In this section, we’ll go through how to leverage these chart patterns to your benefit.
It is not enough to understand how the tools function; we must also learn how to use them. And with all of these new weapons in your arsenal, we should get those earnings going!
Let’s review the chart patterns we just learnt and categorize them based on the signals they provide.
Reversal Chart Patterns
Reversal patterns are chart formations that indicate that the current trend is poised to shift direction.
When a reversal chart pattern emerges during an uptrend, it indicates that the trend will reverse and the price will soon fall.
In contrast, if a reversal chart pattern is seen during a downturn, it indicates that the price will rise later.
In this lesson, we covered six chart patterns that give reversal signals.
- 1. Double Top
- 2. Double Bottom
- 3. Head and Shoulders
- 4. Inverse Head and Shoulders
- 5. Rising Wedge
- 6. Falling Wedge
Simply place an order beyond the neckline and in the direction of the new trend to trade these chart patterns. Then aim at a target that is around the same height as the formation.
For example, if you detect a double bottom, put a long order at the top of the formation’s neckline and aim for a target equal to the distance between the bottoms and the neckline.
Don’t forget to set your stops in the interest of adequate risk management! A decent stop loss can be placed towards the center of the chart formation.
For example, you can measure the distance between the double bottoms and the neckline, split it by two, and use that figure to determine the size of your stop.
Continuation Chart Patterns
Continuation chart patterns are ones that indicate that the current trend will resume.
These are also known as consolidation patterns because they demonstrate how buyers or sellers take a brief pause before continuing in the same direction as the previous trend.
Trends rarely go in a straight line up or down. They pause and move laterally before “correcting” lower or higher to resume the main trend.
We’ve already discussed various continuation chart patterns, including wedges, rectangles, and pennants. Wedge patterns can be classified as reversal or continuation patterns, based on the trend on which they form.
Simply place an order above or below the formation to trade these patterns (following the direction of the ongoing trend, of course). Then, for wedges and rectangles, aim for a target that is at least the size of the chart pattern.
When it comes to pennants, you can aim higher and target the height of the mast.
Stops are typically placed above or below the actual chart formation for continuation patterns.
When trading a bearish rectangle, for example, position your stop a few pips above the rectangle’s top or resistance.
Bilateral Chart Patterns
Bilateral chart patterns are more difficult to interpret since they indicate that the price can move in either direction.
Huh? What kind of signal is that?!
A two-way signal.
This is when triangular formations come into play. Remember how we said that with triangles, the price might break to the upside or the downside?
To trade these chart patterns, think about both options (upside or downside breakout) and put one order on top of the formation and another at the bottom.
If one order is triggered, the other can be cancelled. You’d be a part of the action either way.
Double the fun, double the possibilities!
The only issue is that if you put your entry orders too close to the top or bottom of the formation, you may catch a false break.
So be cautious, and don’t forget to set your stops!
Next Lesson: What are Pivot Points?