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Chart Patterns
Learning chart patterns might be the fastest way to making consistent money in the stock market. For centuries, the market has displayed the same characteristics, over and over again. After all, it’s all about the buying and selling, supply and demand. Human emotions plotted on a graph in ticks and candles and lines and bars.
To that end, the more you learn about these repeatable patterns, the more insight you’ll have. It’s a lot like learning a new language. At first glance, it all seems like gibberish. It’s the patterns that give it meaning. For example, “love” may sound different in another language, but it means just the same.
So it is in the market. Learn the patterns of accumulation (buying), distribution (selling), and stalemate (sideways action), and you’ll be well on your way to exploiting opportunities.
In this guide to chart patterns, we’ll outline for you the most important patterns in the market: From candlestick patterns to bear traps, triangle patterns to double bottoms, we’ll cover it all.
Candlestick Patterns
What is a Candlestick?
Very simply, a candlestick is a plot of price over time. This can be any time frame. For example, a one minute candle is a plot of every traded price of a stock or asset during that one minute interval. Likewise, a 5 minute candlestick is a plot of all the prices that stock traded in 5 minutes worth of time.
This is all very basic information until you realize that candlesticks are telling a story of buyers and sellers during that timeframe.
The formation of a candlestick
How to Read Candlestick Patterns in
Trading
The value of candlesticks, which have been around for centuries, is in the story they tell. As you can see from the image above, a single candlestick shows the open, high, low, and close of the price action during that time interval.
To the naked eye, this might seem inconsequential. However, to the trained candlestick chart reader, all of that information is very, very useful in decision making. Here’s why.
Imagine a stock opens at $1 on a 1-minute candle but gets hit with a lot of selling pressure during the first quarter of the time interval. During the first 15 seconds, it trades below the opening price. This forms the lower wick of the candle.
Then, for the next 30 seconds, demand enters and the price of the stock moves higher to $1.50. It is safe to assume that bulls were able to overcome sellers during that time.
candlestick patterns: bullish, bearish, or indecision patterns. Most of these patterns require the formation of more than one candlestick to create a pattern — and there are many such patterns.
In fact, entire books have been written about all the types of candlestick patterns you can see in the market. And while they are very informative and can add value to your trading decisions, the average trader may find the myriad of patterns daunting. For that reason, most educators try to condense the types of candlestick patterns into the most popular ones.
Here are a few examples of the most popular bullish and bearish candlestick pattern combinations that you might see. Perhaps you are already familiar with a few of them?
Types of candlestick patterns
Let’s dig a little deeper now into what constitutes a bullish or bearish candlestick pattern.
Bullish Candlestick Chart Patterns
A bullish candlestick pattern is one that implies a bullish character — simple enough, right? This could be a reversal of a downtrend, or a continuation in an uptrend.
For a single candlestick, however, we assume it is a bullish candlestick when it “closes green”. What you’re looking for is a candle that closes higher than it opens, essentially. The example we gave above is similar.
Here’s what a bullish candlestick might look like:
Bullish or Green Candlestick
Although this could be considered an indecision candle, the overall nature of the candle leans to the bullish side. It closed higher than it opened. There are plenty of other types of bullish candlesticks more bullish than this one.
For example, a marubozu candle occurs when price opens at the lows (no/small wick) and closes at the highs (no/small wick). We usually consider these very bullish candlesticks in that bulls were in control during the entire time interval.
Notice how strong the green, bullish reversal candle is on this chart. It was enough to overcome the entire red candle preceding it — and the wicks are super tiny. This tells us demand was strong during the formation of the candle.
are just what you would assume. They reveal that bears were in control during the time interval that the candle pattern was formed. Likewise, they may represent a reversal pattern after a strong uptrend, or a continuation pattern during a downtrend.
For bearish candlesticks, we assume the price opens higher than it closes. In other words, bears took control at some point after the open of the candle and pushed price lower as the candle formed.
Here’s an example of what this might look like:
Bearish candlestick formation
Beyond just candlesticks, there are many bearish candlestick combination patterns. These create a series of candles which produce a bearish “event,” per se. They could be parabolic reversals, tweezer tops, abandoned babies, evening stars, or other unique patterns.
Evening star bearish candlestick pattern
Just like this example above, we discuss 8 of the most reliable bearish candlestick patterns in this tutorial.
Shooting Star Candlestick Chart Patterns
Continuing with some of the more popular candlestick chart patterns, let’s look at the shooting star candlestick pattern.
For good reason, most traders assume this is a bearish candlestick pattern. When taken in the context of an uptrend, the presence of a shooting star often signals a reversal. Many contrarian traders love to see these at the top of a parabolic run.
Hammer Candlestick Patterns
Hammer candlestick patterns are somewhat similar to shooting stars in that they often signal reversals. In fact, they can be bullish or bearish depending on the context.
Hammer candlestick patterns
As you can see, a hammer candlestick pattern often signals a reversal of a downtrend, much like a shooting star does on the opposite end of a trend. Both hammers and shooting star candles look the same, don’t they?
