Lesson 11: Classic Chart Patterns

Part of Module 3: Technical Analysis - The Art of Reading Charts

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Introduction: Footprints in the Sand

Over many years, traders have noticed that price action often forms recognizable shapes or "patterns." These patterns reflect the psychology of the market—the ongoing battle between buyers and sellers.

The Two Main Types of Patterns

Chart patterns are generally categorized into two main types:

1. Reversal Patterns: These patterns suggest that the current trend is losing momentum and may be about to change direction.
2. Continuation Patterns: These patterns typically appear as a brief pause or consolidation during a strong trend, suggesting the market is just "taking a breather" before continuing in the same direction.

Common Reversal Patterns

• Head and Shoulders: One of the most reliable reversal patterns. It looks like a baseline (the "neckline") with three peaks: a left shoulder, a higher middle peak (the "head"), and a right shoulder. It signals that buyers are losing momentum.
• Double Top & Double Bottom: A Double Top looks like the letter "M" and forms when the price hits a resistance level twice and fails to break through. A Double Bottom looks like the letter "W" and forms when the price hits a support level twice and fails to break lower.

Common Continuation Patterns

• Flags and Pennants: These are small, brief patterns that form after a very strong, sharp price move. A Flag looks like a small rectangular channel angled against the trend, while a Pennant looks like a small symmetrical triangle. Both signal that the market is likely to make another strong move in the original direction.
• Triangles (Ascending, Descending, Symmetrical): These patterns show a battle between buyers and sellers. An Ascending Triangle has a flat top and rising lows (bullish), while a Descending Triangle has a flat bottom and falling highs (bearish).

The Most Important Rule: Wait for the Breakout!

A chart pattern is only a potential setup. It is not confirmed until the price breaks out of a key level (like the "neckline" of a Head and Shoulders or the edge of a triangle). Trading inside a pattern before it has confirmed is a common and costly mistake for new traders.