Section IV: Chart Patterns
The same psychology used with candlesticks applies to chart patterns.
Investors and traders make transactions for a wide variety of reasons; most trading decisions are emotionally driven: closing a position because of fear of losing more, adding more positions in hope of greater gains and many more. All these result in an imbalance of supply and demand and they are all uncovered by price movements.
These movements tend to repeat themselves, as traders open, close or add positions for the same reasons.
We must remember that the important questions to answer are where is the price? And what it is more likely to do? The reasons behind why is the pattern formed are not important.
There are two types of chart patterns: reversal and continuation chart patterns.
Continuation Chart Patterns – Set up the market for a follow through in direction of the prevailing trend. Among the most important continuation patterns are:
- Wedges – Rising and falling wedges
- Triangles – symmetrical, ascending and descending triangles.
- Rectangles – periods of consolidation*
* When rectangles have a slope they are called rising and falling channels.
Reversal Chart Patterns – These types of patterns set up the market for a trend reversal once the pattern is confirmed. Reversal patterns are:
- Double Top and Bottom
- Triple Top and Bottom
- Head and Shoulders Top and Bottom
Rising and Falling Wedges – Falling wedges can be bullish and reversal patterns. Read this section to discover why.
Next, we will review some of the most important patterns.