Top 10 Stock Chart Patterns
For technical analysts, swing traders and day traders, stock chart patterns are necessary tools to find profitable trades. In this article, we will talk about the top 10 stock patterns that are the most useful in finding entry and exit points in the stock market.
Continuation and Reversal Chart Patterns
There are mainly two types of stock patterns, continuation and reversal chart patterns.
Continuation patterns are used to identify stocks that may continue the current trend. On an uptrend, continuation patterns are effective in finding entry points to establish long positions. On a downtrend, continuation patterns are used to go short on a position or to take profits on a long position.
1. Ascending Triangle Pattern
Ascending triangle pattern is a powerful continuation pattern that is used to find bullish stocks. When a stock is on an uptrend, and an ascending triangle pattern occurs, it indicates strength for the stock.
To form a bullish ascending triangle pattern, a stock chart must meet the following three criteria.
1. A stock is in an uptrend
2. It forms an ascending triangle
3. It breaks out from the triangle and goes higher
When the ascending triangle pattern appears, it triggers an entry to buy a stock or add to an existing position.
2. Descending Triangle Pattern
Descending Triangle Pattern is the exact opposite of the ascending triangle pattern. It is a bearish continuation pattern that shows up on a downtrend of a stock chart. The descending triangle pattern indicates weakness for a stock.
Here's how a descending triangle pattern is formed.
1. A stock is in an downtrend
2. It forms a descending triangle
3. It breaks out from the triangle and goes lower
When the descending triangle shows up on a stock chart pattern, it is a signal to setup a short position. If you are long on a stock and sees this pattern, it may be time to sell the stock for profit or cutting your losses.
3. Double Bottom Pattern
Double bottom is a bullish reversal pattern that signals a change of trend. When a stock is in a down trend and the double bottom pattern occurs, it is a sign of strength.
Following is a how double bottom pattern is formed.
- A stock is in a down trend, and it hits a new low usually on higher volume.
- The stock then rallies, and declines again but failed to break the previous low or support.
- The stock then rises again and rallying above the previous high or break resistance.
The stock chart pattern generates a bullish entry when the stock rises above the previous resistance.
4. Double Top Pattern
Double top is similar to double bottom except that it is a bearish reversal pattern. When a double top pattern shows up on an uptrend, it is time to go short or cut long positions for swing traders and day trader.
- A stock is in an uptrend, and it hits a new high usually on higher volume.
- The stock then declines, and rallies again but failed to break the previous high or resistance.
- The stock then declines again and falls below the previous low or break support.
When the double top pattern occurs on an uptrend, it is time for short term long traders to cut their positions. The double top pattern shows that there is a good chance a downtrend is on the way.
5. Head and Shoulders Pattern
Head and Shoulders is a bearish reversal pattern. When a head and shoulders pattern occurs on an uptrend, it is time to be very cautious.
To form a head and shoulders pattern, a stock chart must do the following
1. A stock is in an uptrend, and it rallies to a peak on heavier volume and then pulls back. (Left shoulder).
2. The stock then rises again and moves higher than the previous peak with lighter volume.
3. It declines again and moves below the previous peak (Head).
4. The stock then rises a third time on noticeably lighter volume and fails to pass the peak of the head and declines (Right shoulder).
5. If the stock drops below the neckline, a head and shoulders pattern is formed.
The head and shoulders pattern signals further decline is likely. Therefore, it is now the time for traders to sell their long positions or establish short positions.
6. Inverse Head and Shoulders Pattern
As the name suggests, inverse head and shoulders pattern is the opposite of the head and shoulders pattern. It is a bullish reversal pattern that happens on a downtrend.
1. A stock is in a downtrend. It drops to a new low and then rises up (Left shoulder).
2. It then drops again and moves lower than the previous bottom and rallies again (Head).
3. The stock then declines another time but fails to break the previous bottom and bounces back. (Right shoulder)
4. When the stock rises above the neckline, an inverse head and shoulders pattern is formed.
Inverse head and shoulders is a bullish pattern indicating the stock is likely to continue the uptrend from there.
7. Cup and handle pattern
Cup and handle is a continuation bullish pattern where a buy signal is generated for a trade.
- On a bar chart, a cup is the round bottom (U shape) of chart pattern when a stock is declining to a new low and then bounces back.
- The handle is formed when the stock reaches a new high and then drops slightly to formed a cup handle.
When the cup and handle pattern is formed, short term swing traders may want to go long on a stock. However, traders should always set stop loss on every trade they place. A pattern is just an indication, it doesn't guarantee a stock will continue to be bullish.
8. Triple Bottom Pattern
Triple bottom pattern is a bullish reversal pattern that triggers a buy entry for technical traders. Similar to the double bottom pattern, triple bottom occurs at the bottom of a stock chart.
- The prior trend is a downtrend when the triple bottom pattern occurs.
- Instead of hitting bottom twice like the double bottom pattern does, triple bottom pattern bounces from support three times.
- The triple bottom pattern is completed when the stock rallies for the third time and break the previous resistance.
The triple bottom pattern produces a strong signal for long positions because the stock tested the new low multiple times and refuses to go lower. That means there are more people who are buying the stock than those who are selling which may ultimately drive the stock price higher.
9. Triple Top Pattern
Triple top pattern is a bearish stock pattern that occurs on an uptrend. When this pattern shows up on a stock chart, it is time to be very cautious.
- The prior trend is an uptrend
- The stock hit a new high and declines and fail to break the new resistance twice
- The stock then declines and drops lower than the previous support, and completes a triple top pattern
The triple top pattern shows that there are more sellers than buyers. As buyers fail to drive the stock price any higher, the stock breaks down and starts a downtrend.
10. Symmetrical Triangle Pattern
Last but not least, the Symmetrical Triangle Pattern. There are two types of symmetrical triangles, bullish and bearish patterns.
The bullish symmetrical triangle is very similar to the ascending triangle pattern.
A bullish symmetrical triangle is formed when the following conditions are met.
1. The prior trend is an uptrend
2. It forms a symmetrical triangle
3. It breaks out from the triangle and goes higher
When a trader spots a bullish symmetrical triangle, it is time to go long on a stock.
A bearish symmetrical triangle is a bearish pattern and it is formed with the following criteria.
1. A stock is in an downtrend
2. It forms a symmetrical triangle
3. It breaks out from the triangle and declines lower
When the bearish symmetrical triangle is formed, consider cutting long positions as the pattern implies the stock could decline further.
Trading Mindset
These are the top 10 stock patterns for short term trading. Please keep in mind simply knowing the patterns is not enough to beat the stock market or any other market. There are other elements in trading that a beginner should learn, such as trading psychology and trading plan.
A stock pattern is only an indication, it doesn’t guarantee that a stock will go one way or the other. During those times when a pattern fails to deliver the results that you expect, you must have the discipline to quickly cut a losing trade. To learn more about trading psychology, read The New Trading For a Living and Trading in the Zone.