Five Essential Stock Chart Patterns

Markets are driven by two of the most powerful emotions – fear and greed.

And because of that, we need to be mindful of where fear and greed are running amok whether it is in stocks, ETFs or indexes.  Having this knowledge can help us better exploit extreme moves.

Double and Triple Top Patterns

As some of you are aware, topping patterns can represent the very moment when selling pressure begins to overwhelm buyers. With double and triple tops we’re able to identify historical points at which a stock begins to fail over and over again. 

Look at Apple (AAPL) for example.

Notice what happened when the stock re-challenged a prior resistance point.  It failed temporarily.  If you can spot similar patterns, you have a better ability to exploit a potential pivot lower with a short position or a put option.

Double and Triple Bottom Patterns

The double and triple bottom is the exact opposite of a double and triple top. In a double or triple bottom, the stock hits a low point and then bounces up. The price may turn lower, however it doesn’t break a previous low.

Look at Lululemon (LULU).  The stock found support twice at nearly the same price, held that level, before accelerating higher.  Points at which the stock holds strong support levels will typically tell us buyers are emerging to support the stock.

As long as support holds and doesn’t drop below that, the argument for upside becomes even stronger with patience.

Trend Lines and Breakout Patterns

When it comes to technical analysis, you’ll often hear, “The trend is your friend.”  Technicians like to identify particular trends and jump on board, making the “trend his or her friend” with the intention of riding it higher or lower with a stock or an option strategy.

Trend lines are drawn using lows and highs on a chart.  Any break in trend can be an indication the stock in question could be about to pivot in the other direction, prompting trades to readjust or to enter a new trade accordingly.

With the iShares NASDAQ Biotech Index (IBB), for example, the trend held up for more than five years before breaking down on presidential candidate threats to rein in drug price gauging and fears of a bubble.  However, in the years ahead of that, the trend was firmly in place because of the strength of underlying fundamentals, including 80 million retiring baby boomers, millions of newly insured Americans, and an explosive M&A boom.

It was no surprise to see the trend hold as well as it did for years.

Head and Shoulder Patterns

In this case, we have a peak (left shoulder), followed by a larger peak (head), followed by a smaller peak (right shoulder) again, or what we refer to as a head and shoulders pattern.  Here, technicians will draw trend lines under recent lows, which are referred to as the neckline.  If and when the neckline is broken, the pattern is said to be complete, and we begin to look for lower lows in the chart.  Typically, head and shoulder patterns are reversal patterns that can indicate a potential shift in bullish sentiment to bearish sentiment.

Triangle Patterns

A common continuation pattern can be the triangle.

It gets its name because the stock tends to trade in a smaller and smaller pattern from a higher or lower level, creating a triangular look once you draw your lines. 

Technicians can assume that when the stock breaks out of such a tight set up, it’s likely to pop in the direction of the prior trend.  So, if the prior trend was bullish, technicians may be given a signal to buy the stock.

In short, there is no such thing as the perfect technical – or even fundamental – strategy, but if you’re well aware of powerful patterns and the knowledge that fear and greed are the key drivers of those patterns, you just increased your odds of success. 

Study and know these patterns.  You’ll be a better trader for it.