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.
Best chart patterns
There is no one ‘best’ chart pattern, because they are all used to highlight different trends in a huge variety of markets. Often, chart patterns are used in candlestick trading, which makes it slightly easier to see the previous opens and closes of the market.
Some patterns are more suited to a volatile market, while others are less so. Some patterns are best used in a bullish market, and others are best used when a market is bearish.
That being said, it is important to know the ‘best’ chart pattern for your particular market, as using the wrong one or not knowing which one to use may cause you to miss out on an opportunity to profit.
Before getting into the intricacies of different chart patterns, it is important that we briefly explain support and resistance levels. Support refers to the level at which an asset’s price stops falling and bounces back up. Resistance is where the price usually stops rising and dips back down.
The reason levels of support and resistance appear is because of the balance between buyers and sellers – or demand and supply. When there are more buyers than sellers in a market (or more demand than supply), the price tends to rise. When there are more sellers than buyers (more supply than demand), the price usually falls.
As an example, an asset’s price might be rising because demand is outstripping supply. However, the price will eventually reach the maximum that buyers are willing to pay, and demand will decrease at that price level. At this point, buyers might decide to close their positions.
This creates resistance, and the price starts to fall toward a level of support as supply begins to outstrip demand as more and more buyers close their positions. Once an asset’s price falls enough, buyers might buy back into the market because the price is now more acceptable – creating a level of support where supply and demand begin to equal out.
If the increased buying continues, it will drive the price back up towards a level of resistance as demand begins to increase relative to supply. Once a price breaks through a level of resistance, it may become a level of support.
Types of chart patterns
Chart patterns fall broadly into three categories: continuation patterns, reversal patterns and bilateral patterns.
- A continuation signals that an ongoing trend will continue
- Reversal chart patterns indicate that a trend may be about to change direction
- Bilateral chart patterns let traders know that the price could move either way – meaning the market is highly volatile
For all of these patterns, you can take a position with CFDs. This is because CFDs enable you to go short as well as long – meaning you can speculate on markets falling as well as rising. You may wish to go short during a bearish reversal or continuation, or long during a bullish reversal or continuation – whether you do so depends on the pattern and the market analysis that you have carried out.
Learn more about CFDs
The most important thing to remember when using chart patterns as part of your technical analysis, is that they are not a guarantee that a market will move in that predicted direction – they are merely an indication of what might happen to an asset’s price.
Technical Indicators to Build a Trading Toolkit
- Technical indicators are heuristic or mathematical calculations based on the price, volume, or open interest of a security or contract used by traders who follow technical analysis.
- Technical analysts or chartists look for technical indicators in historical asset price data in order to judge entry and exit points for trades.
- There are several technical indicators that fall broadly into two main categories: overlays and oscillators.
Tools of the Trade
The tools of the trade for day traders and technical analysts consist of charting tools that generate signals to buy or sell, or which indicate trends or patterns in the market. Broadly speaking, there are two basic types of technical indicators: How Technical Indicators Work
Technical analysis is a trading discipline employed to evaluate investments and identify trading opportunities by analyzing statistical trends gathered from trading activity, such as price movement and volume. Unlike fundamental analysts, who attempt to evaluate a security's intrinsic value based on financial or economic data, technical analysts focus on patterns of price movements, trading signals, and various other analytical charting tools to evaluate a security's strength or weakness.
Technical analysis can be used on any security with historical trading data. This includes stocks, futures, commodities, fixed-income, currencies, and other securities. In this tutorial, we’ll usually analyze stocks in our examples, but keep in mind that these concepts can be applied to any type of security. In fact, technical analysis is far more prevalent in commodities and forex markets where traders focus on short-term price movements.
Technical indicators, also known as "technicals," are focused on historical trading data, such as price, volume, and open interest, rather than the fundamentals of a business, like earnings, revenue, or profit margins. Technical indicators are commonly used by active traders, since they're designed to analyze short-term price movements, but long-term investors may also use technical indicators to identify entry and exit points.
Types of Indicators
There are two basic types of technical indicators:
- Overlays: Technical indicators that use the same scale as prices are plotted over the top of the prices on a stock chart. Examples include moving averages and Bollinger Bands®.
- Oscillators: Technical indicators that oscillate between a local minimum and maximum are plotted above or below a price chart. Examples include the stochastic oscillator, MACD or RSI.
Traders often use many different technical indicators when analyzing a security. With thousands of different options, traders must choose the indicators that work best for them and familiarize themselves with how they work. Traders may also combine technical indicators with more subjective forms of technical analysis, such as looking at chart patterns, to come up with trade ideas. Technical indicators can also be incorporated into automated trading systems given their quantitative nature.