other more conventional
breakout confirmation methods such as breaks above resistance. The rest of the process is
the same when trading the cup and handle pattern.
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The image above is a monthly chart of the popular hotel and casino company Wynn Resorts Ltd.
The chart exhibits a cup and handle formation with a clear prior uptrend as marked by the trend
line showing higher highs and higher lows. A moving average may also be used instead to confirm
the uptrend.

The chart shows two potential entry points denoted by the green arrows. The first entry takes place
on the breakout above the upper end of the price channel akin to a bullish flag with a spike in
volume as verification of the move up. The second entry uses the resistance level between the
highs on either side of the cup as a key price level. Once this is broken, traders can look to go
long. This method is less aggressive, but the patience of additional confirmation can shield against
a false breakout with regards to the handle channel.

Stop levels are often taken from the low of the handle. This can then be projected by a factor of
two to arrive at a take profit (limit) with a ratio of 1:2 risk-reward ratios. Other traders prefer
Fibonacci extensions as a gauge for limit levels. This choice comes down to trader preference.

5. Rounding bottom:
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 Rounding Bottom shows that the stock is reversing from a downward trend towards
an upward trend.
 It can take any time from several months to years to form. It is very similar to the cup
and handle, but the only difference is that there is no handle to the pattern.
 This pattern is also known as the “saucer bottom” and is long-term reversal chart
pattern.

How to identify rounding bottom:

A rounding bottom looks similar to the cup and handle pattern, but does not
experience the temporary downward trend of the "handle" portion. The initial declining
slope of a rounding bottom indicates an excess of supply, which forces the stock price
down. The transfer to an upward trend occurs when buyers enter the market at a low price,
which increases demand for the stock. Once the rounding bottom is complete, the stock
breaks out and will continue in its new upward trend. The rounding bottom chart pattern is
an indication of a positive market reversal, meaning investor expectations and momentum,
otherwise known as sentiment, are gradually shifting from bearish to bullish.

How to trade round bottom pattern:

A trader should look to get long once the stock is able to break through the neckline.

6. Rising Wedges pattern:

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 Wedges are bullish and bearish reversal as well as continuation patterns which are formed
by joining two trend lines which converge. It can be a rising wedge or a falling wedge.
 The rising wedge (also known as the ascending wedge) pattern is a powerful consolidation
price pattern formed when price is bound between two rising trend lines. It is considered a
bearish chart formation which can indicate both reversal and continuation patterns –
depending on location and trend bias. Regardless of where the rising wedge appears, traders
should always maintain the guideline that this pattern is inherently bearish in nature (see
image below).

How to identify Rising Wedges pattern:

The rising wedge pattern is interpreted as both a bearish continuation and bearish reversal
pattern which gives rise to some confusion in the identification of the pattern. Both
scenarios contain a different set of observation dynamics which must be taken into
consideration.

Continuation Pattern:

 Established downtrend
 Rising wedge consolidation formation
 Linking higher highs and lower lows using a trend line assembling towards a narrowing
point
 Confirm divergence between price and volume using volume function - MACD may also be
used
 Overbought signal can be confirmed by other technical tools like oscillators
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 Look for break below support for short entry

How to trade the rising wedge pattern

The rising wedge pattern is linked with both continuation and reversal patterns as mentioned
above. The example below shows the formation of a rising wedge on a pair depicting a
continuation.

The chart above shows a rising wedge „continuation‟ pattern after a determined downtrend.
The rising wedge is outlined by the blue dashed lines showing diminishing bull strength in
the uptrend. Confirmation of the uptrend waning in strength can be seen using the volume
tool on the chart which depicts fading volume in concurrence with the ascending price in
the market. This is known as divergence, showing that the upward movement is coming to
an end.
The entry point (labeled) occurs once the trend support line of the rising wedge has been
breached. There are two common methods of entry:
Wait for a candle close below the support trend line before entry
Enter into the short position as soon as the price breaks the support line, regardless of the
candle close
The stop level as highlighted on the chart is elected from the high point of the rising wedge
located on the resistance trend line. This identification point makes it relatively simple to
locate the stop level for novice traders. The limit in this example was taken from the
previous swing low giving this trade an extremely positive risk-reward ratio.

