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Types of Stock Chart Patterns

Stock chart patterns are the visual cues that emerge from historical stock price data, providing traders insight into existing supply and demand for the stock. Studying the underlying patterns or shapes in a stock chart can aid in evaluating the momentum (uptrend/downtrend), support and resistance of the stock. The next few posts will look at the various chart patterns that can be identified. Please note that the screen shots may not perfectly reflect the definition of that pattern, which a trader performing technical analysis would look for and accept and only meant to provide some visual idea instead of mere text (click on images for enlarged views).

Chart patterns are classified into continuation and reversal patterns:

Continuation Patterns

Cup and Handle Pattern

continuation

This type of pattern occurs during an upward swing of the stock. As the name indicates, the pattern refers to an area where the prices stagnate (the cup) followed by a small increase (to form the handle) before breaking out again to move significantly higher, most likely with increase in trade volume.

Flag Patterns/Pennants

bullpennant

Flag patterns can be of the bull (occurring during continuing price increases) or bear (found during periods of declining prices) type.

Bull Flag Pattern

bullflag

The bull flag pattern is seen during an uptrend where a big price increase is followed by a minor drop in price that resembles a slight downward tilt or the lines at least remain horizontal instead of continuing to rise. The pattern is similar to a flag hoisted on a pole. The volume of the stock will remain consistent during price increases but might shrink during the flagging period.

Bear Flag Pattern

bearflag

The bear flag pattern can be seen during a downtrend. This continuation pattern occurs when a consistent downtrend is interrupted by a minor increase or stagnation. The bear flag is so named due to the similarity to an inverted flag on a pole. The price decline period will have solid volume, while the slight correction may show a decrease in volume.

Bull Pennant Pattern

bullpennant

The bull pennant pattern is seen during an upward movement of the stock and resembles a pennant on a pole. The bull pennant pattern is similar to the bull flag pattern but with converging trend lines in the resting phase instead of horizontal ones. The stock increases in price with solid volume, rests in the bull pennant pattern region with reduced volume before continuing its onward march.

Bear Pennant Pattern

bearpennant

The bear pennant pattern is found during the downswing of a stock and resembles an inverted pennant on a pole. It is a resting period during the decline similar to the bear flag pattern but with converging lines. The stock drops in price with solid volume, rests in the bear pennant pattern region with reduced volume before continuing its slide.

About the Author: Clark works in Saskatchewan and has been working to build his (DIY) investment portfolio, structured for an early retirement. He loves reading (and using the lessons learned) about personal finance, technology and minimalism. You can read his other articles here.







8 Comments, Comment or Ping

  1. To anyone thinking of trying technical analysis, I would suggest first reading Burton Malkiel’s book “A Random Walk Down Wall Street” to see why it may a not work.

  2. Thanks for this, Clark!

    I definitely appreciate this, as it’s not your typical PF blog post: get out of debt, save money, reduce expenses, retire faster…
    Although I have enjoyed those for some time now, I see the same old when jumping from blog to blog.

    This is technical, specific, and useful. May the fact that this post isn’t as highly commented not deter you, but provide support that this is new stuff to most people (including me =D)!

  3. 3. Clark

    @no_more_ratrace: Thanks! I’ve noticed that such posts (the preferred shares series comes to mind) don’t receive many comments but I plan to complete this series nonetheless :)

  4. 4. Ed Rempel

    Hi Clark,

    Interesting article. Sorry, but I think that charting is bunk. The reason is that “stock prices are not serially correlated”. This is the same reason that algorithms to forecast stocks don’t work.

    For every example where a chart pattern works, you can find others where it doesn’t.It is also very subjective when the pattern exists and where it doesn’t.

    I have not seen much evidence that any of this works. If you look at the top investors in the world, none are traders. It is difficult to beat buy-and-hold after all the transaction costs.

    Our investment process is based on evaluating professional investors. When we find one that uses charts, we generally assume he probably does not do much real research.

    Some fund managers use charts, but generally it is the average guys. As a general rule, we find that fund managers that use charts are not as good as fund managers that do not use them.

    Ed

  5. 5. Ed Rempel

    Hi Larry,

    I think the “Random Walk” efficient market theory has been officially debunked. It is still talked about a lot in investing circles, but has essentially unanimously been rejected by academics. Finance professors still teach it, but virtually none believe it.

    The problem with it is that it is based on investors being rational. The truth is that most investors are irrational most of the time. Instead of the market always being properly valued (as in the EMT), the truth is that the market goes through huge manias and is mispriced most of the time.

    The best book I’ve read on it is Justin Fox’s book “The Myth of the Rational Market”.

    I believe that charts don’t work because “stock prices are not serially correlated”, not because of any “random walk” “efficient market theory.”

    Ed

  6. You have a way of putting complicated things up together and explaining it in a very understandable way. I admit you need to read more and learn more to perfect the craft of stock, still your stuff is a good read.

  7. 7. Billie 2 Willies

    Linear regression is my choice for determining the price direction. Its either up or down. Buy below , sell above , it is similar to the 200 day moving average without the wiggles. I also like to plot FX5 which is the cumulative 5 year return for the market. Buy below, sell above. Simple approach. (KISS)
    Chart patterns are not reliable.

  8. 8. Clark

    @Mark Fuller: Thank you!

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