Table of Contents
Summary:
Trading chart patterns help traders predict future price movements by identifying reversal and continuation signals. These patterns are crucial for making informed trading decisions.
Main Points:
- Technical Analysis: Uses past market data to predict future asset prices.
- Reversal Patterns: Indicate a potential change in price direction.
- Continuation Patterns: Suggest that the current price trend will persist.
- Using Chart Patterns: Trend lines and patterns guide trading decisions, optimizing buy and sell points.
Trading chart patterns can be very valuable to traders. These patterns apply to all types of assets in the right contexts. When traders can see clear signals and trends based on patterns, they can make better decisions.
Today, we’ll review what trading chart patterns are. We’ll also look at how they fit into a trading strategy. Then, we’ll take a closer look at two very important patterns: reversal and continuation patterns.
Wondering how to identify trend continuation, or if chart pattern trading works overall? Keep reading to learn more.
The Basics of Trading Chart Patterns
To learn about trading chart patterns, it helps to first know about two key ideas. Let’s take a look at technical analysis and fundamental analysis.
What is Technical Analysis?
In asset trading, technical analysis is a tool used to forecast the movement of asset prices. As the Corporate Finance Institute explains, traders use technical analysis to look at past market data, such as price action. Then, they use it to predict what may happen to an asset in the future.
In most cases, traders look for signs (called indicators) that an asset will either keep on a trend or change. That makes chart reversal patterns and continuation patterns, which we’ll cover in the next section, very useful.
By looking at some or all of the past activity of an asset, traders can make assumptions about the future. This can be a major asset for finding good value in a trade as well as choosing exactly when to take action. This can reduce risk and improve the chances of a good trade with a strong return.
Technical analysis can be used by day traders, swing traders, long-term investors, and many other types of traders.
What is Fundamental Analysis?
Technical analysis looks at market data. On the other hand, fundamental analysis looks at the groups and entities tied to assets.
In the case of forex specifically, traders look for data related to countries that issue the currencies that traders trade in currency pairs.
News and projections about the overall economic state of a country are one example. However, news and events related to politics, changes in industrial production and retail sales, natural disasters, and many other factors can also be useful.
The goal of fundamental analysis is to find the fair market value of a currency pair. Then, traders look for pairs that are out of line (whether trading higher or lower) than that fair market value.
Trading chart patterns firmly fall into the realm of technical analysis. However, it’s key to know that many traders, including prop traders, use both technical and fundamental analysis together. Both can be very useful as part of a personal trading strategy.
What are Trading Patterns?
In basic terms, trading patterns are found by looking at asset changes on charts. By connecting price movements across many time periods, it becomes easier to see if an asset is trending upward or downward.
Identifying a trend early on can help traders make gains due to an asset’s movement, whether it’s rising or lowering in price. Finding trends with trading patterns also helps traders tell if an asset will keep moving in the same way or if a change of pattern is likely.
There are a wide range of trading patterns, as StockCharts details. However, most of these patterns fall into one of two categories. They are either reversal chart patterns or continuation chart patterns.
Reversals show a possible or likely change in an asset’s price (i.e., rising price to dropping price). Continuation patterns show that an asset will likely follow the same course that it’s on at that time.
Trading patterns are often talked about in terms of stocks. However, they’re useful for any type of trading. Forex chart patterns, for example, are often used in technical analysis by forex traders.
What Are Reversal and Continuation Patterns?
As a reminder, the basics of reversal and continuation patterns are the following:
Reversal Chart Patterns
Chart reversal patterns show the potential for change in an asset’s price action. The change can be a rise, with the asset’s price going up, or the opposite. StockCharts shares several examples of reversal chart patterns and details about each.
Continuation Patterns
Continuation patterns show that a price trend will keep going. They help traders see how an asset may move or change after a period where it remains stable. StockCharts also shares several examples of continuation patterns and describes each of them thoroughly.
How to Use Chart Patterns for Trading
Whether it’s a continuation or a reversal, all patterns are formed by drawing lines between price points on the asset’s price chart. These lines are called trend lines.
In short-term asset trend charting, it’s often key to adjust trend lines to make sure a forecast follows past price changes. In trend charting for longer time frames, over weeks or months, not as crucial to redraw and readjust these lines every hour or every day.
These trend lines, and the continuation and reversal chart patterns that they help to indicate, give helpful information to traders. When a continuation of an asset’s price change is likely, traders can make trading choices based on that prediction.
If an asset shows higher high prices and lower low prices, then it may be time to buy that asset. That’s often the case if the trend looks like it will keep going. Buying at the start of an upward trend helps traders to gain an asset that rises in value over time.
In the big picture, the same idea is in play with downward continuations and reversals. These chart patterns can show that an asset will lose value. That means it’s time to sell that asset if it’s held or to short sell that asset.
There are many trend patterns and types of charting used by technical analysts to learn about support and resistance levels for assets. With these basic and useful concepts, it will become that much easier to learn about those trends. Of course, you can also apply them to your own trading strategy.
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