6b. the falling Wedge pattern:

The falling wedge pattern is a continuation pattern formed when price bounces between two
downward sloping, converging trend lines. It is considered a bullish chart formation but can
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indicate both reversal and continuation patterns – depending on where it appears in the
trend.

How to identify Falling Wedges pattern:

The falling wedge pattern is interpreted as both a bullish continuation and bullish reversal
pattern which gives rise to some confusion in the identification of the pattern. Both
scenarios contain different market conditions which must be taken into consideration.

The differentiating factor that separates the continuation and reversal pattern is the direction
of the trend when the falling wedge appears. A falling wedge is a continuation pattern if it
appears in an uptrend and is a reversal pattern when it appears in a downtrend.

Continuation or (Reversal) Pattern:

 Identify an uptrend or (downtrend)

 Link lower highs and lower lows using a trend line. The two lines will slope
downwards and converge
 Look for divergence between price and an oscillator like the RSI or stochastic
indicator
 Oversold signal can be confirmed by other technical tools like oscillators
 Look for break above resistance for a long entry.
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How to trade the falling wedge pattern

Below are various ways to trade the falling wedge using technical analysis:

1. Falling Wedge Continuation Pattern

The descending wedge pattern appears within an uptrend when price tends to consolidate, or trade
in a more sideways fashion. Connecting the lower highs and lower lows will reveal the slight
downward slant to the wedge pattern before price eventually rises, resulting in a falling wedge
breakout to resume the larger uptrend.

In the Gold chart below, it is clear to see that price breaks out of the descending wedge to the
upside only to return back down. This is a fake breakout or “fakeout” and is a reality in the
financial markets. The fakeout scenario underscores the importance of placing stops in the right
place – allowing some breathing room before the trade is potentially closed out. Traders can place
a stop below the lowest traded price in the wedge or even below the wedge itself. or even below
the wedge itself.

Setting the stop loss a sufficient distance away allowed the market to eventually break through
resistance (legitimately) and resume the long-term uptrend.

Measuring Technique to Set Target Levels

Traders can look to the starting point of the descending wedge pattern and measure the vertical
distance between support and resistance. Then, superimpose that same distance ahead of the
current price but only once there has been a breakout. The top end of the line will be the target.
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2. Falling Wedge Reversal Pattern

Traders can make use of falling wedge technical analysis to spot reversals in the market. The chart
below presents such a case, with the market continuing its downward trajectory by making new
lows. Price action then start to trade sideways in more of a consolidation pattern before reversing
sharply higher.

Traders can use trendline analysis to connect the lower highs and lower lows to make the pattern
easier to spot. A break and close above the resistance trendline would signal the entry into the
market. A stop loss can be placed below the recent swing low, while the target can be placed
according to the measurement technique discussed above; or at a previous level of resistance -
while adhering to positive risk to reward ratio.
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7. Pennant or flags:

A Pennant pattern is a continuation chart pattern, seen when a security experiences a large
upward or downward movement, followed by a brief consolidation, before continuing to move
in the same direction. The pattern looks like a small symmetrical triangle called a Pennant,
which is made up of numerous candlesticks. Depending on the direction of the movement,
Pennant patterns are usually described as being bearish or bullish.

Key characteristics of a Pennant pattern

When looking at a Pennant continuation pattern, you will see the following:

 A flagpole: A Pennant pattern always begins with a flagpole, which differentiates it

from other types of patterns (such as the symmetrical triangle). The flagpole is the
initial strong move preceding the symmetrical triangle.
 Breakout levels: There will be two breakouts, one at the end of the flagpole, and one
after the consolidation period, where the upward or downward trend continues
 The Pennant itself: The Pennant is the triangular pattern formed when the market
consolidates, between the flagpole and the breakout. The two converging trendlines
form the triangle - the Pennant.
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These characteristics can be seen below, with respect to the Bullish Pennant Pattern.

Bullish pennants

Bullish Pennants are continuation candlestick patterns that occur in strong uptrends. The Pennant
is formed from an upward flagpole, a consolidation period and then the continuation of the
uptrend after a breakout. Traders look for a break above the Pennant to take advantage of the
renewed bullish momentum.

