Advanced Chart Pattern Identification
One of my favorite financial periodicals is the digital newspaper Investors Business Daily. This is a financial publication that emphasizes Price & Volume when analyzing weekly charts. Chart patterns are discussed in several of their articles.
Another source of chart pattern information, and probably a more complete reference specifically for chart patterns, is a book from Thomas Bulkowski. It provides breakout percentages, items to watch for and several other technical items. I reference his book now and again in some of my stock articles.
Some chart patterns tend to develop quicker while other patterns take longer to develop and breakout. Not all patterns that develop are “textbook”, meaning each chart pattern usually has a slightly different, unique twist. For each of the chart patterns below, I provide what I consider to be “the perfect set-up” for the different chart patterns.
Finding Chart Patterns
Chart patterns can be identified by 2 different methods. The first method is by drawing trendlines on a chart. The upper-most and lower-most price activity should be included when drawing the bare minimum of 2 trendlines.
The second method is simply by visualization. Yes, staring at the chart and looking for a familiar pattern.
Once a chart pattern is identified, a strategy can be concocted based on expectations derived from historical data. Most chart patterns are extremely useful to help calculate price objectives based on the developed pattern. Building expectations for a stock’s upcoming share price movements and then monitoring those expectations based on actual price movements is a great way build your investing skills.
Developing Expectations
I find it extremely beneficial to develop expectations for a stock and then monitor those expectations. Expectations for a stock’s share price are constantly changing and evolving. One thing you will notice in my stock updates as I am constantly referencing and building from prior stock updates.
As I mention in other technical analysis sections, if the target price area from a stock’s chart pattern can be confirmed by another type of technical analysis, it should help build more confidence in the calculated price objective or target area.
When one type of analysis points to a target area, you are started in the right direction. When two or more of the above types of technical analysis point to the same target area, it gives me greater confidence that the target area could be reached. When several types of technical analysis all seem to confirm the same target area, it gives me the greatest confidence that the target area will be reached.
Illustrated Chart Patterns
Following are basic illustrations for several of the more common chart patterns. Each chart pattern has its own page with detailed requirements, guidelines, trading tips and real chart examples. While chart patterns do work on daily candlestick charts and shorter time frames, they are best viewed and searched for on weekly charts.
Cup With Handle
A Cup With Handle chart pattern is a bullish chart pattern that typically signifies higher share prices upon breakout.
Cup patterns are created by a sharp sell-off in a stock, usually based on some news event. The heavy selling starts to fade and then the share price starts to consolidate in a sideways fashion. After most of the selling has been completed, the share price then starts to climb back up to the beginning of where the first downtrend began. This price action forms the Cup part of the pattern.
Some Cup chart patterns go on to form a “handle” also. When a Cup pattern does form a handle, the performance of the share price tends to be greater than Cup patterns without a handle. Thus, most Cup With Handle chart patterns perform better than Cup Without Handle chart patterns.
3 Weeks Tight
The 3 Weeks Tight chart pattern is best viewed on a weekly chart since you compare the closing share price at the end of each week.
A 3 Weeks Tight chart pattern is considered a bullish continuation pattern. This pattern usually leads to upside price gains upon breaking out.
This pattern develops after the stock has been in an uptrend and decides to take a break. However, larger investors and institutional investors do not see a need to sell any shares, even after the share price has moved up nice already. On the flip-side, these larger type investors anticipate even higher prices still. As such, they use any weakness in the share price to add to their holdings.
In order for this pattern to develop, the share price needs 3 straight weekly closes where each closing share price is no more than 1% to 1.5% higher or lower than the previous week’s closing price. It feels as if the share price is “doing absolutely nothing” during the 3 weeks time that it takes the pattern to develop.
Double Bottom
A Double Bottom chart pattern is a bullish reversal chart pattern. This pattern typically develops after a group of buyers step in to stop the downtrend of a stock and create a support area. The Double Bottom chart pattern is formed when the share price is taken back down for a re-test of the support area.
A Double Bottom chart pattern usually develops at the end of a stock’s downtrend. This pattern typically signifies that the downtrend is over and a sharp uptrend should ensue. Before the uptrend really takes off though, there is usually a re-test of the breakout area.
There are different viewpoints on what is considered a successful re-test of the support area from the Double Bottom chart pattern. I discuss those viewpoints on its webpage and offer my opinion on the subject. I also review some of the characteristics to watch for that will help to identify a breakout from a Double Bottom chart pattern.
Double Top
The Double Top chart pattern is a bearish reversal chart pattern. It signifies that the uptrend is over and a new downtrend has begun or is just about ready to begin, depending upon which version of the Double Top chart pattern is developing. There are 2 slightly different versions of the Double Top chart pattern.
Double Top chart patterns are rather easy patterns to identify on a chart. Think of two mountain peaks on the horizon with a valley in between them. Both peaks approximate the same height. That is the basic description of a Double Top chart pattern.
A Double Top chart pattern can be a ferocious reversal signal, leading to quick price declines after the failure to breakout from the previous high.