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Trading using Chart Patterns
Introduction
Thomas N. Bulkowski in his book “Encylopedia of Chart Patterns” talks about around 63 chart patterns. The most researched and comprehensive content on chart patterns till today.
A lot of people have tried to simplify the chart patterns because it would not be possible to remember all those patterns
Types of Patterns
1. Market at rest…………...continuations
2. Market finished …………reversals
3. Market uncommitted……directionless
Types of Patterns
Most patterns have simple names based on what they look like.
A Double Reverse Whirligig, if it existed, would be far too complex to be useful.
K.I.S.S!
Continuation Patterns
Triangles
Rectangles (aka trading ranges)
Flags
Gaps
But look at the next slide….
Reversal Patterns
Triangles
Rectangles (aka trading ranges)
Flags (Not so much)
GapsNot So easy right?
Key Points
The shape of a pattern yields clues to what is going on in terms of market psychology
The position of the pattern in the context of what came before it is also critical
Most of the times Patterns lean one way or the other but the market decides which way it breaks
Decide a timeframe and look for patterns within the timeframe. Do not change the timeframe. At max you can have two timeframes for the defining the pattern. For example for Intraday trading See the pattern in daily timeframe, which would give overall trend / pattern. Plus see the pattern in 10 min / 30 min timeframe whichever timeframe you are comfortable
Directionless Patterns
If your naked eye cannot detect the pattern in half a second,
Then there is no pattern or
You have a “Directionless Pattern”
Move on
All the patterns
Reward:Risk Criterion
On any opportunity...
Assess the Target and Initial Stop values.
Trade those patterns with a Reward : Risk Ratio of at least 3:1.
entry
stop
target
Reward:Risk = 3:1
Reward
Risk
3
1
Most patterns have clear targets.
Prior Move Test
“B” is more ambiguous.
AB
At “A” we can use H.
H
Only Trade Patterns with a clear move (reference) ahead of the signal.
Reliance Infra –EOD chart – Another example
Ascending Triangle
Support line is increasing
which indicates it
would break on the upside
Resistance line is a straight
line
In an Ascending triangle pattern the
breakout is normally on the
upside. In a descending triangle
it is the opposite
MCDOWEL-N
Symmetric Triangle
The Resistance line is going down and
support line is going up and
they are evenly poised. Better to avoid
trading and play the
breakout
SBIN
Rectangle
After a Bull run or Bear run normally
a rectangle is formed which
shows the consolidation or profit booking
happening because the next direction is not yet decided. During the
“Rectangle” days, Sell near the
Resistance line and Buy near the
“Support” line
NIFTY
Support line
Resistance line
FLAG
Shake out the Week
minds
Flag normally occurs
in the middle
of a Strong Bull or Bear trend
MCDOWELL-N
WEDGE
For Aggressive Traders
Wedge is the opposite of the Triangle. But normally the Wedge is for aggressive
Traders. Normally at the support line GO LONG and at
the Resistance line GO SHORT.
INFY
Price Gap StructureBreakaway, Measured & Exhaustion
Long Entry
Short Entry
Long Entry
Measured Gap
Exhaustion Gap
Breakaway Gap
“Breakaway Gaps mark the
beginnings of moves,
Measured Gaps
mark the centers of
moves, and
Exhaustion Gaps
occur at the ends
of moves.”
GAPS
SBIN Daily
GAPS
Measuring Gap
Breakaway Gap
The break away GAP confirms the trend and the breakout.
The measuring Gap normally separates the trend into two
halves. So after a measuring gap, you can
expect another 50% run and plan to close
your positions accordingly
NIFTY
Other patterns
RCOM
DiamondHead and
Shoulders
Summary
Chart patterns exist when the trend is in transition.
Basically, the market is resting. Our job is to determine if it is resting in preparation for the next leg or in preparation to turn around (Reversal).
The shape of the pause gives us clues but we must wait for the market to make the final decision by moving out decisively from the pattern.
Summary
Other than gaps, most patterns are variations of the others
Triangle – Ascending – Mostly bullishTriangle – Descending – Mostly bearishTriangle – Symmetric – Depends ?
Rectangle – Good for Range trading – Same as Resistance and Support – Sell near Resistance. Buy near Support
FLAG – Normally after a strong BULL or BEAR Run to let go the Weak traders.
Breakaway Gap – Start of the TrendMeasuring Gap – More Bull or Bear move left in the Trend Exhaustion Gap – End of the Trend
FINALLY
Reason for analyzing Chart patterns ?
TO make the buy, sell or hold decision.
NOT TO predict the future
References
Basic Patterns Everyone should know – Michael Khan
The 7 Chart Patterns – Confirming Entries and Exits – Nirvana Systems