Bearish pennants

Bearish Pennants are simply the opposite of the Bullish Pennant. Bearish Pennants are
continuation patterns that occur in strong downtrends. They always start with a flagpole – a steep
drop in price, followed by a pause in the downward movement. This pause forms a triangular
shape, known as the Pennant. There is then a breakout, and the downward movement continues.
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Traders look to enter short trades on a break below the pennant.

How to trade bullish and bearish pennants

When trading, the same approach can be applied to both the Bullish and Bearish Pennant patterns
however, the Bullish Pennant will have a long bias and the Bearish Pennant, a short bias. The
example below demonstrates how to trade a Bullish Pennant appearing in

Traders should look to enter the trade on confirmation of the breakout after a sudden, sharp move
in price. The pennant, after a sharp move in price, indicates that there is likely to be a breakout
and continuation in the direction of the initial move.

A candlestick close above the pennant provides the entry point. In this example the break was
rather significant and added to the likelihood of a continued move to the upside.

A stop loss can be placed at the low of the breakout candle, seeing that it was quite a big move or,
for more conservative traders, a stop can be placed beneath the pennant to limit downside risk.
This usually offers an acceptable level of protection for traders.

Keep in mind that the markets don‟t always move in the way you expect which is why traders
should always adopt prudent risk management. To account for this, only ever trade with capital
that you can afford to lose.

To set target levels, traders can measure the distance from the beginning of the flagpole up to the
Pennant, then duplicate this distance from the price break out following the Pennant.
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8. Ascending triangle:
The ascending triangle pattern is similar to the symmetrical triangle except that the upper
trendline is flat and the lower trendline is rising. This pattern indicates that buyers are more
aggressive than sellers as price continues to make higher lows. Price approaches the flat upper
trendline and with more instances of this, the more likely it is to eventually break through to
the upside.
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Ascending triangle trading strategy

An ascending triangle can be seen below. Leading on from the existing uptrend, there is a
period of consolidation that forms the ascending triangle. Traders can once again measure the
vertical distance at the beginning of the triangle formation and use it at the breakout to forecast
the take profit level. In this example, a rather tight stop can be placed at the recent swing low to
mitigate downside risk.

9. Descending triangle:
The descending triangle pattern on the other hand, is characterized by a descending upper
trendline and a flat lower trendline. This pattern indicates that sellers are more aggressive than
buyers as price continues to make lower highs.
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How to trade Descending triangle

Below is a good example of the descending triangle pattern appearing on. A downtrend leads
into the consolidation period where sellers outweigh buyers and slowly push price lower. A
strong break of the lower trendline presents traders with an opportunity to go short. In this
example, it doesn‟t take long for the position to move in the opposite direction, highlighting the
importance of setting an appropriate stop level.
The take profit level is set using the vertical distance measured at the beginning of the
descending triangle formation.

Things to know while trading with triangle patterns

Always be cognizant of the direction of the trend prior to the consolidation period.
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Make use of upper and lower trendlines to help identify which triangle pattern is being formed.
Use the measuring technique discussed above to forecast appropriate target levels
Adhere to sound risk management practices to mitigate the risk of a false breakout and ensure a
positive risk to reward ratio is maintained on all trades.

10.Symmetrical triangle:

The symmetrical triangle pattern can be either bullish or bearish, depending on the market. In
either case, it is normally a continuation pattern, which means the market will usually continue
in the same direction as the overall trend once the pattern has formed.

Symmetrical triangles form when the price converges with a series of lower peaks and higher
troughs. In the example below, the overall trend is bearish, but the symmetrical triangle shows
us that there has been a brief period of upward reversals.
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However, if there is no clear trend before the triangle pattern forms, the market could break out
in either direction. This makes symmetrical triangles a bilateral pattern – meaning they are best
used in volatile markets where there is no clear indication of which way an asset‟s price might
move. An example of a bilateral symmetrical triangle can be seen below.

Chart patterns summed up

All of the patterns explained in this article are useful technical indicators which can help you to understand how or why
an asset‟s price moved in a certain way – and which way it might move in the future. This is because chart patterns are
capable of highlighting areas of support and resistance, which can help a trader decide whether they should open a long
or short position; or whether they should close out their open positions in the event of a possible trend reversal.
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