What are trading patterns?

Trading patterns are scenarios (a graphic pattern) that repeat in a price sequence.

To identify a trading pattern, it is necessary to perform a technical analysis of an asset and reflect that analysis on a chart so that we can easily see how the price of a certain asset behaves. This graphical representation helps you identify recurring situations that can therefore assist in planning your strategy.

The importance of patterns in technical analysis

Trading patterns are important as they can be your best ally when it comes to:

• Identifying trends and consolidation patterns. Consolidation patterns occur when an asset is in an uptrend or downtrend and experiences periods of consolidation, i.e., sideways or range-bound movements. When identified in time, they allow you to anticipate the next price movement and position yourself more strategically.

• Identifying signals of both continuation and reversal of a trend, which will allow you to seize trading opportunities and predict and/or avoid risks or operations that may go wrong.

• Providing you with information on key support and resistance levels in the market, something that is crucial for traders to know at which levels prices tend to stall or reverse.

• Offering you information to adjust your strategy and assist in decision-making.

In short, trading patterns will help you improve your chances of success in trading and lead to better risk management.

Types of trading patterns

There are different types of trading patterns; depending on whom you ask, the number can be as high as about 42 patterns. However, you must keep in mind that sometimes patterns are counted that are combinations or specific patterns for certain markets or strategies.

To simplify their understanding, in general terms, trading patterns are grouped into three categories: trend reversal patterns, continuation patterns, and bilateral patterns.
Here is a summary of each type.

Trend reversal patterns

Trend reversal patterns indicate that an asset's price is about to turn in the market and thus change its direction. Therefore, it is a key pattern for identifying whether we are at the end of a trend or at the beginning of a new one. Among this type of patterns, we summarize the most common ones:

• Head and Shoulders (H&S) and its inverted version, which indicate bearish and bullish reversals, respectively.

• Double top and double bottom, which anticipate changes from bullish to bearish or vice versa after two failed attempts to break key resistance levels (highs or lows).

• Triple top and triple bottom, which reinforce these changes with three consecutive peaks or valleys.

• Rising and falling wedges, which also indicate reversals depending on the previous trend and the direction of the breakout.

Continuation patterns

This type of pattern suggests that the current trend will continue after a pause or consolidation. When traders seek to enter an already established trend, this type of pattern can be very helpful in identifying the best time to enter or add positions since it is a pattern that clearly demonstrates if the trend will continue in the same direction.

Within this type of pattern, we summarize the most common ones:

• Ascending and descending triangle: Suggest bullish and bearish continuations, respectively.

• Symmetrical triangle: Indicates continuity in the direction of the previous trend.

• Flag and pennant: Formations that occur after a strong move and consolidation, suggesting the continuation of the previous trend.

• Rectangle: The price oscillates between support and resistance, and its breakout confirms the continuation of the trend.

• Rising or falling wedge: Indicates the continuation of the trend in the same direction.

Bilateral patterns

Bilateral patterns do not indicate a clear direction but indicate that both a continuation and a reversal of the trend can occur, depending on the direction in which the pattern breaks, requiring the trader to be prepared to act quickly based on the direction chosen when the breakout occurs.

Within this type of pattern, we summarize the most common ones:

• Symmetrical triangle: The price converges and can break in either direction.

• Rising and falling wedges: Indicate trend changes depending on the breakout.

• Rectangle, with lateral consolidation that also breaks in either direction.

• Flag and pennant, patterns of consolidation that typically indicate continuation, but can also be bilateral in certain cases.

The most common trading patterns

To use trading patterns, it is essential that you learn to identify them easily. However, it is not necessary to know all trading patterns. In fact, it is sometimes preferable to thoroughly understand a few types so that you can apply them with complete confidence.

Head and Shoulders

It is one of the most recognizable patterns as it has the shape of three peaks, the center one being the highest (the head) and two on the sides of lesser height (the shoulders).
It is a pattern that indicates a trend change and is used to identify the reversal from a bullish to a bearish trend.
Traders enter the market after the neckline breaks, positioning themselves in the new bearish direction. In addition, they set stop-loss levels above the shoulders to manage risk if the pattern doesn’t confirm.

Double top and double bottom

It is a pattern that indicates a trend change when the price touches a level twice in the case of a double top, and twice in the case of a double bottom.

Triangles (ascending, descending, and symmetrical)

There are three types of triangles: ascending (bullish breakout), descending (potential drop), and symmetrical (breaks in either direction). It is a pattern that indicates the continuation of a trend when support and resistance lines converge.

Flags and pennants

Continuation patterns formed after a strong price movement in one direction. The flag is similar to a rectangle, and the pennant resembles a triangle.

Wedges

Wedges can be reversal or continuation patterns. They form when there is a convergence of trend lines, and their direction will determine if the pattern is bearish or bullish.

How to identify patterns on trading charts?

Tools and techniques for recognizing patterns

There are certain tools and techniques that traders should use to identify patterns in charts. These tools include technical analysis software, candlesticks, and trend lines.

Tips for beginners in pattern reading

If you are starting in reading trading patterns, it is important that you begin practicing identifying patterns on historical charts. Preferably start with simple patterns and then move on to more complex ones. Additionally, always remember that combining pattern analysis with other technical indicators will be useful for you.

What is the most recurring pattern in trading?

