Technical Trading Patterns

These patterns are based on the study of the past behavior of the price and volume of an asset, with the objective of forecasting future movements. When you know how to recognize these patterns in graphical form, it is much easier and allows you to make decisions in a safer and more effective way.

Main types of technical patterns

Reversion patterns

Reversal patterns indicate an imminent change in price direction, i.e. they indicate a change from an uptrend to a downtrend or vice versa. This type of pattern is useful for the trader to identify the entry or exit point in the market.

Bullish reversal patterns

They indicate a change in trend from bearish to bullish patterns, i.e. a bullish reversal pattern can be:

• Double Floor: Two consecutive lows at similar levels.
• Inverted Shoulder-Head-Head-Shoulder: Three lows, with the central one lower than the others.
• Bullish Engulfing Candlestick: A large bullish candlestick engulfs a bearish candlestick.
• Bullish Pin Bar: Candlestick with long lower wick, indicating rejection of low prices.

Bearish reversal patterns

They indicate a change in trend from bullish to bearish:

• Double Top: Two consecutive highs at similar levels.
• Shoulder-Head-Shoulder: Three highs, with the central one higher than the others.
• Bearish Engulfing Candlestick: A large bearish candlestick engulfs a bullish candlestick.
• Bearish Pin Bar: Candlestick with a long upper wick, indicating rejection of high prices.
  

Continuation patterns

Continuation patterns - as the name suggests - suggest that the current market trend will continue in the same direction after a pause. These are patterns that can help the trader to hold his position during a trend. Examples of this type of pattern are, for example, flags and triangles, which indicate that, after a pause, the price will continue its original trajectory.

Bilateral patterns

Bilateral patterns are those that do not indicate a clear price direction. Therefore, the trader usually prepares for a breakout in one of the directions (up or down) before making a decision by using entry orders (buy stop or sell stop) at each end of the pattern. Some examples of this type of pattern are

• Symmetric triangle with descending maxima and ascending minima converge.
• Rectangle (lateral range) in which the price moves horizontally between support and resistance.
• Wedge: Price movement in a narrow range, inclined up or down.

The most effective patterns for trading

Double ceiling and double floor

The double top pattern is a bearish reversal signal that forms after an uptrend, while the double bottom is the opposite and indicates a bullish reversal after a downtrend. Both patterns are very significant and easy to identify visually and are therefore frequently used in technical analysis. However, false signals can be confusing and you should always confirm the pattern as trading or making decisions without confirmation can lead to mistakes. The price could simply consolidate or continue the trend prior to the pattern.

The shape of the double top pattern is that of two consecutive peaks at similar levels, separated by a valley. This pattern indicates that the price fails to overcome a major resistance twice.

The double bottom pattern has a similar shape but inverted, i.e., two consecutive lows at similar levels can be observed, separated by an intermediate peak indicating that the price fails to break a key support twice.

Shoulder-head-shoulder

This pattern is another of the most recognized and visually easiest to identify in technical analysis. The shoulder-head-shoulder pattern indicates a possible trend reversal (a bearish reversal that appears after an uptrend thus indicating a shift to a downtrend) and is shown with a figure of three peaks: two shoulders and a head. Its inverse, the head-shoulder-reversal pattern, is also effective in identifying changes in market direction.

Triangles (ascending, descending and symmetrical)

Triangles are continuation patterns that can be ascending or descending (indicating an uptrend or downtrend) or symmetrical. These patterns are formed in periods of consolidation and their breakout may indicate the start of a new trend movement. However, as discussed above, some triangles can also act as bilateral patterns.

Flags and banners

Flags and pennants are continuation patterns that appear after a significant price movement has occurred. Their formation indicates a temporary pause before the original trend resumes.
You can recognize the flag pattern because it forms a kind of rectangular channel sloping against the main trend, composed of:

• An initial phase: Strong and fast movement in one direction forming a "mast".
• Consolidation phase: Price moves in a narrow range against the main trend. The support and resistance lines are parallel and usually have a slight slope.

On the other hand, the pennant is characterized by a consolidation in the form of a small and symmetrical triangle, composed also by a "mast" (strong and fast movement in the main trend) and the pennant shown as the Contraction of the price with converging lines (support and resistance) and indicating continuation of the trend after the breakout.

Japanese candlestick patterns

The 60 fundamental patterns

Candlesticks are a popular way of representing price movement on charts. They are patterns that visually represent price fluctuations over a period of time. There are approximately 60 patterns that can be used to predict in which direction the market will move. Knowing how to interpret them is not easy, it requires practice and experience, but once you know how to do them - although you should always look for confirmation with other indicators - they can be very useful in decision making.

More reliable reversal patterns

Candlestick patterns show how buyers and sellers interact at a specific time in the market.
Among the most reliable candlestick patterns are the hammer, the engulfing and the doji. We say they are more reliable because they are patterns that show visually (candles) how buyers and sellers are feeling at that specific time in the market. Each of these patterns has its own characteristics to indicate that there is a possible trend reversal.

