It’s no secret that learning the basics of technical analysis in the stock market helps traders and investors determine where stocks are headed.
Technical analysis is based on the assumption that history repeats itself.
In other words, certain trading patterns developed over the years tend to repeat themselves over and over again.
These charting patterns tend to signal a high-probability move in stocks or other financial markets…
So savvy investors watch for these patterns to repeat themselves, and then use them to make smart trading decisions in different financial markets such as stocks, commodities and currencies.
Now, many traders believe computer analysis would end technical analysis of stock market patterns.
But this has proven not to be the case…
As a matter of fact, the basics of technical analysis and visual patterns in the stock market has gained tremendous popularity in recent years. And many professional traders still rely on it, along with their fancy computer algorithms.
The Basics of Technical Analysis in the Stock Market Are Divided Into 2 Separate Categories
There are two primary types of technical chart patterns: continuation and reversal.
A reversal pattern signals that a prior trend will reverse upon completion of the pattern.
A continuation pattern, on the other hand, signals that a trend will continue once the pattern is complete.
Both types of patterns work great with most financial markets, and the time frame can be adjusted anywhere from weekly analysis to intraday time frame.
This is one of the major benefits of learning the basics of technical analysis in the stock market. And the best part is it can be applied to any financial market and different time frame with the same level of effectiveness.
The Head and Shoulders Pattern
A head and shoulders top pattern is a reversal pattern formed after an uptrend.
Its completion signals a reversal of an uptrend and a beginning of a downtrend.
The pattern contains three successive peaks with the middle peak (head) being the highest, and the two outside peaks (shoulders) being low and roughly equal.
The reaction lows of each peak are connected to form support, or a neckline.
A head and shoulders bottom pattern is the exact opposite.
It’s a reversal pattern that forms in a downtrend, and its completion signals a reversal of a downtrend and the beginning of an uptrend.
The line signals a neckline, where you’d place an order to enter.
When the neckline is broken to the upside, a long signal is triggered. And when the neckline is broken to the downside, a short entry is signaled.
The Double Top and Double Bottom Patterns
Another popular reversal pattern is the double top and double bottom.
This pattern is similar to the head and shoulders pattern, and is considered one of the most reliable technical chart patterns ever in the stock market.
These patterns are formed after a sustained momentum move, signaling that the trend is about to reverse.
The pattern is created when price action twice tests support, or resistance levels, and then backs off each time.
In the double top pattern example, the market tried to move above a certain price level twice.
After two unsuccessful attempts at pushing higher, the trend reversed and the price headed lower.
In the double bottom pattern example, the market tried to go lower twice, but found support each time.
After the second bounce off of the support level, the market enters a new trend and heads upward.
2 Popular Continuation Patterns: The Pennant and Flag Pattern
Continuation patterns are the opposite of reversal patterns.
The market doesn’t reverse direction but it continues in the same direction it was moving prior to beginning the pattern.
Markets usually enter continuation patterns after a strong move in a particular direction…
And the pattern typically functions as a temporary pause in the trend.
The continuation pattern is a good way to enter a volatile market while it pauses prior to continuing the trend once again.
This is where entry risk is the lowest, providing the best risk-to-reward opportunities for traders.
It’s also one of the reasons why these patterns and basics of technical analysis in the stock market continue to be popular with swing and day traders alike.
The main difference between the pennant and flag pattern can be seen in the middle section of the chart pattern.
In a pennant, the middle section is characterized by converging trend lines.
The flag pattern shows a channel pattern, with no convergence between the trend lines.
However, in both cases, the trend is supposed to continue going back up.
Learning the Basics of Technical Analysis Patterns
Remember, the main differences between continuation and reversal patterns are simple…
Once the reversal pattern completes, the market is supposed to completely reverse direction, while the continuation pattern is a short pause in the same direction.
During the next few weeks, I’ll provide more technical analysis basics and other patterns to watch in the stock market.
So, stay tuned!
Until then, check out these two articles to learn more about the basics of technical analysis in the stock market: The Ultimate Trader’s Guide to Technical Analysis and How to Analyze Stocks Using Technical Analysis.
All the best,
Senior Strategist, WealthPress