There can be many patterns used in trading or investing, but one of the most common is undoubtedly the Head and Shoulders pattern. It is an easy-to-identify pattern as it gives a clear signal of a trend change.

Pattern-based trading strategies

How to use patterns to make trading decisions

You can use patterns to establish entry and exit points as well as manage risk. For example, you can decide to enter a position once a continuation pattern breakout is confirmed and set a stop-loss below a support level.

Practical examples of pattern-based trades

An example is trading a double top or double bottom pattern. When a trader identifies this pattern on a chart, they can wait for the price to break above the resistance level before entering a long position, setting a stop-loss below the last low.

Candlestick patterns in trading

Introduction to candlestick patterns

Candlesticks are a popular way to represent price movement on charts. Each candlestick provides information about the opening, closing, high, and low prices during a specific period, helping traders interpret price action.

Most popular candlestick patterns and their interpretation

Candlestick patterns are a popular indicator to illustrate price movement on charts. Each candlestick contains information about the opening, closing, high, and low prices during a given time interval. The most popular candlestick patterns include the hammer, shooting star, and engulfing. The formation of these patterns may indicate a possible reversal in price direction and is an integral part of technical analysis.

The role of volume in trading patterns

How volume confirms or invalidates patterns

Volume is a key element that accompanies trading patterns.
For example, during a breakout pattern, a high volume can confirm the pattern's validity, while low volume suggests that a pattern is not entirely reliable.

Volume analysis in different pattern types

For example, in a triangle breakout pattern, an increase in volume at the time of the breakout enhances the likelihood of the trend continuing. Conversely, a breakout with low volume could be a red flag.

Trading patterns in different markets

Patterns in the stock market

In the stock market, patterns that signify a trend change and patterns that represent its continuation are common. Among stock market patterns, the head and shoulders pattern and the flag pattern are used by traders to identify stock trends.

Patterns in the Forex market

In the currency market, patterns are common and are used by traders to identify trading opportunities. Among forex market patterns, triangles and double tops and bottoms are frequently used as they help identify trading opportunities in a particularly volatile environment.

Patterns in cryptocurrency trading

In the cryptocurrency market and given its high volatility, patterns can form quickly. Therefore, traders use candlestick patterns and continuation patterns to capitalize on the rapid price movements.

Common mistakes when trading with patterns

Misinterpretation of patterns

A common mistake is misinterpreting a pattern. Pattern interpretation is not always easy, and lack of experience can lead to seeing patterns where there are none, resulting in wrong decisions.

Over-reliance on patterns without considering other factors

Patterns are not everything. While they can be very helpful, it is important to also consider other key indicators. Ultimately, a holistic approach is the best way to tackle market analysis.

Resources to learn more about trading patterns

For a trader, recognizing patterns on charts is key. We invite you to explore online course options and tools that can help you practice and improve your trading skills, as well as answer some frequently asked questions about trading patterns.

Recommended books on trading patterns

You can find a wide variety of trading books that focus on patterns. Some of the most recommended include:

• “Technical Analysis of the Financial Markets” by John J. Murphy

• “Japanese Candlestick Charting Techniques” by Steve Nison

Online courses and tools for practice

Remember that theory is important, but so is practice, especially when it comes to understanding what's happening in real-time. Therefore, it is important to know of some online courses and tools that can help you:

Trading Courses

• Technical Analysis Course on Udemy: Offers a comprehensive introduction to technical analysis to understand the most used chart patterns and how to apply them in your trades.

• Trading Academy: Platform offering a variety of courses on trading, from basic to advanced strategies. Their modules on trading patterns are particularly popular.

• Coursera: On Coursera, you can find courses from universities and financial experts teaching about technical analysis and trading patterns.

Trading Tools

• TradingView: One of the most well-known among traders. Offers interactive charts and a wide range of indicators to help you identify patterns.

• MetaTrader 4/5: Widely used for forex and stock trading. Allow users to create custom charts and use technical analysis tools.

• Investing.com: Here you will find real-time news, technical analysis, and advanced charts that can be very helpful for identifying patterns in the markets.

Trading Communities

It may also be interesting to join a trading community because you can learn from other traders. Platforms like Reddit and Discord have groups where traders share their experiences and pattern analyses.

Frequently Asked Questions about Trading Patterns

How many patterns are there in trading?

As mentioned earlier in this post, there are quite a few trading patterns; however, the most common ones and the ones you should know best are:

• Continuation Patterns: Flag, Triangle, Wedge.

• Reversal Patterns: Head and Shoulders, Double Top, Double Bottom.

Depending on your strategy, you will use one over the other.

Do graphic patterns really work?

They work as a guide that can offer useful signals for market operations, but they are evidently not infallible.
As long as you understand how they can help you and use them with a broader approach that includes other tools for risk management and analysis of other economic factors, they can be very useful. However, practice and experience are key in determining whether or not they work, depending on how they are used and interpreted.

What is the most reliable pattern in trading?

There is no consensus on which is the best trading pattern, as ultimately it is a decision that depends on each trader’s personality and strategy. Still, the Head and Shoulders pattern is considered one of the most reliable in predicting a potential trend reversal.

Conclusion

Trading patterns are useful tools for making market decisions. But remember, their value lies in making good use of them (for which you will need good learning and a lot of practice) and integrating them as part of a broader strategy that considers other factors.