For example, the hammer pattern: I assume that the price has been falling for a while and a candlestick pattern called a "hammer" appears. That pattern may indicate that sellers were pushing the price down but at the end of the day buyers managed to push the price back up. The information that this pattern is giving us is that the buyers are taking the reins and that the market sentiment is changing from negative to positive which could be interpreted as a sign that the price is going to go up.

Signal interpretation

It is important to know that the interpretation of the signals generated by the Japanese candlestick patterns can be subjective and precisely for this reason, because subjectivity can play tricks, it is important that their interpretation is combined with other technical indicators that confirm the interpretation.

How to identify and operate with patterns

Pattern confirmation

Confirmation is essential before trading a technical pattern. A trader should wait for the price to break a key level or for an increase in volume to validate the identified pattern and reduce the risk of false signals.

Risk management

As you can guess having a good risk management is key to be able to trade. You must set appropriate stop-loss levels and calculate the size of your positions to protect your capital. Remember that good risk management can make the difference between success and failure in trading.

Price targets

When you have identified the pattern and confirmed its validity it is important to set price targets. These targets can be calculated using different methods, such as projecting the height of the pattern or nearby support and resistance levels.

Technical patterns in different markets

Forex Patterns

In the Forex market, technical patterns can be especially useful due to the volatility of currencies and can be of great help in identifying entry and exit points based on price action and market sentiment.
The main patterns in Forex are

Reversion Patterns:

• Double Top: After an uptrend, the price goes up, goes back down and then tries to go up again but fails to do so, which may indicate a bearish reversal.
• Double Bottom: After a downtrend, the price reaches a low, rebounds and falls back to the same level without continuing downward, which usually indicates a bullish reversal when resistance is broken.
• Head and Shoulders : This pattern is formed in an uptrend. You can identify it because it occurs as three peaks (shoulder, head, shoulder) and a break of support (support is an imaginary line connecting the low points between the three peaks) which is shown when the price breaks this line downward and usually indicates a bearish reversal.
• Inverse Head and Shoulders: This pattern is formed in a downtrend and is the opposite of the previous one since it usually indicates a bullish reversal when the price breaks through resistance, i.e. when the price of the asset manages to overcome a key level where it had previously found it difficult to rise.
  

Continuation Patterns:

• Ascending Triangle: You will recognize it because it is like a pause that occurs during a price rise. The price goes up, but every time it tries to go down it does not succeed or at least not as before and an ascending line is formed from below until it meets a "barrier" that it does not manage to overcome. When the price finally overcomes that "barrier" (the resistance) it usually indicates an uptrend that will surely continue.
• Descending Triangle: Appears in a downtrend, it is the opposite of the previous point so the break of the support suggests that the downtrend will continue.
• Flag: First, the price rises or falls rapidly (this is the "mast" of the flag) and then makes a brief pause and moves in a narrow range, but in the opposite direction to the main movement, as if it were taking air, this is what gives it the shape of a "flag. When the price finishes this break and breaks that range, it usually returns in the same direction as before, either up or down. It would be something like pausing when you are running or walking and resting to regain momentum to continue!
• Pennant: Similar to the flag, first, the price makes a strong move, then the price stops a little and starts to move in the form of a small triangle (the pennant), while "resting". When the price manages to break that triangle it usually returns in the same direction it had at the beginning.

Patterns in shares

As in the rest of the cases, in the stock market technical patterns are of great help to identify opportunities based on market trends and patterns observed. In the stock market, patterns such as the double top and the shoulder-head-shoulder are quite common, which as we have seen in the previous point indicate possible trend reversals, signaling that an uptrend can become a downtrend or vice versa.

Patterns in futures

In the futures markets, technical patterns are also of great help to anticipate movements in asset prices, such as commodities and bonds, so it is important to know how to identify patterns to minimize risks and increase the chances of making successful trades.

Common errors in pattern trading

False breakouts

A common mistake is to trade based on false breakouts, where the price seems to break a key level, but quickly returns to the previous trend. Therefore, we never tire of telling you that it is important that before making a decision you confirm what the pattern shows with other tools such as technical indicators (RSI, MACD), trading volumes, etc. to make sure that the breakout is real.

Volume confirmation

Remember to never ignore volume. Trading solely on the information given by patterns can lead to wrong decisions. An increase in volume during the breakout of a pattern provides greater confidence that the move you assume is correct.

Emotional management

Emotional management is crucial in trading. Do not get carried away by emotions and do not act on impulse if you want to achieve good results. Remember that maintaining discipline and following a well-defined trading plan is key to good trading results. However, it is a skill that comes with time and practice, so do not give up if in a first phase or first attempts things do not go according to plan. Instead, bet on training and improving your skills.