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Like it or not, charts serve as an important tool for online traders and play a key role in technical analysis. You may generally look at graphs and numbers and feel a bit overwhelmed, but when you invest in shares, commodities, indices or forex in the form of CFDs, charts can be your best friends. They offer information, long-term insight and can potentially assist you in making trading decisions. Want to know more? Let’s start with the basics and build our way up.
If the notion of charts leaves you hyperventilating, just think of them as visual representations of price movements; a picture of how the market, or a single instrument, moves. This “picture” offers plenty of information regarding market behavior – both past and future. A chart pattern is simply a specific formation on a chart that can be viewed as a trading signal, or as an indication of future price movements. Traders who employ charts – also called “chartists” - use chart patterns to identify trends and reversals and to decide whether they should buy, sell or wait.
There are several chart types that traders use. They all, essentially, feature the same basic information - price movement across time - but they display it differently and go into different levels of detail. Here are just three of the most popular types of trading charts…
A line chart is the easiest chart to explain. The name really says it all: It shows a simple line where each movement represents the movement from one closing price to the next. This type of chart is perhaps the most basic one, so it has its limitations, but if you just want to get a clear - albeit general - view of price changes over time, it can be quite useful.
Here is an example of a line chart of one of our most popular instruments: WTI oil.
If a line chart is one of the simpler forms of trading charts, then a bar chart is one step up in complexity. In this type of chart each ‘bar’ represents a single unit in time: A minute, an hour, a day, etc. It features the opening price, closing price, highs and the lows of every unit of time. The highs and lows are easiest to spot – the highest point of the bar being the high and the bottom of the bar being the low. A vertical line on the left of the bar represents the opening price and a similar bar on the right represents the closing price.
Here is a simple example of a WTI oil bar chart:
We may not know if candlestick charts are the most popular charts among traders, but they’re certainly one of the leading choices. Just like a bar chart, a candlestick chart shows the highs and lows of each unit of time – the top is the high, the bottom the low. So, what’s the difference? We’re just getting to it. A different color is used to indicate if an instrument closed higher or lower than it opened. Often, red represents lower and blue higher, but there’s no real rule. There are also cases when a black or ‘full’ candle means the instrument closed lower than it opened, while white or ‘empty’ means it closed higher than it opened.
If you feel that this is complicated, just give it a go. After browsing candlestick charts for a while you will quickly realize how convenient they are and how easy it is to read the information they present.
Here is an example of a WTI crude candlestick chart...
Are there other types of charts? Of course there are. The three we discussed are just the more commonly-used ones. Investors have different preferences and there are many types of charts to accommodate them. Want a couple of additional examples? Sure…A dot chart looks like this: Then there’s the forest chart that looks like this:
If you’re only just starting on your way through the online trading world, you don’t need to confuse yourself with a variety of different types of charts. You could easily get by just fine with the candlestick chart, and that’s the one you will see most often on market news and analysis. Got it? Great. Now that we’ve covered chart types, let’s look a bit deeper into chart patterns.
There are three main groups of chart patterns that you are likely to encounter: Reversal, continuation and bilateral. We will give you a quick review of each.
It’s not difficult to guess what a reversal pattern means. It signals that a trend could reverse once the pattern is complete. In simple words, if you spot a reversal chart pattern during an uptrend, it theoretically suggests that the price will start to move down soon. If you see a reversal chart pattern during a downtrend, it implies that the price will move up soon. Keep in mind though that “soon” is a vague concept and that this is just a theory and should not be taken as fact.
If you understand the concept of reversal patterns, continuation is exactly the same, only – pun intended - reversed. According to the theory, a continuation pattern signals that a trend could continue after the pattern has run its course. Just think of these patterns as featuring “breaks” investors take before continuing on the same path.
Bilateral chart patterns are a bit confusing, because they essentially mean that the price can move up or down, in either direction. Most commonly, this pattern is shown as a triangle formation. You might be thinking that such an indicator is little to no help, but the importance of bilateral patterns is that they indicate anything can happen, and that investors need to prepare to react to any possible scenario.
Now that we’ve covered the main types of patterns, it’s time to discuss a couple of specific, popular, reversal patterns: Double tops and double bottoms. Both of these cases involve extended theory: How to trade them, when do investors commonly place orders, etc. While we will not go into such depth here, we will give you a quick insight into these patterns and their possible meaning. Let’s start at the top…
A double top is a bearish reversal pattern, which follows an extended uptrend. The ‘tops’ are similar-sized, consecutive peaks formed when the price hits a certain price level and can’t break out. First, the price moves up to the price level. Then, it bounces down slightly before returning to the price level. Once it bounces down again, the chart forms a double top. Confused? Just imagine a kind of a camel hump. Typically double tops can be seen on line, bar and candlestick charts.
According to theory, double top reversal usually suggests a certain change, sometimes a long term change in trend, indicating a possible move from bullish to bearish. This is why some investors look for double tops following a significant uptrend.
