Thursday, April 15, 2021

Understanding The Best Candlestick Chart Patterns

There are many patterns based on which market participants trade & make their decisions.

Whether to go long or short on a particular scrip or stock is decided by the pattern made by the stock prices. No matter which time frame you are trading, it can be 1 day, 1 hour or 5minutes, these patterns mostly work.

The main thing is how to identify these chart patterns & how these patterns look like?

To understand this I am introducing some power chart patterns with most recent examples of their application.

Trading with Power Chart Patterns

1. Triangular Patterns

When the prices are already having a sharp long run on upside or downside there is an indecision in the market among the bulls & bears that whether to go long or short.

This leads to the consolidation of the prices & usually continues the prior trend from which price has been started & therefore these patterns are also known as continuation patterns.

Triangular patterns are very useful & powerful patterns & help to get a better decision on a particular price movement.

These triangular patterns are also being used in wave analysis which usually runs on two types of waves i.e. motive waves & triangular waves.

The most beautiful thing about the wave analysis is that you can trade inside the pattern formation if you have a better understanding of the waves.

There are three basic triangular patterns:

i) Symmetrical triangle
ii) Ascending triangle
iii) Descending triangle

i) Symmetrical triangle

These are further divided into two categories viz: Converging type & Expanding type

Lets us first understand the converging type:

These patterns are found on a regular basis. A converging type triangle forms with connecting two inclined lines which converges to one single point (the prices making lower tops but higher bottoms).

The question is how to identify whether it is going to form a bullish structure or a bearish structure.

To understand this we will see both the structures one by one.

In a Bullish trend:

It is a converging symmetrical triangle pattern as illustrated below:

Bullish Symmetrical triangle

In this pattern, after having a long bullish run, prices are getting into a consolidation zone by trading in a very narrow range. Every upside attempt is getting failed by the pressure of bears & on the other hand, the bulls are not giving up to let the prices go down.

If you see carefully there are five significant points in this pattern. Each point suggesting a reversal in the price of the stock & narrowing the range.

But as soon as prices reach the third time to the lower trend line, it was the last touch & the prices took a breakout from the triangular channel & the prior bull run resumes again on the upside.

So the key point is you need to see ‘The Third Touch’ on the symmetrical triangular pattern.

The target for this pattern is usually taken as the maximum vertical range of the triangle.

In a Bearish trend:

This is a converging symmetrical triangle pattern as illustrated below:

Bearish symmetrical triangle pattern

In this pattern, after having long Bearish run, prices are getting into consolidation zone by trading in a very narrow range. Every upside attempt is getting failed by the pressure of bears & on the other hand, the bulls are not giving up to let the prices go down.

If you see carefully there are five significant points in this pattern. Each point suggesting a reversal in the price of the stock & narrowing the range. But as soon as prices reach the third time to the upper trend line, it was the last touch & the prices took a breakout from the triangular channel & the prior Bearish trend resumes again on the downside.

The target for this pattern is usually taken as the maximum vertical range of the triangle.

symmetrical triangle pattern example
https://ibb.co/Tqt1HMZ   – PERSONAL TRADE ON JET AIRWAYS

ii) Ascending triangle

In a Bullish trend:

This is also a converging triangle formed with one flat horizontal line on the top & an inclined line meeting at a common point as illustrated below.

Bullish Ascending triangle

The flat horizontal line act as a resistance for the prices & the on the inclined line the prices take support. It’s not necessary that the ascending triangle formation takes place only in the bull market, they can be formed in a bearish trend also.

Here also you should concern with the key point “The Third Touch”. The five significant points help us to make our decision in a better way. Here, each points suggesting a reversal point & as soon as price got it’s third touch on the inclined supporting line the price shoot up & a breakout happened.

The target for this pattern is the maximum vertical range of the triangle.

Ascending triangle Example
Infosys Daily Chart

In a Bearish trend:

Similarly, in a bear trend, the formation of ascending triangle formation takes place as illustrated below.

Ascending triangle Bearish Trend

The flat horizontal line act as a resistance for the stock prices & the on the inclined line the prices take support. But the main logic here is to identify the “The third Touch”. As the image depicts that the third touch has been taken place on the flat horizontal resistance line, the breakout seems to happen on the downside.

Again the target for this pattern should be taken as the maximum vertical range of the triangle.

iii) Descending triangle

In a bullish trend:

This is another type of a converging triangle formed with one flat horizontal line at the bottom & an inclined line meeting at a common point as illustrated below.

Descending triangle Bullish trend

The flat horizontal line act as a support for the stock prices & on the inclined line price face resistance.

It’s not necessary that the descending triangle formation takes place only in a bear market, they can be formed in a bullish trend also.

