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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