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Basic Chart Patterns

Chart patterns are the basis for breakout trading, as most (if not all), breakout trades are actually instances of price breaking out of a pattern when the pattern completes. Finding and correctly identifying chart patterns is the first step of preparing the trade. The right pattern must be clearly identified, as there are many instances where something looks like the pattern but in fact is not a pattern. One of the most prominent mistakes like that is e.g. excluding a triangle which is not much triangular, but still has a sequence of lower high points and a sequence of higher low points. When one excludes valid patterns whose only fault is that they are not pretty, one then eliminates potentially good trades, and therefore an initial statistical edge of e.g. 60% for all triangles might drop to an unremarkable 50% when one excludes triangles which are not pretty. The moral of the story is that a pattern is a pattern if it fits its definition, and not because it is an exact copy of a textbook example of the given pattern. Usually, chart patterns are divided into continuation and reversal patterns. Reversal patterns are inherently flamboyant–at every market top, and at most market bottoms one finds a reversal pattern. But be careful: just because there is a reversal pattern at every market top, it does not mean that every reversal pattern is a market top. This is an extremely important point–you can think of it like this: just because every dog is an animal, it does not mean that every animal is a dog! So, be careful about reversal patterns, and do not get overly confident with them. It is great to be the trader that bought at an absolute 20-year low point, but it is far better to actually earn money by trading–and believe us–you cannot have it both ways. Continuation patterns are generally a much more healthy way to trade, giving you more room to be wrong and still be in the direction of the trend. They represent consolidation, and if the trend is strong, you will often get a better trade out of them. The catch is that they are sometimes highly counter-intuitive. E.g. five years ago, gold was at its all times high at 1000 USD per ounce. There was a very healthy uptrend, and imagine you had several charts open, weekly, daily, hourly, even a minute chart. At all of them the current price was at the topmost level of the screen. If you had the willpower to buy on a breakout of 1000 at such high levels you would have been rewarded with almost a 100% gain in the next three years with no leverage used to increase the position and no draw-down at all. Okay–this is stretching it, but it just goes to show what rewards are there for the right approach when one does not get emotional. Finally, we give the illustration of most major (i.e. most common), chart patterns.
Chart Patterns

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Author of Member of the Market Technicians Association.

One thought on “Basic Chart Patterns”

  1. Pretty nice post. I just stumbled upon your blog and wished to say that I have truly enjoyed surfing around your blog posts. Thanks and keep up the great work!

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