Here also you should concern with the key point “The third Touch”. The five significant points help us to make our decision in a better way.

Here each points suggesting a reversal point & as soon as the price did the third touch on the flat supporting line it got shoot up & a breakout happened.

The target for this pattern is the maximum vertical range of the triangle.

In a Bearish trend:

Similarly, in a bear trend, the formation of ascending triangle formation takes place as illustrated below.

Bearish Descending triangle

The flat horizontal line act as a support for the stock price & the on the inclined line the prices face resistance.

But the main logic here is to identify the “The Third Touch”. As the image depicts that the third touch has been taken place on the inclined line, the breakout seems to happen on the downside.

Again the target for this pattern should be taken as the maximum vertical range of the triangle.

Descending triangle Example
Yes Bank – Example

Reverse Symmetrical Triangle Or Expanding Triangle

Apart from the converging symmetrical triangle, there is another triangular pattern which is known as expanding triangle or reverse symmetrical triangle.

The formation of triangles takes place via connecting two expanding trendlines on which the stock prices take resistance & support respectively.

This triangle also can be formed in any trend. But we are only concern with our basic concept “The Third Touch”.

In a Bullish trend:

In this triangular pattern, we can see that there are two trendlines connecting the tops & bottoms of the prices.

The prices are making higher highs & lower lows in an expanding triangular pattern. On the upper trendline, the prices facing resistance while the lower trend line giving support to the stock prices.

As soon as the prices took the support third time on the lower trend line they got shoot up & the breakout of the pattern takes place to the upside.

Bullish Expanding Triangle

In a Bearish trend:

In this triangular pattern, we can see the there are two trendlines connecting the tops & bottoms of the prices.

The prices are making higher highs & lower lows in an expanding triangular pattern. On the upper trendline, the prices are facing resistance while the lower trend line giving support to the stock prices.

As soon as the prices face resistance third time on the upper trend line they got crash & the breakout of the pattern takes place to the downside.

Bearish Expanding Triangle

2. Diamond Pattern

This pattern is a more powerful pattern than what we have discussed earlier.

The formation of this pattern is rare. But, whenever this pattern forms it gives massive movement on the breakout.

How does it look like? It looks like a diamond.

Geometrically, we can say its a type of a rhombus having four sides almost equal & on the right angle the breakout of this pattern gives a massive bull run or bear run according to the side where the breakout has happened. (As shown below)

Diamond pattern on crude oil
Diamond pattern on crude oil formed on 23rd August (15 min chart)
Diamond pattern
Diamond pattern formed in crude oil 11th August 2019 (1hour chart)
Diamond Pattern breakdown
Confirmation of breakdown
breakdown of the diamond pattern
11th August 2019 after the breakdown of the diamond pattern (15 min chart)

3. Head & Shoulders Pattern

This is the most powerful chart pattern & gives you much profit if identified & traded correctly.

This pattern has two types:

  • Type-1 forms after a massive bull run & is known as Head and Shoulders Pattern.
  • Type-2 forms after a massive bear rally & is known as Inverse Head & Shoulders Pattern.

Basically, Head & shoulders pattern is a reversal signal. The reversal of the prices don’t take place abruptly but take some time for consolidation & forms some pattern.

Head & shoulders pattern is one such kind. How does the pattern look like?

This pattern is shown below having a left shoulder, a head & a right shoulder.

Head and Shoulders Pattern
TYPE-1
Inverse Head and Shoulders Pattern
TYPE-2

The most important thing to note about this pattern is the volumes which many traders avoid while trading this pattern & end up with false breakout & loss. 

Type-1: Head and Shoulders

This pattern forms after an extensive upside rally. It consists of a left shoulder, a head, and a right shoulder. The left shoulder is formed after a big bull rally in which the volumes are quite large.

At the end of the left shoulder, a minor correction takes place on the downside which happens on the low volumes comparatively the starting of the left shoulder. After this, again an up move can be seen on large volumes forming a head whose top is above the left shoulder following a correction on lower volumes & completing the head.

The completion of the head must be below the top of the left shoulder. If the prices fall down below the low of the left shoulder then too this pattern remains intact. In the end, the right shoulder is formed usually on smaller volumes comparatively the previous two rallies.

Head and Shoulders Example
TATA MOTORS
Head and Shoulders Example Crude oil
Pic courtesy Sharat Nik
Head and shoulder Trading Idea
Trading Idea Posted by me based on the H&S pattern

Now if you connect the bottoms of the left shoulder, head & the right shoulder there will be a formation of the ‘Neckline‘.  This line will act as a decision line.  If the prices break this neckline & give closing below the line, this will be the confirmation of the breakdown of the H&S pattern.

