Heres a guide to the most powerful price patterns in technical analysis!
Keep analysing various charts so that you become skillful in catching the hot stocks before others!
Technical analysis is a subject that many people often find difficult to understand. Correlating volumes and technical indicators with price seem like Everest to climb. However, it is important to understand that a step-by-step approach is necessary for understanding technical analysis. In this knowledge article, we bring you the building blocks of technical analysis i.e. price patterns.
As a trader, it becomes of utmost importance to understand price patterns. It helps to know the psychology behind the demand and supply of the stock as well the strength of the stock. It helps with the idea of selecting the right stocks, which can give you good returns in a given time period. A trader is no trader without understanding price patterns. So let’s begin with some of the powerful price patterns that will help you grow your technical skills.
There are mainly two types of price patterns: Continuation patterns & reversal patterns.
Continuation patterns: These patterns usually follow the major trend. It is obviously true that prices do not go up or down in a straight line. Stocks rally and then, they halt before the next leg of the rally kicks in. They tend to show continuation while they pause to gain momentum. Some popular continuous patterns to name here are triangle patterns, flag patterns, pennant patterns, etc.
Reversal patterns: These patterns signal the beginning of the newer opposite trend of the major trend as well as its exhaustion. Unlike continuation patterns, these patterns show a higher possibility of a reversal of the price action. Some notable reversal price patterns to mention here are head & shoulders, double tops, double bottoms, morning star, etc.
Now that you know the basics of price patterns, let’s understand how you can apply them in your trading setup. First, let’s start with continuation patterns.
Triangle pattern: In this pattern, the stock forms higher lows and lower highs. On the technical chart, we can see it forming a triangle-shaped pattern by joining the falling trendline and upward sloping trendline. A breakout in the direction of its major trend is the sign of the next leg of the rally. Triangle patterns can be further categorised into a) Symmetrical triangle patterns b) Ascending triangle patterns c) Descending triangle patterns.
The above chart is an example of a symmetrical triangle pattern. Observe how AEGISCHEM formed a symmetrical triangle post a strong uptrend from Rs 165 level to near Rs 250 level. What followed was a strong breakout from the pattern and resultantly, the stock soared further!
Flag pattern: It is one of the most commonly used continuation patterns. The major trend acts like a pole while the stock consolidates in a confined range. A breakout in the direction of the major trend paves the way for a stronger uptrend that might be equal to its pole length.
After a strong uptrend, OIL consolidated in a range with lesser volumes. In a confined range, it traded for about three months and registered a strong breakout from there.
Now that you know what continuation patterns are, let us look at reversal patterns, which would help you get a complete idea.
Head & Shoulders: A popular reversal pattern occurs when the stock is in an uptrend. It tends to make three swing highs with the middle one being at a higher level called the head. The side swing highs are called the left shoulder and the right shoulder, respectively. Interestingly, the stock forms a neckline (also called a baseline), which acts as strong support. A fall below this neckline indicates that breakdown has occurred and the stock is likely to fall sharply. Meanwhile, the opposite of this pattern is called inverse head & shoulders, which is found during a downtrend and indicates exhaustion.
Observe the head & shoulders formed by SRTRANSFIN. It broke down from its neckline and saw a drastic change in trend and fell sharply.
Double bottom: Double bottom patterns are common reversal patterns generally found in a major downtrend. Stock tends to take support at a crucial juncture twice before soaring higher. It makes a swing high before testing the support again and that level is called the breakout level. A rise above this breakout level, once it has formed a double bottom pattern, is a confirmation of a trend reversal.
A strong downtrend dragged LAXMIMACH to Rs 8,200 levels. However, it formed a double bottom pattern and registered a breakout at Rs 9,500 levels. It has then gained about 12 per cent upside.
Remember, expertise only comes with practice. Keep analysing various charts so that you become skillful in catching the hot stocks before others!