Trading Patterns Introduction

Trading Patterns Introduction

You can use trading patterns to help you understand how a stock is performing. This guide explains how to use them for analysis and to try predict the future.
By: Harry Atkins
Harry Atkins
Harry joined us in 2019, drawing on more than a decade writing, editing and managing high-profile content for blue… read more.
Updated: Mar 4, 2021
0/5 Star rating
Beginner
4 min read

Trading patterns refer to distinctive formations that appear on trading charts of individual stocks. Such patterns show up as transitions between rising and falling trends caused by price swings.

Pattern recognition is at the core of technical analysis, which focuses on trying to predict prices based on patterns that happen as stocks move up and down. The pattern recognition process involves tested methods that have proven to lead to profitable trades over the years.

Trading patterns can occur at any point while trading stocks. Spotting the various types of patterns requires learning to identify them, then practicing on smaller trades. There are three basic types of trading patterns.

I. Types of Trading Patterns

Continuation Trading Patterns

Continuation trading patterns are a set of chart patterns that affirm a prevailing trend, be it bullish or bearish. Often referred to as consolidation patterns, they indicate a consolidation period prior to sellers or buyers resuming control and pushing the price in a given direction.

Common continuation patterns include Pennants, which are formed using two converging lines, where flags are drawn using two parallel trend lines. Then there are wedges, which are constructed using two converging trend lines, angled either up or down.

Bullish Continuation Patterns

Bullish continuation patterns indicate that the price of the underlying stock is likely to continue moving higher once the consolidation phase comes to an end.

Bearish Continuation Patterns

Bearish continuation patterns occur when prices are running lower, followed by a period of consolidation. After some time, sellers resume control, pushing prices lower.

II. Bilateral Trading Patterns

Unlike continuation trading patterns that indicate price would ultimately move in one direction along a prevailing trend, bilateral chart patterns signal that price might move in any direction.

When the above-listed chart patterns occur in a chart, then the price could break in either direction, be it on the upside or downside. Technical analysts leverage these trading patterns by placing orders on top and at the bottom of the formation so as not to miss whichever direction the price decides to break. Once one price order is triggered, then cancellation of the other order usually comes into play.

III. Reversal Chart Patterns

Occasionally the price will reverse from a dominant trend and start going in the opposite direction. For instance, if the price was moving upwards in a chart, it might hit a point of resistance, then start retreating on huge volume, indicating a sharp reversal.

Should a reversal trading pattern form during an uptrend, it would indicate that the price will likely starting retreating lower. Likewise, when a reversal chart pattern forms during a downtrend, the price is likely to start moving up.

Below are some of the patterns commonly used to signal a possible reversal in the direction of trade.

IV. Bearish Reversal Patterns

Double-top chart patterns are some of the best examples of bearish reversal patterns. Such trading patterns come in the form of two short-term swings higher, followed by a near-term high, followed by reversals lower each time. When a double-top chart pattern occurs, it will take the form of two brief forays into new high ground, two failures to break out, then a reversal lower.

Head-and-shoulders patterns also signal a bearish reversal. In this case, that reversal takes the form of two smaller price movements surrounding a larger price movement, with a silhouette that resembles a head and shoulders. When a head-and-shoulders pattern occurs, it’s a strong signal to sell a stock.

V. Bullish Reversal Patterns

Double-bottom chart patterns are essentially the flip side of double-top patterns. With a double-bottom, a price chart will resemble a W. An ideal double-bottom chart pattern sees the middle of the W trace higher than the midpoint of the overall pattern, but without hitting a new high. After that, the price heads lower, then shoots back up, setting up a potential breakout.

Bounces off the 50-day moving average occur when a stock’s price heads lower, then finds support at the line running through the chart that shows the stock’s 50-day moving average. When that bounce occurs, it’s often a sign that the near-term downtrend is over, and that a positive price rebound is on the way.


Fact-checking & references

Our editors fact-check all content to ensure compliance with our strict editorial policy. The information in this article is supported by the following reliable sources.

Risk disclaimer

Invezz is a place where people can find reliable, unbiased information about finance, trading, and investing – but we do not offer financial advice and users should always carry out their own research. The assets covered on this website, including stocks, cryptocurrencies, and commodities can be highly volatile and new investors often lose money. Success in the financial markets is not guaranteed, and users should never invest more than they can afford to lose. You should consider your own personal circumstances and take the time to explore all your options before making any investment. Read our risk disclaimer >

Harry Atkins
Financial Writer
Harry joined us in 2019, drawing on more than a decade writing, editing and managing high-profile content for blue chip companies, Harry’s considerable experience in the… read more.

Related courses

Choosing the right stock to invest in needs time and care; it is never something that can be done on a whim. From the type of company you are investing in and its financial status to overall market conditions and the need to mitigate risk, there are a variety…
Investing in the stock market is one of the best ways to make money and grow your wealth. Stock investing can serve as a reliable passive income stream that protects your capital against inflation. In addition, many companies share a portion of their profits with investors in the form of…
Luckily, it’s far easier to begin trading than it was in the 90s when Wall Street and big money were the only options. Get started with our introduction to stock trading. You’ll come away feeling more confident about the task ahead, while acquiring a base knowledge of all the most…