04 discovering multiple period chart patterns

8/10/2019 04 Discovering Multiple Period Chart Patterns

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Technical pattern analysis is an art form, it is not

a science, and subsequently it is very difficult to

automate. This is why one traders view on the chart

may differ from anothers. The main issue with pattern

recognition is that traders can often be so desperate to

see a pattern that they fool themselves into believing

one is there, when it is not. Unless the pattern jumps

out of the screen then caution should prevail. Seeing

something that is not there suggests that you will be

trading on incorrect information, which can often lead

to losses.

Chart pattern analysis can be used to make short-

term or long-term forecasts. The analysis can be done

intraday, daily, weekly or monthly and the patterns

can be as short as a matter of minutes or as long as a

number of years. In the following, some of the more

popular chart patterns will be reviewed.

HANTEC RESEARCH WEBINARS - TECHNICAL ANALYSIS SERIES

4. Discovering Multiple

Period Chart Patterns

Chart Patterns

One of the basic premises in technical analysis is

that history repeats itself and the theory behind

chart patterns is based on this assumption. A

chart pattern is a distinct formation on a price

chart that gives an indication of the future price

movement.

It is through recognising these chart patterns

that we can get an indication of how high

the probability of a price moving in a specific

direction is. In short, we look for chart patterns

to identify trading opportunities.

As previously discussed in our Trade with

Trendlines session, there is a popular saying in

technical analysis, the trend is your friend. A

trend is merely an indicator of an imbalance

in the supply and demand which is shown

through changes in acceptable levels of theprice. These price changes can often develop into

recognisable chart patterns that act as signals for

deriving potential future movements in price.

Most importantly though, chart patterns in

technical analysis can help to determine whether

it is the bulls that are winning the battle, or it

is the bears. As a trader it is possible to then

position yourself accordingly.

BEGINNER / INTERMEDIATE

Top Tip: Dont see

what isnt there!

When learning about technical pattern

recognition, one of the big mistakes to

avoid is to think that you see a pattern

that is not there.

If it doesnt hit you between

the eyes, then it is not a pattern.

In my experience, this can often be the

case with patterns that have a sloping

neckline.

Reversal patterns

The Reversal pattern suggests that the current

trend is coming to an end and that the pattern is a

signal for the beginning of a new trend.

Continuation patterns

The Continuation pattern signals that the existing

trend will remain in place after a period of

consolidation and the completion of the pattern.

There are two main categories of charting patterns:


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Reversal Patterns: Tops and Bottoms


4. Discovering Multiple Period Chart Patterns

Whats in a name? A top is just a top and a bottom is just a bottom.

Just before we delve into the detail of the variety of tops

and bottoms, I am going to keep it simple. Whether you

are looking at a Head & Shoulders top, a Double Top, aTriple Top or a Rounding Top, the implied target will be the

same. It will still be measured from the pattern peak to the

neckline and projected downwards.

Therefore there is no need to get bogged down with what you call your top pattern. As long as the

basic principles of building the pattern are there, a top is a top. The basics of technical analysis can be

formed in Dow Theory, which states that uptrends are defined as a series of higher highs and higher lows

(downtrends are defined as a series of lower lows and lower highs).

Therefore, as long as you have a high in the price with a subsequent reaction low; followed by renewed

upside which fails at or just below the previous high (breaking the sequence of higher highs), and a move

back below the previous reaction low (breaking the sequence of higher lows), the top pattern will be

complete.

Ultimately, the number of times that the highs and lows are tested before the pattern completes is of

minor detail (although it can add to the conviction on the break). The most important fact we need to be

concerned with is the fact that a reversal pattern has completed and there is a change of trend underway.

Is it a head and shoulders?Or is it a double top?

Trading the Pullback

Very often on the completion of a pattern breakout, there will also be a pullback. The pullback uses theprinciple that in a bullish breakout, old resistance becomes new support; whilst in a bearish breakdown, old

support becomes new resistance. Subsequently, in an upside breakout, this pullback correction gives the bulls

a second chance to buy. Also, in a downside break, a pullback rally gives the bears a second chance to sell.

