We perform stock technical analysis and identify stock chart patterns so we can more accurately predict future market movements. It would be a mistake to work on the assumption that a major chart reversal pattern emerges quickly, but it does enable us to understand when a sudden change of market direction is likely to take place. It can take several months for a trend to be reversed, but there are key market indicators that can help us to decide when a change of fortunes is likely to transpire.
Common Characteristics of All Major Chart Reversal Patterns
- There must be an identifiable previous trend.
- An important trend line has now been breached.
- The longer it takes for the pattern to emerge, the larger the subsequent movement.
- Topping patterns, a negative price movement, have a tendency to be shorter and more volatile.
- Bottom patterns usually have a smaller price range and take far longer to establish.
- Volume is a far greater influence in stock market technical analysis for rising share prices.
Stock Technical Analysis Using the Head and Shoulders Reversal Pattern
The head and shoulders is the best-known stock chart pattern for identifying a stock price reversal. It is characterized by an upward trend followed by a subsequent drop based on lower volume. It touches a previous support level, forming the left shoulder.
This is followed by a rise in volume to a new high , but you'll notice that the volume is lighter than during the previous rise. The subsequent fall to the neckline follows, forming the head. The recovery is slightly below that of the left shoulder and is based on far lower volume.
You'll notice that the price breaks through the supporting neckline due to a higher volume of trading. This is followed by a modest recovery, but this stalls when it reaches what was the previous support level. The decline then continues based on a high trading volume.
When looking for technical analysis patterns, you may also notice the head and shoulder bottom or inverse head and shoulders. It is pretty much a mirror of what has been outlined above, but there is an upward price movement instead.
Double Top or Double Bottom for Stock Market Technical Analysis
The double top or bottom is another widely used pattern for stock technical analysis. It is characterized by a rise to a new high or low due to a higher than normal volume of activity. This is then followed by a decline to the support level based on lower volume.
The next rally is unable to breach the previous support or resistance level and volume is usually slightly lower. The double top or double bottom chart reversal pattern is completed when the price breaks through the support or resistance level. The volume of trading activity should be very high.
Triple Top or Triple Bottom Form Major Chart Reversal Patterns
This is a slight variation of the head and shoulders pattern so the two are often confused. Each peak is formed on a slightly lower volume with the third peak or trough indicating the potential for a break-out. The reversal is completed when a higher level of volume leads to a breach of the previous support or resistance level. The rise of fall will be based on the height of the pattern.
Saucers and Spikes Provide Useful Technical Analysis Indicators
Although not seen as frequently as head and shoulders and double tops, the saucer bottom is a stock chart pattern that signifies a fundamental change of stock price direction. It is characterized by a gradual downward, sideways and upward movement.
Spikes are difficult to predict because, from a stock technical analysis perspective, they tend to happen extremely quickly giving you little time to react. You'll tend to find that they happen when a market is overextended in one direction and a sudden piece of news leads to a chart reversal pattern emerging.
Sources
"What is technical analysis?" Stockcharts.com.
Disclaimer: As with all forms of speculative activity, please remember that trading stocks carries risk and you could lose your investment capital. Trading patterns can and do fail so only invest money that you can realistically afford to lose.
Asa Ghaffar - Asa has over 10 years of practical experience in loan approval, secured lending, bad credit repair, stock trading and debt management.
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