Many of you will fall into this trap when it comes to technical analysis. Yet many of you still believe technical indicators to be valuable tools. You rely on them because you consider that the financial markets have evolved immensely. At least on this point, we do agree. However, this is not a long-lasting pretext. Let’s be honest. You are overwhelmed by an abundance of information coming in from all sides with the development of new communication and information technologies. Your thought process become confused. Instead of taking action, you hesitate, afraid that your investments will cause you to lose money.
The stock market is no exception to this trend. When analysing a share price graphically, your focus is mainly drawn to technical indicators such as the RSI or MACD. You wait impatiently for the so-called neutrality zone to be finally broken so you can act. Unfortunately, basing your strategy on the strengths of technical indicators is a recipe for disaster. Why is that? Firstly, because they have no effect on the evolution of the share price. Secondly, because they don’t tell you anything about the current mood among investors. And thirdly, because it is somewhat amateurish to ignore the traditional principle of technical analysis, which is chart analysis.
You may believe that chart analysis is too “old school” for today’s financial markets. But the relevance of chart analysis should not be underestimated. It has the advantage of giving you a precise idea of the continuation or reversal of a stock market trend. The signals provided by the charts are more reliable for taking long positions. Take the time to draw in trend lines and identify horizontal supports and resistances. This is the icing on the cake. You can perfect your technical analysis techniques by using chartist patterns. You’ll be interested to hear what we can tell you about them. Some of them have a predictive power that is close to 65-80%. And this figure is statistically proven. You don’t need to know all of them. Focus on the ones that are easy to spot and offer the best results.
Before we look at some specific chartist patterns, let’s first talk about why they are so valuable to your overall mastery of technical analysis.
Why are Chartist patterns useful to you?
The most important thing to know about Chartist patterns is that they are covered over and over again in training programs.
With a little practice, you will learn to spot some of them. If you manage to spot them early, you will have a competitive advantage in the markets.
They also reflect the current mood of investors in the stock market. This is something that technical indicators cannot do.
As we said earlier, they signal the continuation or reversal of a trend in the event of a breakout, with a significant predictive capacity.
Now, let’s take a look at the ones that are of the most interest. Read on for an analysis of the 4 of the most profitable Chartist patterns to be exploited by investors or traders.
The double bottom: Ideal for spotting stocks in a reversal phase or in a Weinstein Phase 2
This is a trend reversal pattern. It is formed by 2 troughs that form between a support and a resistance. It has a W shape and occurs after a downturn or bearish trend.
The price level initially stabilizes on a support and then rises again, hitting a resistance level. This forms the first trough.
The price then falls back down towards the support line. Some short sellers will take advantage of this breakout. But they will lose out to the big buyers who support this level. The price rises again and breaks through the resistance level. The second trough acts as a reversal of the upward trend.
How to take a long position with a double bottom
This is a chartist pattern to take advantage of if you want to make the most of your investments. There are three solutions for taking a long position.
First solution. You spot the resistance breakout point. You are unsure about the quality of the buy signal. Ideally, you wait for one or two confirmation sessions.
Second solution. You notice that the bullish exit was very sharp. You are afraid of being caught off guard by short sellers. Play it safe and wait patiently for a pullback to the resistance line.
Third solution. You decide to anticipate the breakout of the resistance line on shorter time units and thus gain an advantage over your competitors. If, for example, you see on your screens a breakout of the current double bottom in weekly units then you fine tune your entry point in daily units.
On the Italian stock index in daily units, FTSE MIB, a large blue candle was in the process of confirming the breakout of the double bottom in an upward direction. The next two candles validated this enabling you to enter in a long position.
The horizontal channel: A chartist pattern that requires patience
The horizontal channel is a chartist pattern consisting of two parallel lines resembling a rectangular pattern. This chartist pattern often follows a significant bullish or bearish trend. The upper line acts as resistance. The lower line acts as support.
To validate a horizontal channel, you need to at least 2 contact points of the price level on each line. The third point of contact on one of the two lines is considered the breakout point whether it goes in an upward or downward direction.
That said, watch out for the simplicity of its shape. It can play with your nerves. Why is that?
Because a horizontal channel is an indicator that buyers and sellers are hesitant. The price is unable to break through either of the two lines to form a clear trend. This can go on for several weeks or even years.
And lastly, remember not to confuse the horizontal channel with a double/triple bottom. Why is that?
Because price fluctuations in a horizontal channel are irregular. Whereas in a double/triple bottom, they tend to be uniform.
How to take a long position with a horizontal channel
False breakouts in an upward direction are common. You need to be patient to avoid trend reversals.
Always play it safe. Wait patiently for the price to break through the resistance line after one or two confirmation sessions. By doing this, you create a safety buffer.
Also, watch out for the possibility of a pullback to the resistance line, which is a common occurrence in today’s financial markets. It aims to challenge the emotions of less experienced investors.
It is always an advantage to stay one step ahead of the competition by anticipating a breakout in an upward direction, still in the process of validation on shorter time units. If you have weekly unit scenario then optimise your entry point in daily units.