However, it has been noticed that after breaking of the neckline the prices again attracted towards this neckline. We say this phenomenon as a retest of the neckline which will add some more confidence while trading this pattern.

After retesting if the prices again come down this will be the final confirmation of the downside movement of the price as shown below.

The bookish target of this pattern is taken as the vertical price range from the top of the head to the neckline & the bookish Stop loss should be the top of the right shoulder. However this stop loss can be big, so it is advised to keep a stop loss of 4-5% of the price range above the neckline.

Type-2: Inverse Head and Shoulders

This pattern forms after an extensive downside rally. It consists of a left shoulder, a head, and a right shoulder. The left shoulder is formed after a big bear rally in which the volumes are quite large.

At the end of the left shoulder, a minor correction takes place on the upside which happens on the low volumes comparatively the starting of the left shoulder. After this again a down move can be seen on large volumes forming a head having its bottom is below the left shoulder following an upmove correction on lower volumes & completing the head.

The completion of the head must be above the top of the left shoulder. If the prices rise above the top of the left shoulder then too this pattern remains intact. In the end, the right shoulder is formed usually on smaller volumes comparatively the previous two rallies.

Inverse Head and Shoulders Pattern Example
Crude Oil Inverse Head and Shoulders Pattern
Trading idea posted by me based on Inverse H&S on 20th January 2019

Now if you connect the tops of the left shoulder, head & the right shoulder there will be a formation of the ‘Neckline‘. This line will act as a decision line. If the prices break this neckline & give closing above the line, this will be the confirmation of the breakout of the Inverse head and shoulders pattern.

However, it has been noticed that after breaking of the neckline the prices again attracted towards this neckline. We say this phenomenon as a retest of the neckline which will add some more confidence while trading this pattern.

After retesting if the prices again start rising, this will be the final confirmation of the up move as shown above.

The bookish target of this pattern is taken as the vertical price range from the bottom of the head to the neckline & the bookish Stop loss should be the bottom of the right shoulder. However this stop loss can be big, so it is advised to keep a stop loss of 4-5% of the price range below the neckline. 

That’s it for today.

Now, here’s what I would like to know from you.

Which chart patterns do you love to trade and why?

Have you traded any of the patterns featured in this post?

Leave a comment below and share your thoughts with me.

POST AUTHOR

Manish Bhardwaj
Manish Bhardwaj is a full-time trader investor, an analyst for over four years and now, he is also a trading content creator. On a random day, Manish and Sharat were discussing their plans of helping people and both understood that they have almost the same vision. So, they collaborated to take TradingSutra to the next level.

19 COMMENTS

    • Hey Gautam,

      No problem. We all deal with such confusion in the beginning.
      Also, we won’t see the patterns always as described in this post or any textbook. But they are same or similar.

      With experience, you will start identifying the patterns.
      And, once you start identifying them quickly with your eyes, you won’t focus on their names.

      Keep looking into charts 🙂

      • Today I had done homework like back testing to find out patterns. But it is difficult right now as didn’t able to understand the start point. Hope with your teachings will learn some day.

  1. Thank you, very good teachers (Manish sir and Nik sir). You teach us without any demand or guru darshan, the god may increase health and wealth of both gurus. I never lose this gift guruji.
    Thank you once again

  2. I Like the diamond pattern a lot as it gave me good profit from the guidance of Mr. Master Brain (MB)

    Join the group to know more about Manish! He is really talented and superb Analyst and Sharat is the real Motivator!
    Both are God gifts for me in the stock market!!

    • Hey Lohith,

      We both are blessed and happy that we have people like you in our community who are ready to learn, contribute and push us ahead.

      Keep growing!

  3. Awesome Gurus, really you are doing very genuine work which can’t be explained in words…praying God to give you all blessings, peace and satisfaction in life…

  4. I am very happy with the Manish (MB) and Sharat, I wanted a good person that is good at the fundamentals and somehow I got in contact with MB and MB’s team helped me get exactly what I was looking for.

    I can’t believe I ate the whole thing, My father (Who’s does not support for share market and he thinks that it is nothing more than Gambling), even he said after reading observing tradingsutra.com “how great trading is” and now I am getting real confidence in trading.

    Thanks Sharat and MB ur my real tutor ..

    • Hey Raj,

      Thanks a lot for your comment. We are glad that you like our work.

      This market isn’t at all gambling but we cannot ignore the fact that many people in this market gamble by not learning how to trade, how to invest and how to manage their risk. I suggest you to have patience, keep learning and keep growing.

      And, I wish your dad great health & happiness.

      Thanks again

  5. Thank you Sirs!
    Seeing a chart earlier was a bouncer reading the notes n trying to find patterns is helping a lot to read the charts, genuine learning is happening .🙏

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