The skill of recognizing patterns in price action charts

  • By Jeff Cartridge

  • September 7, 2018
  • 12:05 am BST

With the large variety of chart types available, the ability to recognize patterns is a highly advantageous skill in all trading strategies. This technique forms part of technical analysis, whereby price action and volume are traced. Pattern recognition is highly useful for determining entry and exit points, stop loss orders and profit targets.

Pattern types

Each pattern creates a different visual shape on the chart and can be recognized by this shape. All of these formations allow you to monitor trends in price changes and use this knowledge when entering your own trades. One of the greatest benefits of this method is that it is not limited to one market. There are chart patterns available for all markets, such as forex, CFDs, stocks and commodities. They are also applicable to long-term and short-term traders on charts of any time frame. The shapes of each pattern reflect a trend in the movement of supply and demand, which in turn indicates which positions are wise and which ones are risky.

Triangles 

Patterns that take the shape of a triangle do not favor either the long or short side, which makes them favorable for CFD trading. There are three main types of triangle patterns. The first is an ascending triangle, which incorporates support and resistance lines. The resistance line marks the top boundary above which the pattern seldom goes. Another vital line is the uptrend line, which indicates the rate at which the price ascends. If the pattern should continue ascending and eventually break the resistance line, a breakout occurs, indicating unexpected price or volume changes.

The second type of triangle is the descending triangle. This is recognizable by a decreasing movement in the chart, heading downwards toward a support line. This support line is a straight lower boundary of the chart movement. The downtrend line will follow the slope of the trend, and if the pattern goes lower than the support line, a breakout will occur. With the ascending and descending triangles, the trend is more beneficial when it sees a breakout as this creates the opportunity for trading against the pattern and potentially making large profits.

The third triangle type is the symmetrical triangle. In this pattern, the price movement is directed toward a smaller range. Similar to the above patterns, a breakout in the trend is where profitable opportunities lie.

Rectangles

A rectangular pattern shape can be recognized if the support level at the bottom and resistance level at the top are parallel to each other. The price movement will reach a breakout once it exceeds one of the boundaries. As with the triangle patterns, these breakouts may be false breakouts at times, or whipsaws, which can then reverse. However, in most cases, the breakout will continue heading in the same direction for some time, creating an opportunity for trade entry.

Flags

The flag pattern is formed by parallel support and resistance lines that run diagonally across the chart. The price movement enters this shape from the bottom upwards, creating what looks like a flag pole. For this pattern to be applicable, the breakout needs to be moving in the same direction as the original price entry movement. This indicates a very sharp price movement, which is usually followed by increased volume.

Establishing price targets

These patterns can be used to set a price target as a potential profit point. For both triangle and rectangle patterns, the price target can be found by measuring the pattern height and placing the price target directly above the breakout point at the vertical distance of the pattern height. For flag patterns, the length of the flagpole line is added onto the breakout line and the price target will be at the end point of that line. By recognizing these chart patterns and correctly locating the price target, your trades can strategically gain the potential for high profits.