In daily units, Bic’s share price remained frozen in a horizontal channel between €59 and €68 throughout the whole of 2011. The breakout was made in an upward trend in the first quarter of 2012 with a large blue candle.
In this example, you can see that the second to last contact point on the upper line was a false breakout.
The triangle: A classic chartist analysis pattern
A triangle is a continuation pattern on a chart that forms a triangle-like shape with two converging straight lines when volatility is low. The amplitude of the fluctuations decreases. Buyers and sellers are undecided.
To validate a breakout from a triangle pattern in one direction or another, there must be at least 2 points of contact on each of the lines. The third point of contact on one of the 2 lines is the breakout point.
If you are familiar with triangle geometry, there are three different triangle formations or technical patterns that you are likely to encounter: symmetrical, ascending and descending.
For a symmetrical triangle, the breakout will depend on the current trend in 2 out of 3 cases.
For an ascending triangle, the breakout point occurs on the upside during an upward trend in 2 out of 3 cases. Conversely, the price may be blocked by the horizontal line which acts as resistance, to counter your buying intentions.
For a descending triangle, the breakout point occurs on the downside during a downward trend in 2 out of 3 cases. Conversely, the price is likely to be supported by the horizontal line which acts as a support, to prevent short sellers from buying.
How to take a long position with a triangle pattern
Avoid playing against the downtrend even if you have an ascending triangle. In 1 out of 3 cases, the breakout point occurs on the upside.
Don’t fall into the “You can’t catch a falling knife” trap, which means you should wait for the price to bottom out before buying it.
First solution. You have a symmetrical, ascending or descending triangle in an upward trend. The breakout point on the upside is currently forming. Refrain from buying impulsively and wait for one or two confirmation sessions.
Second solution. Anticipate the breakout point by switching to a shorter time frame and take full advantage of the movement. For example, you have a triangle in an uptrend in weekly units so you work your entry point in daily units.
In weekly units, the breakout point from the descending triangle on Kering occurred on the upside with a large blue candle that passed the second to last contact point. It would have been better to wait a few sessions before taking a definitive position.
You will notice that the trend that preceded the descending triangle is not bearish. The hypothesis of a breakout on the downside could be ruled out.
The cup and handle: A chartist pattern for saving time
You have probably already heard of the cup and handle technical indicator. This is one of the 3 most traded chartist patterns. It’s possible that you didn’t realise you were trading on this chartist pattern when you took a position.
The price forms a U-shaped trough, in the shape of a cup, which initially hits a resistance line. It then drops back down to form a smaller trough, in the shape of the handle, to break it up in a stable way.
For the cup with handle pattern to be credible, it must be preceded by an uptrend and the downward consolidation phase that forms the handle must not exceed 50% of the cup.
In 80% of the cases, the breakout from this chartist pattern occurs on the upside.
You may encounter a pullback on the resistance line in case of a bullish exit, as some wise guys want to make you believe that this is a bad buy signal. But in the end, they get ripped off by buyers who were willing to wait patiently.
How to take a long position with a cup and handle pattern
Knowing how to take advantage of this chartist pattern could be of interest to you.
First solution. You play on the breakout of the resistance line. I recommend that you wait for one or two confirmation sessions. Nothing new about that.
Second solution. The bullish breakout can be very sharp. You may worry that your timing is not right for action. Play it safe and wait for a pullback on the resistance line.
Third solution. You anticipate the breakout of the resistance line by juggling time units. This is a daring option. But being one step ahead of the competition comes at a price.
In weekly units, Peugeot’s price is forming a cup and handle with breakout from the neckline at around €11. This took place at the beginning of 2015. On this example, you can anticipate it in daily units. That said, it’s always easy to say with hindsight but not so easy to implement in the moment.
To conclude, here is a video summary of the 4 Chartist patterns we have looked just at.
Use the charts to master technical analysis with confidence
You’re in luck. Yes, effective technical analysis puts you on an equal footing with financial professionals. However, it does not have the ability to detect insider trading, which is common in the financial markets.
It definitely offers you a wide choice. However, it is important to keep the analysis simple and clear, to avoid dispersion in your analysis.
Please take this advice on board. Don’t be drawn in by the technical indicators because they will not provide you with the main buy signals.
Your top priority is to focus your attention on reading the chart of a stock price. With practice, you will come to realise that this is not an impossible task.
While trend lines, resistance and support lines may be helpful, don’t overlook the benefits of chartist patterns, especially those we have mentioned in this article.
Take a step back. You will see that they are actually quite easy to spot. But you may not spot them every time.
Don’t bother searching for the perfect configuration. Experience shows us that there is often a gap between theory and practice.
A final word of advice, avoid taking long positions at all costs when the chartist pattern is not yet fully formed. This is possible to do, but it does take quite a bit of experience.
So there you go. You now know the basics of traditional technical analysis using chartist patterns. You may disagree with my selection of chartist patterns, I focused on my own personal favourites here. If there are other chartist patterns that you think deserve to be highlighted, then please go ahead and share them. This is an open debate.
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