Beginner's Guide to Classical Chart Patterns

What are Classical Chart patterns?

The price action of an asset is the transition from rising and falling trends that can be detected through price patterns. A price pattern is a readable price movement that can be found using an amalgamation of candlesticks that form trends. Price patterns form the foundation of technical analysis; thus, it is relied upon by almost all technical analysts. The most common and basic chart patterns are known as “classical chart patterns.”

Examples of classical chart patterns

Price patterns are distinguished into two main categories; continuation and reversal patterns. They are formed through simple trendlines; hence, it is essential to understand what trendlines are before looking at chart patterns.

Continuation

A continuation pattern signals that the current trend will continue after a brief period of consolidation (sideways movements) in the market. Technical analysts will pay particular attention to the trend lines to see whether the price will break above or below the continuation zone. Common continuation patterns include:

• Pennants

A pennant is a continuation pattern represented by two converging trendlines. It represents a period of consolidation in the market, which is further confirmed by reduced volume. The trend continuation is confirmed to break out.

Image 3: The image above represents a pennant. As one can see, the upper and lower trendlines are converging during a period of consolidation. Given that the pre-existing trend was an uptrend, the price will need to break above the upper trendline at the end of the pennant to complete the continuation pattern.

• Flags

A flag is a continuation pattern formed by a sharp move to the upside or downside. The pattern visually looks like a flag pole because of the sharp straight movement and then a period of consolidation. At the end of the flag pole, one can expect a break of the upper or lower trendline to continue the pre-existing trend.

Image 4: Bull flag                                                  Image 5: Bear Flag

Reversal

A reversal pattern is a chart pattern that signals a change in the current trend's direction; for example, from an uptrend to a downtrend or vice versa. Often the current trend will pause (a period of consolidation) before changing to move in the opposite direction. Reversal patterns at market tops are collectively known as distribution patterns. Alternatively, reversal patterns at market bottoms are known as accumulation patterns. Examples of common reversal patterns include:

• Head and Shoulders

This is a reversal pattern that can appear at market tops or bottoms. A series of three pushes represent it; the first initial peak, the second peak much larger than the first, and the final third peak similar to the first. The two peaks on either side of the larger middle peak are known as the “shoulder,” while the middle peak is known as the “head,”; thus forming the head and shoulders pattern.

The straight line is known as the neckline, which is the trendline considered as support if the price is hanging above it or resistance if the price is hanging below it; a break above or below this line will confirm the head and shoulders reversal.

Image 6: Head and Shoulders pattern                Image 7: Inverse head and shoulders pattern

• Double top (M-Shape) and

A double top is a bearish reversal pattern. It is formed when the price makes two failed attempts to break above a resistance level, signaling that it has reached its peak; thus, it falls even below its support level. Triple tops also provide a similar signal with much stronger evidence, although they are rare.

• Double bottom (W-shape)

Alternatively, a double bottom is a bullish reversal pattern. It is formed after the price tries to push below a resistance level twice but fails to signal that it has reached a market bottom; thus, it rallies to break past its resistance level. A triple bottom also provides a similar signal with much stronger evidence, although they are rare.