Technical analysis is the art and science of using stock charts and other relevant data to determine price direction of an equity. While no analysis is perfect, it is possible to put the trading odds in your favor using technical analysis. An important aspect of technical analysis is spotting stock chart patterns.
Chart patterns are a reflection of the underlying psychology that is going on in the minds of people and institutions that are buying and selling a particular stock or index. Since these psychological aspects tend to repeat throughout the forex markets, recognizable chart patterns have been documented. Some of the more commonly known chart patterns are:
1) Flags – Flags are consolidation periods where a stock trades within a tight range. There are both bullish and bearish flag formations and their interpretation generally depends upon the overall trend of the equity. If a stock is trending up, a bull flag tends to trend slightly downwards. If a stock is trending down, a bear flag tends to trend slightly upwards.
2) Double Top – This is where the equity price has hit a high, backed off and then made another run to the high.There is an 80% chance that the price will fail to break through the top and then drop in price.
3) Double Bottom – This is where the equity price has hit a low, rallied and then made another drop to the low.There is an 80% chance that the price will find support at the low and rally again.
4) Cup and Handle – This is a bullish pattern that looks like a coffee cup as it has a rounded bottom with a handle that usually extends slightly downward.
5) Inverse Cup and Handle – This is a bearish pattern that looks like an upside down cup and handle as it has a rounded top with a handle that usually extends slightly upward.
6) Trend Channel – This is where the price fluctuates between parallel lines that define the top and bottom of the channel. If the channel is sloping upwards it is bullish, if it is sloping downwards it is bearish. These are relatively easy to trade as you can buy at the bottom of the channel and sell at the top of the channel.
While there are many other chart patterns, these are the ones that are most frequently encountered. If you can master these patterns you will be well on your way to mastering the stock market.