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Chart Patterns

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 Table of Contents   


Educate Yourself:

Open Gap

Resistance

Support

Trading Channels

Exponential Moving Averages

Simple Moving Averages

Bull Flags

Bear Flags

Spinning Tops

Head and Shoulders




Open Gap

It is common for an index to open at a price different than it closed the previous trading day. When it opens at a price that was never reached the previous trading day the chart produces an open gap between the days' trading ranges. Open gaps are commonly produced by news between trading session that triggers after hours trading in a particular index either up or down in value.

Open gaps are important technical indicators for a chart; a big point being they tend to get 'filled'. Meaning the index eventually returns to trade at the prices left untouched within the gap; but this does not always happen right away.

The chart below contains five gaps in SPY over a four month period. Four of the five were closed while the most recent was being approached. The four closed gaps all vary in size and time before they were closed.



Open gaps can indicate the start of new momentum often triggered by the same cause of the gap itself; the case in gap 1. It is also common for gaps to be filled relatively quickly. This is in the case when the gap is produced from over optimism or pessimism and is then corrected later. The filling of open gaps can also be a case of a self-fulfilling prophecy. Chart technicians are all looking at the open gap and trading accordingly. They know others are also eyeing the same price gap. You can see technical evidence of such in the gaps above:

  • The top of gap 2 marks the closing price of the day it was filled
  • The top of gap 3 marks the highs of the day it was filled
  • The bottom of gap 4 was the opening price of the day it was filled
These may not be extreme examples but the point is open gaps on charts are a technical tool used by traders. The characteristics of the gaps may be different but each affects the price action in some way following.



Resistance

Trend lines are a product of price demands and trading psychology. For a period of time a stock or index will peak at a particular price. When the stock or index returns to that price traders may see this as a selling opportunity. It is not always reflective of the 'real' value of the index but is a sociological byproduct of collective traders looking at the same chart.

When the chart does break above the established resistance this usually open the gates for traders to pay for the asset at prices higher than the resistance price. You can see in the chart below how the price action changed once the resistance price is broken.

It can be common to see a chart that has broken above its resistance to fall back and test the previous resistance as support before continuing trading above the resistance price.


 


Support

Support is the other side of the coin of resistance. A price trend that has consistency will lead to traders exploiting this pattern and purchase the asset at the prices the asset was bought in the past. The bottom support line in the chart below shows the lows of October were also the lows of November. This was a price where chart readers knew others were willing to buy in the past.

Resistance and support are not always a single price but sometimes a price pattern like seen in the V pattern below. A number of lows lower than the previous low, or higher than the previous low, will establish a buying pattern that may be used by traders.





Trading Channels

Together resistance and support can create trading channels. In the case below the resistance line and support line are parallel and both rising. This can established a trading channel for some time until either the resistance or support is broken.

Traders will attempt to trade this pattern by selling when resistance price is hits and buying when the support price hits. This creates a sell fulfilling prophecy until something breaks the pattern and changes trader behavior.

Trading channels can be rising like below, flat, falling, or the resistance and support could not be parallel and the prices are eventually wedged together or the trend lines grow further apart.


 


Moving Averages

There are two types of moving averages traders use as indicators: Simple Moving Average (MA) and Exponential Moving Average (EMA). The MA is the average price of previous specified days. The EMA is also an average of the last specified days but with the more recent days weighted heavier in the equation. Because of the this, the EMA may move closer than MA to the current price.

The EMAs and MAs can act as support or resistance lines. They may also signal the beginning or end of bull or bear circuit. An example being if an index continues to trade above its 50-day EMA than that says it has been a growing asset in that time. If it is trading under the 50-day EMA that signals the asset has been losing value over time.

Below are example when the EMAs acted as support, resistance, or changed the trading characteristics of the chart once the price moved though it.




Here are examples of MA that affect the price action of the chart.


 

Like other trend lines, moving averages don't always predict the charts next move but can be used to find educated buying or selling opportunities or to gauge the health of the current price action in a particular asset.


Spinning Tops

Spinning tops signal indecision and lack of conviction by both bulls and bears. They are characterized by a candlestick pattern with a short body that is vertically centered between larger upper and lower shadows. The spinning tops can be a signal  that the current trend is about to change, could signal a continuation of sideways movement in a chart, or could be a pause in momentum.

Spinning tops are not particularly buy or sell signals but are used to get some insight to how investors are feeling as a whole in an index. The action following a spinning top will be the confirmation to what that spinning top was signaling about the current trend.


 


Head and Shoulders

Head and shoulder pattern are seen at the top of markets and when completed usually signal a longer-term pullback from the peaks. These patterns are seen across days, months, or years.

The pattern is not always perfect but the general idea is a price peak followed by a decline to form the left shoulder. The chart will then reverse the decline producing the neckline at the lows and eventually produce a higher peak known as the head. The price will eventually fall back to test the established neckline where it will again reverse and create a smaller peak than the head and fall back to again test the neckline to complete the right shoulder. Once the pattern is complete it is common for the neckline support to break as support and the chart to break into a downward trend.


 

Without the noise the pattern will ultimately resemble the pattern below when completed:


Inverse head and shoulder patterns will be the opposite pattern and will happen at the bottom of markets and usually break out to the upside like so:


Tommy IV


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Chart Patterns

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