What Are Reversal Chart Patterns ?
EDUCATIONAL POST
Aldona Šabanienė7 min read·Just now--
This post is a continuation of my series on Chart Reading and Candlestick Analysis. So far, I’ve covered how individual candles tell short-term stories and how volume confirms market conviction. I’m stepping one level higher today, into Reversal Chart Patterns. These are the formations that signal when a trend is losing strength and a new direction is likely about to begin. Understanding them is what separates reactive traders from prepared ones.
What Are Reversal Chart Patterns?
Reversal patterns are technical analysis formations in price charts that signal the exhaustion of a prevailing trend and the likely start of a new, opposing trend. These formation suggest a shift in market sentiment when buying pressure turns to selling (top reversal) or selling turns to buying (bottom reversal). Reversal patterns are critical for identifying potential market turning points.
Head and Shoulder Pattern
Head and shoulders is a chart pattern in which a large peak has a slightly smaller peak on either side of it. Traders look at head and shoulders patterns to predict a bullish-to-bearish reversal.
Typically, the first and third peak will be smaller than the second, but they will all fall back to the same level of support, otherwise known as the ‘neckline’. Once the third peak has fallen back to the level of support, it is likely that it will breakout into a bearish downtrend.
Double Top
A double top is another pattern that traders use to highlight trend reversals. Typically, an asset’s price will experience a peak, before retracing back to a level of support. It will then climb up once more before reversing back more permanently against the prevailing trend.
Double Bottom
A double bottom chart pattern indicates a period of selling, causing an asset’s price to drop below a level of support. It will then rise to a level of resistance, before dropping again. Finally, the trend will reverse and begin an upward motion as the market becomes more bullish.
A double bottom is a bullish reversal pattern, because it signifies the end of a downtrend and a shift towards an uptrend.
Rounding Bottom
A rounding bottom chart pattern can signify a continuation or a reversal. For instance, during an uptrend an asset’s price may fall back slightly before rising once more. This would be a bullish continuation.
An example of a bullish reversal rounding bottom — shown above– would be if an asset’s price was in a downward trend and a rounding bottom formed before the trend reversed and entered a bullish uptrend.
Cup and Handle Pattern
The cup and handle pattern is a bullish continuation pattern that is used to show a period of bearish market sentiment before the overall trend finally continues in a bullish motion. The cup appears similar to a rounding bottom chart pattern, and the handle is similar to a wedge pattern — which I’ll explain in the next section.
Following the rounding bottom, the price of an asset will likely enter a temporary retracement, which is known as the handle because this retracement is confined to two parallel lines on the price graph. The asset will eventually reverse out of the handle and continue with the overall bullish trend.
Rising Wedge Pattern
A rising wedge is represented by a trend line caught between two upwardly slanted lines of support and resistance. In this case the line of support is steeper than the resistance line. This pattern generally signals that an asset’s price will eventually decline more permanently — which is demonstrated when it breaks through the support level.
Falling Wedge
A falling wedge occurs between two downwardly sloping levels. In this case the line of resistance is steeper than the support. A falling wedge is usually indicative that an asset’s price will rise and break through the level of resistance, as shown in the example above.
Symmetrical Triangle
The symmetrical triangle pattern can be either bullish or bearish, depending on the market. In either case, it is normally a continuation pattern, which means the market will usually continue in the same direction as the overall trend once the pattern has formed.
Symmetrical triangles form when the price converges with a series of lower peaks and higher troughs. In the example above, the overall trend is bearish, but the symmetrical triangle shows us that there has been a brief period of upward reversals.
Ascending Triangle
The ascending triangle is a bullish continuation pattern which signifies the continuation of an uptrend. Ascending triangles can be drawn onto charts by placing a horizontal line along the swing highs — the resistance — and then drawing an ascending trend line along the swing lows — the support.
Ascending triangles often have two or more identical peak highs which allow for the horizontal line to be drawn. The trend line signifies the overall uptrend of the pattern, while the horizontal line indicates the historic level of resistance for that particular asset.
Descending triangle
Descending triangles generally shift lower and break through the support because they are indicative of a market dominated by sellers, meaning that successively lower peaks are likely to be prevalent and unlikely to reverse.
Descending triangles can be identified from a horizontal line of support and a downward-sloping line of resistance. Eventually, the trend will break through the support and the downtrend will continue.
Bull Flag
A flag pattern is highlighted from a strong directional move, followed by a slow counter trend move. The above chart highlights a bull flag. The strong directional move up is known as the ‘flagpole’, while the slow counter trend move lower is what is referred to as the ‘flag’.
Traders of a bull flag might wait for the price to break above the resistance of the consolidation to find long entry into the market.
Bear Flag
A bear flag will look like an inverted bull flag. In a downtrend a bear flag will highlight a slow consolidation higher after an aggressive move lower. This suggests more selling enthusiasm on the move down than on the move up.
Traders of a bear flag might wait for the price to break below the support of the consolidation to find short entry into the market.
Triple Bottom
The triple bottom pattern is used in technical analysis as a predictor of a reverse position following a long downward trend. The triple bottom occurs when the price of the currency creates three distinct downward movements, at around the same price level, before breaking out and reversing the trend.
Inverse Head and Shoulders (IH&S)
The inverse head and shoulders chart pattern is used as a predictor for the reversal of a downward trend. It is also sometimes called the “head and shoulders bottom” or even a “reverse head and shoulders, ” but all of these names mean the same thing within technical analysis.
It gets the name from having one longer peak, forming the head, and two level peaks on either side which create the shoulders.
Simple Moving Average
A simple moving average is an arithmetic average of a set of data points where each data point is added together and then divided by the total number of data points.
For example, a 50-period simple moving average finds the closing price of the last 50-periods, sums the 50 closing prices, and divides by 50 to calculate the average closing price of the previous 50 periods. New periods are then added to the calculation, while the oldest period is removed from the calculation.
In summary, Candlesticks show short-term emotion while chart patterns show trend psychology over time. When you combine the both of them, the market becomes much easier to read. In my next posts I’ll cover technical indicators that are used to provide mathematical data to confirm price trends or identify overbought/oversold conditions.
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