We could probably fill close to 500 Web pages on this topic. There are about as many chart (or price) patterns as there are stock market analysts, and there are many of them! To give you an idea of the different patterns available to you, here is a partial listing: trend lines, support/resistance, fan lines, channel lines, retracement, speed resistance, gaps, reversal patterns, head and shoulder patterns, double tops/bottoms, triple tops/bottoms, saucers or rounding patterns, cup and handle, V-formations, triangles, diamonds, flags and pennants, wedge formation and trading ranges. Candlestick charts have their own series of price patterns such as hammers, doji, stars, dragonfly doji, spinning tops, and we could go on and on for a while. The most widely used charting methods are bar charts and candlestick charts; some traders also use point and figure charts. Fortunately it is not necessary to understand all these patterns to be a successful trader, however, you should be aware of their existence. Tonight we will look at some of the most widely used patterns and some of the patterns we use in our trading system. Support/resistance and breakout patterns Suppose a stock is declining and at a certain level it starts to rebound. Let's say that this rebound happens at $40. What happened is that buyers were waiting to buy at that price. The stock now starts to climb because buyers are stepping in. Imagine someone had planned to purchase but at the last minute decided against it. After seeing the price rise, he vows to not let the stock get away from him again. In the meantime, the stock continues to rise some more till many traders start taking profits, the stock declines and comes close to $40 again. Remember the traders that didn't buy the stock before? They are now buying! This will push the stock up again. An area of support has now been formed. At this point the market at large will develop a frame of mind that $40 is a good place to buy this stock and the $40 "support" level becomes a self fulfilling prophecy. Similarly with resistance levels. An advance to a price, say $45, which is repeatedly followed by a pullback to lower prices creates an emotional barrier. The market develops a mental picture that says that you should sell at $45 if you don't want to lose your money. You can also imagine that it is quite significant if the stock breaks through these support or resistance levels. It can drive some serious follow through in the trend because the expectation did not come true and now all bets are off. One strategy is to attempt to purchase near support and take profits near resistance. Another is to wait for an "upside breakout" where the stock penetrates a previous resistance level. After a breakout above resistance, resistance becomes the new price level for support. The longer the prices are trading in a support or resistance area, the more significant that area becomes. Prices often trade in a "congestion" area for quite a while before they breakout again. Volume is an important indicator to measure how significant the support level is. When a lot of shares change hands at a support price level it clearly indicates that many traders view that level as a significant buying opportunity. to be continued... Volume and breakout Volume is an important indicator in breakouts above resistance levels (or breakouts below support levels). Volume often spikes sharply when a breakout occurs. A surge in volume often precedes a price breakout, then the breakout point through the area of resistance becomes a level of support a few days later. A decline in volume during down days is often a sign that the sell off is only a temporary setback in a generally upward trend. There is a tendency for round numbers to stop advances or declines, at least in the short term. These round numbers, such as 50, 80, 100 will often act as psychological support or resistance levels. A trader can use this information to his or her advantage and begin taking profits, or enter the market, when round numbers are approached. |
