The importance of the stock price pattern

The Stock Price Pattern How To Identify It
The price pattern is a visual illustration of market psychology. It shows when traders are inspired and move, when they are taking a breath and when they are willing to move further.

The stock price pattern represents a form of price movement that is recognized by a set of trendlines and curves. Changes between rising and falling trends are usually shown by price patterns. The stock price pattern is important for technical analysis because it shows the current movement but also enables traders to predict future changes. For example, if the stock price pattern shows a change in trend direction, it is a reversal pattern. But if the pattern shows a continuation that means the trend proceeds in a direction following a shortstop.

To explain this a bit clearer, for example, you are driving your car and the traffic is heavy, and you have to drive and stop, and drive and stop. Every time when you see the brake lights in the car in front of you, you know that you have to slow down. Otherwise, you’ll crash into the other car. The unknown fact is will the car in front of you continue to move in the same direction, pull aside or stop after that slowdown. 

The same is with the stock price pattern. 

When you notice a stock price pattern beginning to develop on a chart that is the sign the stock is going to slow down or consolidate. At that moment you have to slow down too and estimate what may happen. Also, at that very moment, you cannot know if the stock price will breakout and continue to move in your direction or it will change direction.

Every trader must understand how important the stock pattern is. It is a really valuable tool that you need in your trader tool kit. Recognizing and understanding patterns isn’t easy but once you learn how to do that, you’ll be able to uncover the future price action with high probability.

Characteristics of the stock price pattern

So, we all understand that the price pattern is an evident picture of market psychology. It shows when traders are motivated and move, when they are taking a pause and when they are ready to move further. For some image in the stock chart to be a pattern, some conditions must be fulfilled. 

Every single pattern is composed of four parts. Firstly, the pattern has to show an old trend. This means the trend of the stock price when it started to form the pattern. Also, the pattern must show the consolidation area. The consolidation area represents the zone where the trend is channeling or undefined. It is the area defined by set support and resistance levels. Further, the pattern must unveil the breakout point. That is the level where the stock price breaks the consolidation area. And, also as a part of an image on the chart to confirm it is a pattern, you must clearly see the new trend. The new trend represents the trend of the stock price when it starts coming out of the consolidation area. That’s how you can know that the stock price creates a pattern.

What types of stock price patterns do we have?

Chart patterns are an essential aspect of technical analysis. You’ll need to understand them. Stock price patterns are classified into two main categories: continuation patterns and reversal patterns.

Continuation pattern unveils you the new trend has the same direction as the old trend was going. 

The reversal pattern shows you the new trend is in reverse directions and starts to move in the opposite direction from the old trend direction. And that is the main difference between them. – the direction in which the new trend is moving.

Both types of patterns have the characteristics we mentioned above.

Trendlines

Stock price patterns are recognized using a series of lines and curves, as we said. But how to guess trendlines and draw them? It is important to locate zones of support and resistance.
To draw trendlines just connect by straight lines the dots of highs or lows, meaning descending peaks or ascending troughs. When the stock prices have higher highs or higher lows we are speaking about an up trendline. The opposite occurs when we notice a down trendline. That means the stock price has lower highs and lower lows.

The body of the candle bar will show where the bulk of price activity happened. So, it is a better point where to draw the trendline.

To draw a trendline you can use closing prices instead of highs or lows. And it is maybe better because the closing prices express the traders’ decision to hold a position. But be careful, the trendline drawn with only two points may not be quite valid. Always try to find three or more points.

Uptrend happens where the price is making higher highs and higher lows. Up trendline connects at least two of the lows and registers support level below the price.

The downtrend is the point where the price is making lower highs and lower lows. Down trendline combines at least two of the highs and shows a resistance level above the price.

Consolidation happens where the price is swinging between an upper and lower span, which are shown as parallel and horizontal trendlines.

Continuation stock price pattern

A price pattern that signifies a brief break of a current trend is a continuation pattern. It is just a break, a short time for traders to take a breath when an uptrend occurs or to relax during the downtrend. The first is in connection to the bulls, and second to the bears.

While a stock price pattern is developing, we can’t know if the trend will continue or reverse. So, we have to take attention to the trendlines and realize if the price breaks above or below the continuation area. It is always better to suppose a trend will continue until it is verified that it has reversed. Keep in mind, if the pattern needs more time to develop and you see the large price movement inside the pattern, it is a stronger sign the price will significantly break below or above the continuation zone.

But if the price remains on its trend, it is a continuation pattern. Continuation patterns can be pennants, flags, wedges, triangles.

Pennants are created by using two converging trendlines.
Flags can be drawn with two parallel trendlines.
Wedges are created with two converging trendlines, but both have to be angled either up or down.
Cup and handles, which is a bullish continuation pattern. When having this pattern, you can be sure an upward trend has stopped for a short but will proceed after the pattern is confirmed.

Triangles are the most popular chart patterns in technical analysis and they occur more frequently than the other patterns since they can last from a few weeks to several months. There are three most typical types of triangles: symmetrical triangles, ascending triangles, and descending triangles.

Reversal pattern

It indicates a change in the current trend. This pattern indicates the period where the bulls or the bears have run out of money. This means the trend will pause and then continue in the same direction.

For example, an uptrend backed by enthusiasm from the bulls will pause. That means the influence of both the bulls and bears, so the result is a change in trend to the downside. The reversal that happens at market tops is a distribution pattern. That means more sold than bought assets. Opposite, a reversal that happens at market bottoms is an accumulation pattern, which means there are more bought than sold assets. 

When the stock price reverses later, we are talking about the reversal pattern. Reversal patterns can be head ad and shoulders, double tops or bottoms, gaps.

Bottom line

You can identify the stock price pattern when the price makes a pause which indicates the zone of consolidation. Trendlines help in recognizing the price pattern that can develop in forms of flags, pennants, and double tops. The volume will decline during the pattern’s development, and increase when the price breaks out of the pattern. To have the better trading experience you can learn more in the Two Fold Formula book but first, try it with Etoro’s virtual trading system and check it.

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