Understanding chart patterns and formations is really the foundation for more advanced technical analysis and trading strategy. However, some chart patterns are more valuable and consistent then others, so I decided to put together this list of what I personally believe to be the 4 best chart patterns for day trading!
Before getting into the chart patterns, it's important to understand a bit about what makes up a chart in the first place. The foundation of our charting and analysis are candlesticks. To summarize and simplify candlesticks, they are formed by an open, high, low and close over a set period of time. That period of time is dependent on what timeframe your chart is set to. That means that your candlesticks can represent 1 minute of price action, 1 week of price action, or just about any amount of time between. The image below shows how candlesticks are formed and why they look the way they do.
The real body, which is the colored portion of the candlestick, shows us the difference between where the price opened and closed for that period of time. Of course, a positive change will create a green candlestick, and a negative change will create a red candlestick. The upper and lower wicks are then the lines that stick straight out from the top and bottom of the real body. These lines show us the highest and lowest point that the price went before the candlestick closed.
All of this can be very useful while doing technical analysis and analyzing chart patterns, because this data from candlesticks can give us exact prices to get the most out of the chart patterns! With that being said, let's get started with the chart patterns themselves!
Bull Flag: A bull flag is a bullish chart pattern, indicating a continuation upward. This patterns will typically form after a strong move up and is a consolidation period for the stock before it breaks out again and continues its run. The bull flag is a great chart patterns for traders looking to take advantage of a stock's momentum. You can look to either buy at/ear the bull flags support level, or buy the bull flag breakout for the stock's continuation.
ABCD Pattern: The ABCD pattern is another bullish pattern, which can offer traders some great opportunities to safely buy the dip/pullback in a stock. The great thing about the ABCD pattern is that it allows you to get into a stock without chasing at the highs and it also offers a clear level of risk so that you can cut your losses quickly if the pattern doesn't happen to follow through.
You can see in the diagram and example below that the pattern is made up of four points (A,B,C and D). The way we use these points to actually find trades is fairly simple. After the high point of A and the low point of B have formed, you look for a higher low at point C to buy. From there, you of course want to see the breakout at point D, but if it happens to fail you can use the low from point B as your risk level to cut losses. Alternatively, you can wait for a confirmed breakout at point D to buy into the stock's momentum! If you want to see my youtube video going over this pattern in more detail, you can check it out by clicking here!
Head and Shoulders: Unlike the first two patterns, the head and shoulders pattern is actually a bearish chart pattern. It typically forms at the top of a strong move up or uptrend, indicating a reversal to the downside. For that reason, this pattern is typically used to sell long positions and lock in profits or even to short-sell to profit from the reversing and heading back down.
The time to sell or short-sell within this pattern is when the right shoulder forms. At this point it will confirmed that the stock is not in an uptrend, since the right shoulder will be lower than the head of the head and shoulders pattern. By short-selling into the right shoulder, you can then use the high point at the head as your risk level to cut losses on your short position if the stock happens to rebound and begins to move higher. Alternatively, you can wait for a confirmed breakdown below the support level that is formed between the two shoulders to sell or open your short position!
Bullish Wick Reversal: The pattern is one that is actually formed by individual candlesticks themselves. To spot this pattern you have to pay close attention to the lower wicks of the candlesticks. Since the lower wick represents the lowest point the stock went before the candlestick closed, a long lower wick shows us that the demand (buying) in the stock increased before the candlestick closed. For that reason, long lower wicks can be a great indicator of a bullish reversal.
Look for candlesticks similar to the ones in the diagram and examples below to potentially buy into the stock in anticipation of a reversal and move higher. As always, you also should have a risk level when you buy into this formation. You can simply use the lowest point from the lower wick to risk off of in case it happens to be a fake out rather than a major reversal.
These four patterns are a great foundation for any trader and can be very beneficial for improving your technical analysis. I hope found this post and keep an eye out for these patterns during your next trading session! If you enjoyed and want to learn more about day trading, swing trading or even long-term investing, check out the Master the Market programs and come join the team chat today!
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