Chart Patterns

Using chart patterns to explain prices. The sole purpose of this article is to show our point of view, our way of viewing chart patterns.

There is the classical way of looking at patterns, naming them and attempting to “predict” the future using them, and then there is our way, which is more simplistic and practical.

Chart patterns are caused by different support or resistance lines. Some are horizontal and some are diagonal. Support or resistance lines on the price chart are caused by changes in the collective psychology of traders that are participating in the trading instrument.

As a simple example, let’s use an all time high on a stock. Let’s say that the all time high is 35. The stock has been bumping against this level for quite a while, but never broke it. That makes it a resistance level. The psychology behind it is very simple. If all time high is 35, it means that everyone who has ever bought the stock owns it below 35. Everyone who is short the stock is short below 35 as well. The stock will keep bumping against the 35 level, since people are reluctant to buy at the absolute high.

As soon as the stock does trade above 35, there will be an interesting situation. All buyers will now be profitable, since they all own the stock below 35. They will not be in a hurry to sell at this point, since they have a profit. All short sellers are now at a loss, since the stock is going above their entry price. Short sellers will have to cover by buying the stock and driving it up. This is a simple breakout description and explains the basics of price patterns.

The most basic price pattern is a trend. A trend is a series of waves which can be sideways, up or down. An up trend is a series of higher highs and higher lows. A down trend is a series of lower highs and lower lows. A sideways trend can be called a range.

When these waves are tight, as in narrow range between the highs and the lows, you have base patterns and ranges. These usually show the actual trend. A break out of these ranges can either accelerate the trend or decelerate the trend.

The next set of patterns, basically, mark the stop of a trend. These patterns can result in a reversal of trend or a start of a new trend in the same direction.

The next set of patterns usually mark trend reversals, although they can also generate a continuation of trend. The continuation of trend dives into the more complicated roam of combination of patterns and so on.

The problem with classical technical analysis is that it tries to predict the market. By classifying and naming different patterns, people tend to “expect”, which in turn locks them into a mind set. Any time a trader is locked, convinced, expects or sure, they are setting themselves for failure. The market is a breathing living animal, a trader an only follow it, not rule it.

Chart patterns should be viewed as possible points of entry, a way to follow the beautiful flow of prices. Understanding patterns allows us to become familiarized with price action, which is always king.

Our online courses expand on price patterns and how to trade using them as a guidance.