Fig 1. Illustrating the concept of a pullback


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Head & Shoulders

This is one of the most popular and reliable chart patterns in technical analysis. A head & shoulders is a reversal

chart pattern that when formed, signals that the price is likely to move against the previous trend. There are

two versions of the head & shoulders chart pattern. The Head & Shoulders Top is a pattern that is formed at

the high of an upward movement and signals that the upward trend is about to end. A Head & Shoulders

Bottom, also known as an inverse head and shoulders is the opposite pattern and is used to signal a reversal in

a downtrend.

Also note how in Fig 3, in the second hour following the completed breakout,

there is a pullback correction back to the neckline support which gives a second chance to buy.

Technical analysis theory suggests that a target can be derived from the completed head and shoulders pattern.For the top patterns, measuring the move from the tip of the head to the neckline and then projecting this

measurement downwards gives us an implied downside target.

Fig 2. A head & shoulders top on the STOXX 600 hourly chart

Fig 3. A head & shoulders bottom on the Sterling/Dollar hourly chart

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Both of these head &

shoulders patterns are

similar in that there are

four main parts: two

shoulders, a head anda neckline. Also, each

individual head and

shoulder is comprised of

a high and a low. For

example, in Fig 2, the

right hand shoulder is

made up of a low at the

support of the neckline,

followed by a lower high

and subsequent breach of

support to complete thepattern. Remember that an

upward trend is a period of

successive rising highs and

rising lows. With the head

& shoulders top pattern,

the neckline is a level of

support throughout the

pattern that illustrates a

weakening in a trend that

subsequently breaks down.


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Double Tops and Double Bottoms

Double Tops and Double Bottoms are popular trend reversal patterns. Formed after a sustained

trend, the pattern is created when a price movement tests support or resistance levels twice and isunable to break through. The breakouts from double tops and bottoms are often considered to

move with greater conviction than other reversal patterns.

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Fig 4. A double top on the Euro/Dollar hourly chart

Fig 5. A double bottom on the Dollar/Yen hourly chart

N.B. Imperfect

pattern targets

Patterns are imperfect where the reaction from the neckline in the second move may not bequite as large as the first move, leaving a pattern that is not uniform in shape.

You can either derive a conservative target (from the smaller peak/trough)

or measure the full implied target (higher conviction).

In the double top

pattern, the price

movement has twice

tried to move above

a certain price level.

After two unsuccessful

attempts at pushing theprice higher, the trend

reverses and the price

heads lower. In the case

of a double bottom, the

price movement has tried

to go lower twice, but

has found support each

time. After the second

bounce from the support,

the price begins a new

trend and heads higher.

As with the head &

shoulders patterns, a

target can be derived

from the breakout. For

double bottoms, measure

from the limit of the

troughs to the neckline

and project higher; whilst

for double tops, measure

from the two peaks tothe neckline and then

project downwards.


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Rounding Tops and Bottoms

Another multiple top and bottom formation is the Rounding Top and Rounding Bottom. Once

more this is a pattern that consists of neckline before the construction of a rounding element to the

pattern rather than an obviously defined series of peaks or troughs. This is far more of a generic

pattern and is often referred to as rounding due to the lack of clarity with the pattern. However,

there is still a topping or bottoming process that plays out and therefore needs to be covered.

The implied target of the rounding bottom pattern comes from the measurement from the key low

up to the neckline resistance and then projected upwards. The rounding top is the opposite.

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Fig 6. A rounding bottom on the Dollar/Swiss hourly chart

Triple Tops and Triple Bottoms

Triple tops and triple bottoms are extensions

of the double top and bottom reversal pattern.Although not as frequently occurring as head

& shoulders, double tops and double bottoms,

they act in a similar fashion. Both patterns are

formed when the price tests a level of support

or resistance three times and is unable to break

through. The breakdown at the neckline signals

a reversal of the prior trend.

N.B. A Triple Top or

a Range Breakout?

