Step 3: Chart Patterns

A chart pattern is a shape made by many candles over days, weeks, or months. Where a candle pattern shows one short fight, a chart pattern shows a whole battle. Because it takes longer to form, it usually leads to a bigger move, and most chart patterns give you a measured target.

Chart patterns fall into two groups.

• Reversal patterns form at the end of a trend and signal that it is turning. An uptrend turns down after a head and shoulders top, or a downtrend turns up after a double bottom.
• Continuation patterns form in the middle of a trend. They are a rest before the trend carries on, such as a flag or a triangle.

Rules that apply to every chart pattern

1. A reversal needs a trend to reverse. A "double top" after a small bounce in a downtrend is not a double top.
2. The pattern is not complete until price breaks the key line. For a head and shoulders, that is the neckline. For a triangle, it is a trendline. Anticipating the break is guessing.
3. Confirm with a close, and ideally with volume. A close beyond the line on above-average volume is a strong break. A wick through the line that closes back inside is not a break.
4. Expect a retest. In large public studies of chart patterns, price comes back to test the broken line in most cases, often about two times out of three. A retest that holds is a second, often safer, entry.
5. Targets are estimates. Measured targets are reached a little over half the time for many patterns. Take partial profit near the target, and trail the rest.
6. Taller and wider patterns tend to work better than small, narrow ones, and patterns with the higher-timeframe trend behind them work better still.

Lessons in this step

1. Reversal patterns
   • Head and shoulders top, and inverse head and shoulders
   • Double top, including the version with a false breakout, and double bottom
   • Triple top and triple bottom
   • Rounding top and rounding bottom
   • Rising wedge at a top and falling wedge at a bottom
   • Broadening top and diamond top
   • V-reversal
2. Continuation patterns
   • Bull flag and bear flag
   • Pennant
   • Cup and handle
   • Rectangle
   • Ascending, descending, and symmetrical triangles
   • Expanding triangle
   • Wedge against the trend
   • Measured move

Start with the core set

Learn these first: head and shoulders (both kinds), double top and double bottom, bull and bear flag, and the three basic triangles. They appear often and have clear lines to trade.

What to do next

When you can draw the key line and the measured target for each pattern, go to Step 4: Price action.