CHART PATTERN ANALYSIS FOR BETTER INVESTMENT

Spread the love

Chart pattern is graphical presentations of price information of securities over time. They plot historical data based on a combination of price, volume as well as a time interval.

For example, line, bar, candlestick chart patterns are the major ones.

TOPICS TO COVER

  1. Types of chart patterns
  2. Parts of candlesticks
  3. History of candlestick
  4. Categories of chart pattern
  5. Caution
  6. DIFFERENCE BETWEEN CONTINUATION AND REVERSAL CHART PATTERN
  7. WHY USE CHART PATTERN
  8. FAQs

TYPES OF CHART PATTERN

1. LINE CHART

The line chart is the most basic type of chart. Because it is formed by employing only one data point (the close price).

Only the closing price is plotted to draw a line chart for various time frames. Therefore the line chart has very little significance in TA as it only shows only the closing price. But the line chart is simple and one can easily identify the trend.

As it ignore open, high, low, and only consider close price, thus traders prefer not to use the line charts.

ALSO READ: Line chart

2. BAR CHART

Bar charts are a little more versatile as compare to line charts because they represent four data points: open, close, high, low. The components of bar charts are:

  • The central line:
    • The top indicates the highest price.
    • Likewise, the bottom end indicates the lowest point
  • The left mark: Indicate the open.             
  • Similarly, the right mark: Indicates the close.   
Bar chart pattern

In bar charts, if the open is higher than the close of the market price then the bar chart is drawn in red color & vice versa.

Bullish Bar chart
Bearish Bar chart

ALSO READ: Bar chart

3. CANDLESTICK PATTERN

bullish and bearish candlestick
bullish and bearish chart pattern

Similarly, candlestick is formed with four data points: open, low, high, and close & rectangular body represents the body of the candlestick.

If the closing price is higher than the opening price then the candle is either green or white (bullish).

And if the closing price is lower than the opening price then the candle is either red or black(bearish).

In addition, the color of the candle is customizable.                                         

PARTS OF CANDLESTICKS                                     

Candle is formed by two-part: body and shadow. In addition, shadows are also divided into two parts: upper shadow and lower shadow. The shadow is also known as a wick (upper wick and lower wick).

Components of candlestick
  1. The central body: The central body has a rectangular body that shows the open and close price.
  2. The upper shadow: Connects the high point and represents the highest price.
  3. The lower shadow: Similarly, it connects the lower point and represents the lowest price.

HISTORY OF CANDLESTICK

The name suggests the candlestick is originated in Japan. Therefore, it is first used by the Japanese rice merchants back in the 18th century. So, people used candlesticks in trading for centuries.

Japanese traders use the candlestick for centuries, but the western traders remain clueless about it until the late 1980s.

Steve Nison discovered the candlestick accidentally and after that introduced the concept and methodology to the rest of the world.

He write the first-ever book on candlestick patterns to make the world familiarize with Japanese Candlestick. so most of the candlestick pattern holds their centuries-old Japanese name.

CATEGORIES OF CHART PATTERN

Chart patterns can be divided into three categories. These are:

(I)REVERSAL CHART PATTERN:

Indicates that a ongoing trend may change direction.

So, an uptrend followed by a reversal pattern indicates that a downtrend or sidewise trend may come.

Similarly a downtrend followed by a reversal pattern indicates that an uptrend or sidewise trend may come.

Some important Reversal chart patterns are:

BULLISH

  1. Double bottom
  2. Triple bottom:
  3. Reverse Head and Shoulder
  4. Descending wedge
  5. Bullish expanding triangle

BEARISH

  1. Double top
  2. Triple top
  3. Head and shoulder
  4. Rising wedge
  5. Bearish Expanding triangle

(ii) CONTINUATION CHART PATTERN:

Signals that a ongoing trend will continue.

BULLISH

  1. Cup and handle
  2. Bullish pennant
  3. Bullish Flags
  4. Ascending triangle

BEARISH

  1. Inverted cup and handle
  2. Bearish pennant
  3. Descending Triangle
  4. Bearish Flags

In conclusion, a continuation pattern in an uptrend indicates that the uptrend will continue and vice versa.

Rounding bottom: They represents either continuation or reversal depending on the market situation.

CAUTION

(i) Use chart patterns with volume, indicators for confirmation.

(ii) Chart patterns are just indicators and therefore there is no guaranty that the price of the security will follow the predicted direction.

(iii) Chart patterns are objective because traders own view, perception, biases direct his decision. Thus the same chart pattern can indicate different signals (buy/ sell) for different traders.

(iv) Most importantly, have realistic expectation.

DIFFERENCE BETWEEN CONTINUATION AND REVERSAL CHART PATTERN

In technical analysis, we assume that price moves in trends, and history repeats itself.
When bulls control the market, the demand increases which leads to an uptrend. Similarly when the force of supply is dominant then bears are the controller of the market-leading to a downtrend.

However, price fluctuates and never trend forever as the bears and bulls repeatedly switch their position as the dominant force of the market. Hence chart pattern begins to emerge.

Chart pattern falls largely in two groups:
1. Reversal pattern:
(i)Reversal pattern indicates a change of the trend
(ii)It can be broken down into top or bottom formation.
2. Continuation pattern: Continuation pattern indicates a pause in the trend an indication that the price will resume the previous trend after a period of time.

WHY USE CHART PATTERN

There are hundreds and thousands of investors or traders participate in the stock market (buy or sell) to earn profit. Their decision to buy or sell is influenced by a wide variety of reasons.

They are the hope of gain, fear of loss, someone’s advice, brokers advice, hedging, tax consequences, short-covering, long built up, long covering, short built up, stop-loss triggering, fundamental analysis, some major announcement of the Govt., price target triggering, and many many more.

So trying to figure out the reason behind the decision of each and every market participant is a daunting process. In TA (chart analysis) how is more important than why.

Chart patterns are the concise picture which is formed by considering the forces of supply and demand generated by all the selling and buying occurs in the market.
So Chart patterns are the reflection of all known and unknown information present in the public domain. So chart patterns is the complete picture of the battle between bulls and bears

In conclusion, technical analysis is very helpful to identify great trading opportunity and

ALSO READ:
1. WEDGE PATTERN
2. HEAD AND SHOULDER CHART PATTERN

FAQs

Q.1. DO CHART PATTERNS REALLY WORKS?

ANS: Charts works for two reasons:
First, Charts are the visual representation of supply and demand which affects the price of the security and forces it to move around in a certain way on the price chart and form a pattern to which trader forms a memorable name.

Second, Most popular chart patterns are known by almost all traders who largely look to trade in a similar way. Hence the price move in the desire direction. These are known as the self-fulfilling prophecy.

Whatever the reason behind the effectiveness of Charting techniques, it is a highly profitable way to learn easy money.

Q.2. Why are chart patterns are so important?

ANS: Stock chart patterns are visual representations of the price action of the stock market. It can be over any time frame—second, 1 min, 5 min, 1 hour, 3 hour, daily, weekly, monthly, yearly, etc. The chart patterns tend to repeat itself. That’s why chart patterns are an integral part of Technical analysis.

Q.3. What are the best chart patterns should I look out for?

ANS: Market is highly versatile and hundreds and thousands of situations can occur in the stock market. So there is no “best” chart pattern. The term “best chart pattern for a particular market” is more suitable and accurate.

Leave a Comment