The triple formation in reversal patterns

is also the opposite of many Range

Breakouts which are continuation

patterns (see later).


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Triangles

Triangles are some of the most well-known

consolidation patterns used in technical analysis.

The two main types of triangles, which vary in

construct and implication, are the ascendingtriangle and descending triangle.

TheAscending Triangle develops as a

consolidation in the price during a bullish trend.

In an ascending triangle, the upper trendline

is flat, while the bottom trendline is upward

sloping. The ascending triangle is generally

thought of as a bullish pattern in which chartists

look for an upside breakout. The price knocks

up against the resistance, whilst continuing to

leave a series of higher lows. The eventual breakthrough the resistance can often be seen with

a burst through a supply vacuum and a sharp

rise in price. The implied target derived from

the pattern uses the upslope of the triangle,

projected higher from the resistance point.

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N.B.

The Third Triangle

There is a third triangle pattern, the

symmetrical triangle, which is a patternwhere the two trendlines converge

toward each other. However this is

a neutral pattern with no symmetry

between the trendlines and no indication

of which direction the breakout will

subsequently come.

Although the breakout will often be in

the direction of the prevailing trend,with the price action providing little clue

to the breakout during the formation, it

cannot therefore be considered as a true

continuation pattern.

Continuation patterns are technical consolidation patterns that ultimately breakout in the direction

of the prevailing trend prior to the consolidation.

Continuation Patterns - Triangles, Flags, Wedges and Ranges

A downside break from an ascending triangle An upside break from a consolidation range


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The Descending Triangleis the opposite of an ascending triangle and develops as a consolidation

pattern during a bearish trend. In a descending triangle, the lower trendline is flat and the upper

trendline is descending. This is generally seen as a bearish pattern where chartists look for adownside break. The price this time has been trending lower but then encounters support which is

tested on a consistent basis. During this test of support a series of lower highs is left. The eventual

break through the support will often be characterised by a demand vacuum, where a series of stop-

losses are triggered leading to a sharp decline in price. The implied target derived from the pattern

uses the downslope of the triangle, projected lower from the point of support.

Fig 7. An ascending triangle on the Dollar/Yen hourly chart

Fig 8. A descending triangle on the Gold daily chart


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Wedges

A wedge pattern is similar to a flag pattern but the period of consolidation can last a lot longer. As

with flag patterns what tends to happen is that you will get a Falling Wedge in an uptrend, which is a

bullish pattern, and a Rising Wedge in a downtrend which is a bearish pattern. The similar principles

apply as for flag patterns.

Unfortunately, just to make things a little bit more complicated, you can also get falling wedges in

a downtrend (which are usually considered to be a bearish continuation pattern) and also get rising

wedges in an uptrend (which is usually considered to be a bullish continuation pattern).

Fig 10. A Rising Wedge on FTSE 100 daily chart

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Flags

A flag is a short-term continuation pattern, formed over just a few periods. Flags can be both bullish

(in an uptrend) and bearish (within a downtrend). Flags are formed on the consolidation which canfollow a sharp price movement. With a Bull Flag the consolidation can often be characterised by a

gradual drift lower which culminates in another sharp move to the upside in the same direction as

the prevailing trend.

A Bear Flag is the

opposite, with a sharp

decline followed by a

consolidation pattern

(which can often contain

a slight upside drift.The pattern is then

completed after another

sharp price movement in

the same direction as the

move that started the

trend.

Fig 9. A Bull Flag on the S&P 500 hourly chart


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Range Breakouts

A Range Breakout is another trend continuation pattern. It is a consolidation phase that follows

a strong move. The consolidation is characterised by a series of highs and lows within a range thateventually break in the direction of the prevailing trend. It is then subsequently possible to trade

in the direction of the breakout. Note how in the example of Euro/Dollar below, how there was a

pullback towards the breakout, before the trend eventually continued higher.

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Fig 11. A Range Breakout on the Euro/Dollar daily chart


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Figure 4: Range trading using the Bollinger Bands on Silver

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04 discovering multiple period chart patterns

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