Technical analysts often study stock charts for recurring price patterns, or stock chart patterns, that appear on price charts on fairly a regular basis. These recurring chart patterns are one of the key elements of technical analysis and can be used on their own or as confirmation for signals from technical indicators. They are based, by and large, on trend lines, which are lines drawn on a chart to indicate support and resistance levels. A support line is a level where the stock price appears to have difficulty moving or penetrating below while a resistance line is a level that the stock price appears to have difficulty moving above.
Chart patterns can be based on any price chart of any time-frame, and usually provide clear entry and exit signals, as well as price projections, stop levels and profit targets. Most patterns fall into two categories: continuation patterns and reversal patterns, but some are both continuation and reversal patterns, depending on the price breakout.
- Continuation patterns indicate a higher probability for the continuation of the existing trend. These are usually momentary consolidation or retracements within the trend. Common continuation patterns include flags and pennants, and the various triangle patterns, namely the symmetrical triangle, the ascending triangle and the descending triangle.
- Reversal patterns indicate a high probability that the existing trend has come to an end and will reverse direction. The common reversal patterns include double tops and double bottoms, triple tops and triple bottoms, head and shoulders, rising and falling wedges, and the less common rounding tops and rounding bottoms.
However, a few of these recurring chart patterns, such as the rectangle pattern can be either a continuous or a reversal pattern.
Most of these chart patterns can be applied to bar charts, candlestick charts, and line charts. Some technicians suggest that the best type of chart for identifying common chart patterns is the line chart. However, some chart patterns are specific to bar charts, candlestick charts, and point and figure charts.
Quite a number of these patterns, such as the flag, pennant, head and shoulders, and rising and falling wedges have logical price objectives where a trader could seek to take profits. However, these price objectives do not represent the end of a particular price action and should not be misconstrued as a point at which to reverse one's position as it does not mark the start of a new trajectory in the price action.
Furthermore, technical analysis is not an exact science, thus these patterns indicate direction and target prices not with absolute certainty, but with a degree of high probability. However, there is a danger of seeing patterns that are not there. For this reason, the use of volume as confirming the underlying market psychology and possibly the use of other technical indicators is highly recommended.