HIGH GROWTH INVESTMENTS
Understanding Chart Patterns
Technical analysis is the study of market action, primarily through the use of charts , for the purpose of forecasting future price trends. The term "market action" includes price volume and range.
Technical analysis is based on three premises:
1) Market action discounts everything
2) Prices move in trends
3) History repeats itself
Chart patterns are formations or pictures on stock charts derived from price action. Chart patterns are classified into two major categories, reversal and continuation. Both patterns assume that there is a trend already in place.
Another important consideration when confirming the validity of any pattern is volume. In times of doubt, the study of volume accompanying the price data will often be the catalyst as to whether the pattern can be validated.
This section is designed to introduce you to some of these chart patterns, as well as teach you to identify repetitions in the market, to make timely and more accurate decisions when forecasting market trends.
The Flat Base is a continuation pattern and goes horizontal for any length of time. I like to see flat bases last for a minimum of five to eight weeks. Another trait of a strong flat base is a tight price range.
At the top of the range there are willing sellers (supply) at the bottom of the range there is willing buyers (demand). Not until the last seller sells at that level will price advance.
Another thing I look for is volume drying up as time passes (fewer sellers).
The buy point on this pattern is when price crosses through a point just above a trend line at the top of the range.
As price breaks through the upper trend line it must be confirmed by increased trade.
The Symmetrical Triangle is usually a continuation pattern. It represents a pause in the existing trend which is typically resolved with the continuation of the existing trend.
It is represented by two converging trendlines, the upper line descending and the lower line ascending.
A minimum of four reversal points is required to qualify as a triangle. Very often a triangle has six reversal points. three peaks and three troughs.
Supply and demand are considered nearly equal here. The price at which sellers are willing to sell and buyers are willing to buy gets closer together as the pattern forms.
Again we look for volume to be falling off, but we like to see a bit more volume on up days and a volume surge during an upside (bullish) break and vica-versa for a downside bearish) break.
The Ascending Triangle is a bullish continuation pattern. In this pattern the upper line is flat while the lower line is rising. Here the price that buyers are willing to buy gets higher as the pattern forms.
Volume is an important part of the validation of this pattern. A break of the trendline should come with a rise in trade.
Occasionally the Ascending Triangle will develop at the end of a downtrend. Never the less the pattern is still interpreted as bullish. The break of the upper line signals the completion of the base.
The Descending Triangle is a mirror image of the ascending triangle and considered bearish. The pattern indicates that sellers are more aggressive than buyers and typically resides to the downside.
The supply of stock for sale is greater than the demand to buy shares.
The conformation comes when price closes below the lower trendline.
Here we look for volume to fall off while the pattern matures as buyers leave the market. A surge in volume acts as additional confirmation.
The Wedge Formation is like the symmetrical triangle in appearance, they have converging trend lines. Wedges are distinguished by a slant, either to the upside or to the downside. As with triangles, volume should diminish during its formation and increase on its resolve.
A falling wedge is a bullish pattern found in up-trends. But it can also be found in down trends as well. The implication however is still generally bullish. This pattern is marked by a series of lower tops and lower bottoms.
A rising wedge is generally considered bearish and is usually found in down trends. They can be found in up trends too, but would still generally be regarded as bearish. Rising wedges put in a series of higher tops and higher bottoms.
Flags and Pennants are continuation patterns. They usually represent only brief pauses in a dynamic stock. They are typically seen right after a big, quick move. The stock then usually takes off again in the same direction.
Flags and Pennants are continuation patterns. They usually represent only brief pauses as part of a more dynamic move in price.