You want an example? Look at this one…
Much like double tops, the double bottom is a trend reversal formation, commonly used as part of technical analysis. The difference is that in this case the two ‘peaks’ are actually two ‘bottoms’. A double bottom looks a bit like the letter W – made up of a drop in the price of an instrument followed by a rebound, then another drop to a similar price level followed by a second rebound. The bottoms are created when the price can’t seem to break a specific level, which is referred to as a “resistance level”. Because - in theory - double bottoms are considered as trend reversal formations, some people look for them following a significant downtrend.
Want an example? Here you go…
Remember: While double tops and double bottoms may seem pretty clear, investors need to be careful not to be fooled by deceptive reversals, as well as to learn how and when they could act. You can do some additional reading in order to master this theory and its possible implications.
You didn’t think double tops and bottoms were the only patterns in existence, right? There are many chart patterns that traders use and while we cannot possibly mention all of them here, we will look into a few of the better-known ones. Here they are...
Head and shoulders
A head and shoulders pattern is also a trend reversal formation. It’s called head and shoulders because this is, kind of, what it looks like. It arrives after a long bullish trend and is formed by a peak (the left shoulder), followed by a relatively higher peak (which forms the head) and finally a second, low peak (the right shoulder). You can draw a line connecting the lowest points of the external part of the “shoulders”, as shown in the example below. Why would you want to? Well, according to the theory, if the slope of this line (sometimes referred to as “neckline”) is a down slope, the signal is viewed as more reliable.
Cup and handle
Also known as ‘cup with handle’, this chart pattern is composed of a drop in the price, a bounce back to the original price, then a smaller drop followed by a price rise beyond the previous peak. The resulting pattern looks a bit like a teacup – a U shape followed by a slightly downward “handle”.
A cup and handle is viewed, in theory, as a bullish continuation pattern, used to identify potential buying opportunities. This formation is viewed as significant only when it follows an upward price trend, especially a trend that lasts for no more than a few months.
When spotting cup and handle patterns, technical analysis investors often consider the length, depth and volume of the pattern. For example, cups with a longer, more U-like shape (unlike a V shape) are viewed as stronger signals.
A gap is simply a break between prices on a trading chart. Gaps are created when the price of an instrument makes a sharp up or down move, with no trading taking place in between. Reasons for gaps include earnings reports, major news releases or just regular trading. Sometimes, a gap is created when relevant breaking news occurs over the weekend, leading to a surge – or a crash – in the price, once the market reopens. Want an example of a gap? Here’s one…
Remember: Gaps are a familiar phenomenon in financial markets, but rarer in the forex market, where trading takes place throughout the day and night. In the forex markets, gaps are most likely to appear at the opening of the 1st trading day of the week.
Triangle chart patterns form – can you guess it – triangles. Essentially, they feature the convergence of two trend-lines, and the price of the instrument moves between them. There are three major types of triangles and here they are…
The symmetrical triangle is often viewed as a continuation pattern, signaling a period of consolidation of a specific trend before it resumes. It is made from the convergence of an ascending support line and a descending resistance line. Typically, the price of the instrument will bounce between the trend lines, moving closer and closer to the apex (that’s the name for the point where the two lines meet), before breaking out in the previous trend’s direction.
An ascending triangle is typically viewed as a bullish pattern, indicating the price of an instrument will move higher once the pattern is complete. This type of triangle is created from an ascending trend line serving as a price support and a flat trend line serving as a point of resistance. Confused? Look at this example and you’ll see what we mean. Note that the pattern is complete once it breaks out above the resistance level, but it can still drop below the support line.
A descending triangle is exactly the opposite of the ascending triangle. It is viewed as a bearish pattern, indicating the instrument’s price will move down, once the pattern is complete. It’s composed of a downward-sloping resistance line and a relatively flat support line, which the price cannot seem to break.
In technical analysis, a wedge signals a pause in an existing trend. Wedges can be either reversal or continuation patterns. There are two main types of wedges.Rising wedge
When a price consolidates between upward support and resistance lines, this results in a rising wedge. According to the theory, if the rising wedge is created following an uptrend, it could signal a continuation. Note that because a rising wedge indicates a possible downtrend (in theory of course), it can be viewed as a bearish chart pattern.
A falling wedge can serve as a continuation or reversal signal. As a continual, it’s formed during an uptrend, suggesting the upward price movement could resume. As a reversal, it is formed at the bottom of a downtrend, serving as an indicator that an uptrend could appear next. As you’ve probably noticed, the result is the same: An uptrend, making the falling wedge a bullish chart pattern.
We’ve had triangles, wedges and gaps. Now, it’s time to talk about rectangles. This chart pattern is formed when the price moves between parallel support and resistance levels. This is the last pattern we’ll discuss today and there are two common types to consider.Bearish rectangle
In a bearish rectangle, the price stays relatively flat - for a little while - during a downtrend, before continuing the trend (in theory of course). Here is an example…
You can probably guess what this rectangle is about. During an uptrend, the price stays relatively flat (a.k.a. consolidates) for a while, before it continues in the original direction (again, in theory). Want a visual example? Here you go…
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