In the Hammer candlestick pattern example, we have sellers capitulating into stronger hands who buy up their shares. This leaves a long bottoming wick, and signals a reversal. To take this trade, you simply buy the breakout above the hammer candle after it is formed, risking to the low of the wick.
Inverted hammer patterns can also signal reversal in a downtrend. It simply means that sellers were not able to continue pushing the stock price lower. Once they realize this, they give up and begin covering their positions, pushing the price higher.
For more on how to trade hammer candlestick patterns, check out this guide.
Doji Candlestick Patterns
Doji candlesticks are often referred to as indecision candles. They can show up red or green on a chart, but aren’t exactly considered bullish or bearish. They typically indicate a stalemate between both forces.
Like the example above, what you typically find in a doji candlestick is a very narrow body with wicks on either end. Similar to what we discussed above, this informs the chart reader that both bears and bulls created a tug-of-war while this candle was forming, and neither really won, despite the candle closing green or red.
However, if you spot the doji candlestick pattern in certain contexts, it might signal a reversal. We discuss this in our tutorial on dojis. Here are a few examples of where you might see doji candlesticks, and how they differ from the large marubozo style of candlestick patterns:
Gravestone doji reversal
Candlestick Patterns Cheat Sheet
In order to keep from getting overwhelmed, we created a cheat sheet for you of the most popular candlestick patterns. Ideally, you’ll keep this handy while you’re trading in order to train your chart eye.
Over time, you should expect to recognize these patterns instead of having to refer back to the candlestick pattern cheat sheet. As you see a stock becoming more and more
extended, it will become second nature to you to start spotting these patterns.
Feel free to save this for your own trading purposes:
Candlestick pattern cheat sheet We’ve broken the most popular patterns into bullish and bearish candlestick patterns in this cheat sheet. We recommend taking the following approach to learning these:
1.Pick a side (bullish or bearish) 2.Focus on 2-3 candlestick patterns for 2-3 months 3.Identify all the examples you can find of those patterns 4.Document what makes the pattern work or fail 5.C r e a t e a l i s t o f c r i t e r i a y o u c a n u s e t o s t a y disciplined as you trade the setups
How to Read a Triangle Chart Pattern
Triangle patterns begin with broader price range and volatility. Over a period of time, they contract into an apex on lower volatility and narrowing price range. This is accompanied with a series of higher tops and higher bottoms, or lower tops and lower bottoms or a symmetrical sideways pennant of lower highs and higher lows. Some variances to this can occur, like a flat base or flat top.
Regardless of the formation specifics, the goal as a trader is to determine the path of least resistance once the stock leaves the formation. Along those lines, we typically see ascending triangles resolve downwardly; descending triangles usually resolve upwardly.
Volume and price action are also key in how to read a triangle pattern. Every chart pattern should tell you a story, much like candlestick patterns. Are bulls absorbing downward pressure in a descending triangle? Or, are bears selling to the bulls in an ascending triangle?
Each pattern will show you, if you look intently enough, the path of last resistance on the horizon. Once you spot it, the triangle pattern gives you a great risk to reward setup for your trade plan.
Let’s look at each type of triangle pattern a bit more in depth.
Descending Triangle Patterns
T h e d e s c e n d i n g t r i a n g l e p a t t e r n i s o n e o f t h e m o s t recognizable chart patterns in trading. It usually forms as a reversal at the end of a down trend or as a continuation pattern in an uptrend. It offers a chance for bulls to reload after profit taking in a stock.
Often labeled a descending wedge, it is important to note that the stock can resolve in either direction, up or down. For that reason, it’s always best to respect your stops. However, it is generally assumed to be a bullish pattern.
In our tutorial on descending triangles, we teach you a handful of ways to trade this pattern. One of the most popular is the breakout strategy. In this strategy, you wait for the stock to put in a series of volatility contractions, then buy on the breakout of the upper trend line.
Ascending triangle pattern breakdown
In the example above, notice how as the stock advances, selling pressure prevents it from putting in a new high. It’s akin to “walking the plank.” The end result is inevitable, it just takes a little time to get to the end of the plank.
For entries, take your position on the breakdown, risking the highs. Targets can be set at the lows of the structure, or by measuring the broad part of the triangle and applying it to your breakout point.
Symmetrical Triangle Patterns
Symmetrical triangle patterns are a lot like pennants. As the structure forms, you expect to see higher lows and lower highs. This contracts into an apex formation. However, unlike the ascending or descending triangles, it may be a bit harder to predict the direction of least resistance at first. Sometimes they can seem a bit 50/50 in nature.
Similar to the volatility contraction pattern we discuss in our best small account strategy, it can lead to big gains under the right circumstances. Here are a few chart examples of what to look for in a symmetrical triangle pattern.
Symmetrical triangle false breakout
In this example we have a false breakdown. As you can see, it is sometimes difficult to judge such a tight pattern. However, as the pattern evolved and reclaimed, you could flip your bias and risk off the most recent low for a long trade.
Here’s an example of managing your risk and setting your targets for the symmetrical triangle pattern:
Symmetrical triangle pattern breakout In this example we measure the widest part of the triangle and apply it to our breakout in order to set our 1st target zone.
