Price pattern

Price pattern also known as chart patterns are the basic concepts in technical analysis. Price pattern is characteristic visualisation of goods (for example stocks, currencies, gold, oil, etc.) price on chart. Based on Dow Theory price patterns are indicatiors of future market movements. There are two types of price patterns: reversal patterns - suggest major market change (trend reversal) and continuation patterns - suggest that market only slows down for bigger accumulation/distribution.

Reversal patterns

The most popular reversal patterns are:

• Head and shoulders/reversal head and shoulders - formation head and shoulders is one of the basic reversal pattern formations. That price structure is build form three peaks on the top of ascending trend. Left and right peaks should be at lower level than middle peak. Formation is fully formed when price movement cross line which connects 2 low levels place between left shoulder - head and head - right shoulder (so called neckline). Similar situation observed during descending trend is called reversal head and shoulders.
• Triple top/triple bottom - formation tripple top (ascending trend) or tripple bottom (descending trend) is one of the strongest reversal pattern. It's formed by 3 consecutives lows/highs drawed on price chart. It's very similar to head and shoulders, but the only difference is that middle peak is placed on the same level as neighboring peaks.
• Double top/double bottom
• V formation
• Cup formation

Continuation patterns

The most popular continuation patterns are:

• Triangles:
  • Symmetrical - it's price pattern that occurs during both ascending and descending trend. It's recognized as pattern that indicates current trend continuation. It's build from 2 convergent lines upper resistance line and lower support line.
  • Ascending - ascending triangle it's a price pattern formed during ascending trend. It's build from upper horizontal resistance line and lower ascending support line. Signal for taking long position is when price breaks upper resistance line. Ascending triangle is bullish formation.
  • Descending - descending triangle it's a price pattern formed during descending trend. It's build from upper descending resistance line and lower horizontal support line. Signal for taking short position is when price breaks lower support line. Descending triangle is bearish formation.
  • Expanding - expanding triangle is considered as reversal pattern. It's usually formed at the end of ascending trend. Expanding triangle represents situation on market when many investors is involved and they are guided by pure emotions. It's build from two expanding lines: upper - resistance line and lower - support line.
• Flag
• Pennant
• Weggie
• Rectangle

Examples of Price pattern

• Head and Shoulders: This is a popular reversal pattern that appears at the end of an uptrend and signals that the trend may be coming to an end. The pattern consists of three consecutive peaks: two smaller peaks, called shoulders, on either side of a larger peak, called the head. The pattern is considered complete when the price falls below the neckline formed by the two lower peaks.
• Double Top and Double Bottom: This is another popular reversal pattern that usually appears at the end of an uptrend or downtrend. The pattern consists of two consecutive peaks or lows that are roughly at the same price level. The pattern is considered complete when the price breaks below the support or resistance level formed by the two peaks or lows.
• Flag and Pennant: This is a continuation pattern that appears in the middle of a trend. The pattern consists of two parallel lines (flag) or a triangle (pennant) that slope in the same direction as the trend. The pattern is considered complete when the price breaks above or below the flag or pennant.

Advantages of Price pattern

Price pattern is an important tool used in technical analysis to identify potential market movement. It has various advantages such as:

• It gives a clear visual representation of the current and past market trends. This makes it easier to identify potential future market movements.
• By looking at the price patterns, traders can determine whether the market is in a bullish or bearish mood and can adjust their strategies accordingly.
• Price patterns can also be used to identify support and resistance levels which can be used to determine when to enter and exit trades.
• Price patterns can be used as a signal for traders to determine when to buy and sell.
• Price patterns can help to identify potential trend reversal points.
• They can also provide insight into the strength of a trend and whether the trend is likely to continue.

Limitations of Price pattern

Price patterns are a useful tool used in technical analysis; however, they have several limitations. These include:

• Lack of accuracy: Price patterns are based on past price movements and are not necessarily indicative of future developments. Additionally, the same pattern may have a different interpretation depending on the analyst.
• Subjective analysis: Due to the subjective nature of interpretation, different analysts may have differing opinions on the same price pattern.
• Limited scope: Price patterns are limited in scope and only cover a small portion of the market.
• Time-frame dependency: Price patterns are dependent on the time-frame being used, with different patterns being applicable on different time frames.

Other approaches related to Price pattern

• Volume analysis - an approach that uses volume of traded assets to understand its price movement.
• Support and Resistance - a concept where certain price levels are considered as strong to beat for buyers or sellers.
• Trendlines - a graphical tool used to identify up and down trends in the market.
• Moving averages - a tool used to smooth out price fluctuations and identify the main trend.
• Candlestick analysis - a technique that uses candlestick patterns to identify the market sentiment.

In summary, price pattern analysis is one of the main approaches to technical analysis, however there are other approaches such as volume analysis, support and resistance, trendlines, moving averages, and candlestick analysis that are also used. Each of these approaches has its own advantages and can be used in combination with price pattern analysis to give more complete insight into the market.

Footnotes

Price pattern — recommended articles

Long-legged doji — Dragonfly Doji — Bullish divergence — Gravestone doji — Bear flag — Symmetrical triangle — Bull flag — Three white soldiers — Uptrend

References

• Caginalp G., Laurent H., (1998), The predictive power of price patterns, Mathematical Finance 5
• Goumatianosa N., Christoua I., Lindgrenb P., (2013), Stock Selection System: Building Long/Short Portfolios Using Intraday Patterns, Procedia Economics and Finance 5
• Lim M. A., (2016), The Handbook of Technical Analysis: The Practitioner’s Comprehensive Guide to Technical Analysis, John Wiley & Sons Singapore Pte. Ltd.
• Murphy J., (1999), Technical analysis of the financial markets, New York Institute of Finance
• Osler C. L., Chang P.H.K., (1995), Head and shoulders: Not just a flaky pattern, Staff Report, No. 4, Federal Reserve Bank of New York

Author: Agata Skalska