The trend
Many people assume that the market is always in an uptrend or in a downtrend. In reality, however, the price of the market can move in three directions – down, up and sideways. A directionless market is called a sideways trend. The three directions of the trend can be classified into three further categories. These categories consist of long-term, medium-term and short-term trends. So, in reality, there are an infinite number of trends that may only last for a few minutes or hours, or even for whole days, weeks and months. In chart analysis, it is of great importance to recognize the trend correctly, because this is the only way to identify a reversal formation (trend change) or continuation formation (the trend remains).
reversal formations
These formations indicate that a trend is likely to reverse. The dominant trend is changing and a reversal pattern is forming. In this context, resistance and support are often mentioned. Support is a price area below the current price where higher demand will start to outstrip supply. This will stop a further fall in price. Resistance is the direct opposite of support. Resistance is a price barrier and can stop the price from rising. In this area, the supply slowly exceeds the demand and the price stops rising.
Shoulder-Head-Shoulders Reversal Formation
The Head and Shoulders is one of the most well-known reversal patterns in chart analysis. In a long-term uptrend, there is a succession of rising peaks and troughs, but these gradually lose strength and speed. Here, the previous upward trend flattens out for a certain period of time. At this moment supply and demand are in relative equilibrium. As soon as this equilibrium tips over, the lower resistance line is broken and a new downtrend is established. The break of the upward trend is considered the first warning signal for the investor, after which the price only reaches a lower high. This move forms the right shoulder of the pattern, which is roughly at the price level of the left shoulder. The high price between the two shoulders is considered the head. The connection of the lows before and after the high is considered the neckline. If this neckline is breached, a sell signal is generated. The resolution of a shoulder-head-shoulder is the significant breakthrough of this neckline.
This formation can also develop as a ground formation. The inverse head and shoulders formation is a mirror image of the peak formation.
The Triple Tips
This formation is also known as a triple top or triple bottom. It differs only slightly from the shoulder-head-shoulders formation. In the triple top formation, all three highs are at the same level. This level acts as a strong resistance line and price will not break through it. A sell signal occurs when the support line of the previous lows is breached.
Such a formation can also be formed as a triple bottom. Here, the three consecutive lows are on the same level. These lows are considered strong support and will not be breached by price.
The double peaks
One of the most common reversal formations in chart analysis is the double top. This formation is the easiest for the investor to identify. The constellation is identical to the triple top formation, only here only two tops are formed at the resistance line before the sell signal is generated.
There is also a ground formation associated with this constellation. In a double bottom formation, the price twice hits a strong resistance line and then forms a new buy-signal.
continuation formation
These chart patterns are also known as trend confirmation patterns. The continuation patterns indicate that subsequent price action is moving in the same direction as the previous trend.
pennants and flags
The pennants and flags are very common formations. They are very similar in their arrangement and are therefore treated together. As a rule, pennants and flags represent short breaks during dynamic trading. The formations are preceded by an almost vertical price movement, which analysts call the flagpole. After the rapid rise, a brief consolidation follows. This then forms the shape of a pennant or a flag. When the consolidation phase is complete, the flag or pennant is breached to the top. This is followed by another rise in price, which is about the same length as the rise before the formation. The flag should always be formed in the opposite direction to the trend. After the formation is completed, the flag should be at half mast, which means that the post-consolidation surge will be followed by another surge. This keeps the pennant or flag in the center of the formation at all times.
Pennants and flags can also develop as prices fall. This leads to an extreme price slump, which is followed by another price slide after a brief consolidation. Here, the second dip is about the same length as the slide before the formation.
The rectangle formation
The rectangle formation represents a break in the prevailing trend. The price encounters a resistance line, which it can break through only after several attempts. In a short sideways movement, the price oscillates between two parallel horizontal lines. The course moves back and forth between the upper resistance and the lower support. If the price breaks through the upper resistance line, the actual uptrend will continue. Investors can then bet on further price gains.
The rectangle formation can also form in a downtrend. In this case, the course hits a support zone several times, which is broken through after a short consolidation phase. If this support line breaks, the initial downtrend will resume.
The triangles
This continuation pattern houses the ascending, descending, and symmetrical triangles. The symmetrical triangle shows a break in the current trend, which continues after the formation. If the trend before the triangle was up, it will continue in that direction after the formation. The symmetrical triangle has two converging trend lines, with the top line falling and the bottom line rising. The point where the lines meet is called the apex. In the consolidation phase of the trend, lower highs and higher lows are formed. This constellation leads to a symmetrical triangle. The original trend will resume if prices break the triangle to the upside. Investors can use the pre-breakthrough phase to buy.
With a symmetrical triangle in a downtrend, the triangle breaks down and continues the negative trend. Investors can use the pre-breakthrough phase to sell their position.
The ascending triangle forms in a prevailing uptrend, with the price repeatedly hitting a resistance line. In an ascending triangle, rising lows form during consolidation. The high prices, on the other hand, remain at the level of the resistance line. A buy-signal is given for the investor when the resistance line is crossed to the upside.
The descending triangle forms in a prevailing downtrend with price repeatedly hitting a support line. In a descending triangle, falling highs form during consolidation. The low prices, on the other hand, remain at the level of the support line. A sell signal will be given to investors if the area of support breaks down.
The Wedge Formation
A wedge, like a symmetrical triangle, is formed by two converging trend lines. These trend lines meet at the apex. A wedge can have a negative or positive slope. A wedge always points against the prevailing trend with its tip. A rising wedge indicates a downtrend and a falling wedge indicates an uptrend. Breaking the trendline of a rising wedge gives the investor a sell signal as the downtrend will resume. On the other hand, a buy signal is generated when the trendline of a falling wedge is broken as the uptrend continues.
In chart analysis, it is usually only about general tendencies and not about fixed rules. So there can always be exceptions. In addition, a comprehensive chart analysis should also include turnover and open interest.
Pierre Bonnet / Editor finanzen.net
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