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Chart patterns are an important aspect of technical analysis, but they need some familiarity before they can be used effectively. To help you get to grips with them, here are 10 chart patterns that every trader must know.
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Chart patterns are shapes within a price chart that help suggest what prices mht do next, based on what they have done in the past. Chart patterns are the basis of technical analysis and require traders to know exactly what they are looking for, as well as what they are looking for.
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There is no ‘best’ chart format, as they are all used to hhlht different trends in many markets. Often, chart patterns are used in candlestick trading, which makes it easier to see the opening and closing of the previous market.
Some styles are more suited to a changing market, while others are less so. Some patterns are best used in trending markets, and some patterns are best used when the market is down.
That being said, it’s important to know the ‘best’ chart style for your particular market, as using it incorrectly or not knowing which one to use could cause you to miss out on a profitable opportunity.
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 the price of the asset stops falling and bounces back. Resistance is where the price usually stops rising and falls back down.
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The reason for the support and resistance levels is due to the balance between buyers and sellers – or demand and supply. When there are more buyers than sellers in the market (or more demand than supply), prices tend to rise. When there are more sellers than buyers (supply is greater than demand), prices tend to fall.
For example, the price of an asset may increase because demand exceeds supply. However, eventually the price will reach the maximum that buyers are willing to pay, and demand will decrease to that price level. At this point, mht buyers decide to close their positions.
This creates resistance, and the price starts to fall towards the support level as the supply starts to exceed the demand as more and more buyers close their positions. When the price of an asset falls enough, buyers mht buy back into the market because the price is now more acceptable – creating a support level where supply and demand begin to equalize.
If the increased buying continues, it will bring the price back to the resistance level as the demand starts to increase compared to the supply. When the price breaks through the resistance level, it may become a support level.
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For all these models, you can take positions with CFDs. This is because CFDs allow you to go short and long – meaning you can predict the market going down as well as going up. You may want to go short during a reversal or continuation down, or long during a reversal or continuation – whether you do so depends on the model and market analysis you have implemented.
The most important thing to remember when using chart patterns as part of your technical analysis, is that they are not a guarantee that the market will move in the predicted direction – they are only indicators of what may happen to the price of the asset.
A head and shoulders is a chart pattern where a large peak has a smaller peak on one side of it. Traders look at head and shoulders patterns to predict a bullish-to-bearish reversal.
Typically, the first and third peaks will be smaller than the second, but they will all return to the same support level, otherwise known as the ‘neckline’. When the third peak has fallen back to the support level, it is likely that it will break out into a bearish decline.
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The double top is another pattern that traders use to hhlht trend reversals. Typically, the price of the asset will experience a peak, before returning to the support level. It will then climb once more before permanently reversing back against the prevailing trend.
The double bottom chart pattern indicates a period of selling, which causes the asset price to fall below the support level. Then it will rise to the level of resistance, before falling again. Finally, the trend will reverse and start moving higher as the market becomes more bullish.
A double bottom is a trend reversal pattern, as it marks the end of a downtrend and a change to an uptrend.
Round bottom chart pattern can sniff continuation or reversal. For example, during a trend the price of an asset may fall slightly before rising again. This will continue the trend.
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An example of a pull-down reversal – shown below – could be if the price of an asset is in a downtrend and a bottom cycle occurs before the trend reverses and enters an uptrend.
Traders will find capital in this pattern by buying halfway around the bottom, at low points, and investing in continuation when it breaks above the resistance level.
The cup and handle pattern is a trend continuation pattern that is used to show a period of declining market sentiment before the overall trend finally resumes in a trending movement. The cup appears similar to the round bottom table style, and the handle is similar to the wedge style – which is explained in the next section.
After the bottom round, the price of the asset may enter a temporary retracement, which is called a handle because this retracement is limited to two parallel lines on the price chart. The asset will eventually break out of the breakout and continue its upward trend.
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Wedges form the price movement of thten assets between two downward trend lines. There are two types of wedge: rising and falling.
A rising wedge is represented by a trend line caught between two support and resistance lines. In this case, the support line is steeper than the resistance line. This pattern generally predicts that the price of the asset will eventually fall permanently – which is shown when it breaks the support level.
The fall occurs between two levels down the slope. In this case, the line of resistance is steeper than the support. A falling wedge usually indicates that the price of the asset will rise and break the resistance level, as shown in the example below.
Both rising and falling wedges are reversal patterns, with rising wedges representing a bearish market and falling wedges typical of a bullish market.
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Pennant patterns, or flags, are created after an asset experiences a period of upward movement, followed by consolidation. In general, there will be a snificant increase in the early stages of the trend, before it enters a series of ups and downs.
Pennants can be bullish or bearish, and they can represent continuation or reversal. The chart above is an example of a bullish continuation. In this regard, pennants can be a form of two sides because they show continuity or reversal.
While the pennant may seem similar to the wedge pattern or triangle pattern – explained in the next section – it is important to note that wedges are narrower than pennants or triangles. Also, wedges differ from pennants because the wedge is always up or down, while the pennant is always up.
An ascending triangle is a trend continuation pattern that causes an upward trend continuation. An ascending triangle can be drawn on a chart by placing a horizontal line along the swing hhs – resistance – and then drawing an ascending trend line along the swing lows – support.
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Small to large triangles often have two or more identical vertices that allow a horizontal line to be drawn. The trend line sniffs the overall upward trend of the pattern, while the horizontal line indicates the historical level of resistance for that particular asset.
On the other hand, the descending triangle will sniff a
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