Patterns
How to read and interpret price patterns
In technical analysis, often the best way to spot rising or falling trends in the market place to study the movement of prices. This is best done by studying price pattern which are nothing but graphs or charts of price movements over a given point of time. These are useful because it is far easier to spot trends than it is to analyze numbers. Analysts have long used these charts to predict future trends in price. For instance, a price pattern that signals a change in the trend is called a reversal pattern while a pattern that signals a continuation of the trend is called a continuation pattern.
One convenient way of pinpointing support and resistance levels on a price chart is to learn to draw what are called trendlines on the chart. These are straight lines that connect a series of descending highs or ascending lows are trendline that is pointing upwards is known as an up trendline and occurs when both price highs and price lows are ascending while a trendline that is pointing downwards is called a down trendline and is caused by descending highs and lows.
The appearance of the trendlines would depend on where they are drawn for instance on a candlestick chart. Because the major part of the price action occurs within the candle bar and not in the wicks at the top and bottom, you will get a more accurate picture if you use the candle bar. This is particularly true of intraday trading charts where you could have price action that falls outside what could be described as “normal”. On daily charts, many experts prefer to use closing prices rather than highs and lows because the closing price indicates the willingness to hold a position overnight.
You will normally see up trendlines when both highs and lows are moving upwards. If your up trendline connects two or more low prices, it will indicate the support levels. Similarly you will see down trend lines when both highs and lows are moving downwards and a trendline connecting the high prices will indicate resistance levels. A market that is moving sideways will have parallel trendlines that are often horizontal.
A price pattern that momentarily halts the prevailing trend and then resumes the trend is known as a continuation pattern. When you first see signs of the formation of a price pattern, you’ll find it difficult to establish where the trend is is going to continue or to reverse. You have to be particularly careful in drawing your trendlines and most experts recommend that you should assume that the trend will continue until you have confirmation that it is reversing. In fact, the longer the time taken for the formation of the pattern and the larger the price swings within the pattern, the more significant will be the breaks in price as and when they occur.
On the other hand, a reversal pattern will occur when either the buying or the selling activity runs out of steam and the established trend will reverse itself on renewed buying or selling as the case may be. For instance, a rising trend may pause indicating that bulls and bears are equally matched and then reverse itself if the bears gain the upper hand. Reversals at the top of the market are called distribution patterns where there is more selling than buying. Conversely reversals at the bottom of the market are called accumulation patterns where there is more enthusiasm by rather than sell