How to Analyze Price Patterns

By Adinah Brown

In technical analysis the transitions between rising and falling prices are signaled by price patterns. A price pattern identifies the changes in value of an asset by the recognizable configuration of trend lines. Identifying price patterns is a major part of Technical analysts in order to examine current movements and forecast future market movements.

All price pattern formations are identified on a trading chart from the patterns formed by an instrument’s change in price activity, whether they be the price of stocks, currencies, commodities, etc.

Charts rarely show price action going in a straight line, although this does occasionally happen during periods of strong price movement. Most often, prices zig zag, creating price peaks and troughs. Often these make easily-identified patterns that traders use to provide hints to future market direction.

This diagram shows prices falling to Point 1, before rising again to Point 2. Prices then retrace to Point 3 before rising once again to Point 4, and so on. By drawing a line joining Points 1, 3, and 5, the trader has formed a support line indicating that the market is on the rise. While, points 2, 4 and 6 form the resistance line, which indicates the outer parameter of which prices are likely to go up. The trader can then use this line to build future trading strategy.

 

Price patterns fall into two categories of continuation patterns and reversal patterns. The former shows that a market is just taking a break before continuing from a previous price direction, the latter suggest that a previous trend has completed its course and that a change in market movements is about to unfold.

We address some common price patterns that are used for indicating whether a previous trend will continue, reverse or stay within its range.

Let’s first introduce the Reversal Patterns:

• Head and Shoulders

Literally looking like two shoulders on either side of a head. They are indicative of complex market activity where a new, significant change of trend is about to take place. These patterns are extremely common.

The chart in the (above) image shows an example of a Head and Shoulders pattern. You can see here the left and right shoulders (LS and RS), the head (H), the neckline (N), and the return move or bounce (RM. The target of a Head and Shoulder is calculated to be the distance from the top of the head, to the neckline, extended from the neckline against the direction of the previous trend.

• Double and Triple Tops and Bottoms

This pattern appears when price action has attempted a price breakthrough from a particular high or low price, but failed. The market then normally retraces the distance from the high or low taken from previous support or resistance.

This chart shows two Triple Top formations as well as a very clear Head and Shoulders pattern.

Let’s now look at the Continuation Patterns:

One of the more common are triangle formations, these can be ascending (flat top), descending (flat bottom), or symmetrical.

Other price patterns include flags (two parallel trend lines), pennants (two converging trend lines) or wedges (where the two converging trend lines are angled up or down). Like the triangles, they can be bullish, indicating a downward trend, or bearish indicating and upward trend.

These price patterns are typically found when the price “takes a break” in a sense and goes through a period of consolidation, the result will either culminate in a continuation or reversal of the prevailing trend. Analyzing trend lines should be an underlying aspect of your technical trading strategy as it is used to forecast future price behavior.

About the Author:

Adinah Brown is a professional writer who has worked in a wide range of industry settings, including corporate industry, government and non-government organizations. Within many of these positions, Adinah has provided skilled marketing and advertising services and is currently the Content Manager at Leverate.