Stock pattern analysis is something that is usually performed by technical stock traders. However, even ordinary investors can hugely benefit from understanding stock patterns.
Not an Exact Science
Before we delve deeper into stock pattern and their analysis, it is important to understand that it is not an exact science. Many times, even the best technical traders cannot predict the future price movements of the stock based on the chart patterns.
However, understanding stock patterns and recognizing them can definitely give you an edge over the other (regular) investors who do not perform stock pattern analysis. Even if the buy-and-sell decisions may not turn out to be accurate every time, they often prove to be true.
What is a Stock Pattern?
Stock patterns are clear and distinctive patterns that are believed to be capable of signaling the future movements in the price of the stock. The traders make use of these patterns for identifying prevailing trends and for predicting whether the trend would reverse or continue. Typically, in the case of stock patterns, history repeats itself.
Important Reversal and Continuation Patterns
Over a period of time, be it days, weeks, months, or years, there are clear reversal and continuation patterns formed on stock charts. Following are some of the important chart patterns used by technical traders.
Cup and Handle Pattern: This pattern appears like a cup and a handle. This is a bullish continuation pattern. This pattern can be formed within a few months to a year or more.
Rounding Bottom Pattern: Also known as Saucer Bottom, this is a bullish reversal pattern. When this pattern is formed, it implies that the prevailing downtrend of the stock price may be reversed to an uptrend.
Head and Shoulders Pattern: This is a bearish reversal pattern which implies the reversal of a prevailing uptrend to a downtrend.
Inverted Head and Shoulders Pattern: This is a bullish reversal pattern which implies the reversal of a prevailing downtrend to an uptrend.
Flags and Pennants: These are continuation patterns. They are usually formed within a few weeks or months. After the pattern is confirmed, prices move in the same direction as the initial trend.
Double Top Pattern: This is a bearish reversal pattern. It is formed when the resistance level is tested by the price movement two times, without breaking out of it. The price then reverses its uptrend and plunges downward.
Double Bottom Pattern: This is a bullish reversal pattern. It is formed when the support level is tested by the price movement two times, without breaking down from it. The price then reverses its downtrend and surges upwards.
Gaps: Whenever there is a huge price difference between two periods (be it two days, two weeks, or even two months), it forms empty spaces between the two trading periods. This is called a gap. Whenever a gap is formed, it implies that there is something significant that happened to the stock between the two trading periods. It could be a major earnings announcement, lawsuit, any new product launch, change in company management etc.
In addition to these patterns, there are also patterns like Triple Tops and Triple Bottoms, Triangle Pattern, Wedge Pattern etc.
Some of the important chart patterns are covered in detail in the professional penny stock course, with illustrations and examples for better understanding.