How To Read Chart Pattern And Profit From Stocks

Bullish PatternBearsish Pattern

Cup and Handle

As the name implies, the cup and handle pattern consists of a large cup like formation with a small pullback area following it, forming a handle like pattern.

This is developed by the stock selling off over a period of a few weeks, bottoms out and starts moving up close to the initial highs before the drop. Then prices start to drift lower on decreasing volume, building a consolidation area. After the selling dries out, the stock resumes it's uptrend.

Optimum buy point is when the stock makes a new high on increased volume. In some cases, depending on the shape of the handle, a trendline can be drawn on top of the handle pattern and this line can be used as a buy point, to move in a bit earlier and therefore increase profits.

Double Bottom

The double bottom can be formed over several different timeframes and should have a significant bounce in between the bottoms.

This chart pattern is developed by the stock selling down, then bounces off after developing some bottom. After the bounce the stock resumes the downtrend but cannot make a new low. At this point, a lot of bearish sentiment is in the stock and short positions have been setablished over the declining period, as buyers step in and move the stock up. At this point, traders start closing their short positions and move the stock up even higher. Increasing volume on the stock chart should reflect this behaviour.

There are two buy points to initiate long positons. First buy would be close to the double bottom, with a protective stop right below the double bottom low. The second buy would be at the penetration of the previous high before making the first bottom.

Bull Flag

The bull flag is a channel formation that forms in the opposite direction to the uptrend. Volume typically dries up as the flag progresses.

A bull flag's channel is created after a period of uptrend, where sellers start showing up taking profits. In a healthy uptrend, the sellers dry up as the channel progresses. After the selling volume dries up, buyers are now willing to step in again to move the stock higher.

Buy point is at the break of the upper trendline on increased volume. You want to see buyers show up and support a higher price. A second buy point to add to positions would be at the break of the initial high at the start of the flag.

Ascending Triangle

The ascending triangle is shaped after a stock has reached resistance, then pulled back two or three times and been bouncing to higher lows with resistance at about the same level.

This pattern usually occurs if there are some bigger sellers at resistance. New buyers bidding up the price until it reaches resistance and the sellers step in again an push the stock back again. Once the sellers have completed their selling, or the new buyers have overpowered the sellers, the stock breaks out of the pattern and moves hingher.

Point to enter into positions is at the break of resistance, or upper trendline on good volume. There should be at least two bounces of the lower trendline or the pattern has a bigger chance of failure.

Symmetrical Triangle

The ascending triangle is shaped after a stock has reached resistance, then pulled back two or three times and been bouncing to higher lows with resistance at about the same level.

This pattern usually occurs if there are some bigger sellers at resistance. New buyers bidding up the price until it reaches resistance and the sellers step in again an push the stock back again. Once the sellers have completed their selling, or the new buyers have overpowered the sellers, the stock breaks out of the pattern and moves hingher.

Point to enter into positions is at the break of resistance, or upper trendline on good volume. There should be at least two bounces of the lower trendline or the pattern has a bigger chance of failure.

Head And Shoulder

The head and shoulder chart pattern is another bearish formation. Stocks on the move up pull back and suseqently move up again to make a new high. Then another pull back and finally another attempt for a new high but fails this time.

At this point, stock trader psychology changes as the stock fails to make a new high. Investors take profit as a correction might be coming.

Short entry point with this pattern is at a break of the neckline. It is the line in green which connects the lows of the right and left section of the shoulders. Another entry can be at the throwback, which occurs if there is a steep selloff with a subsequent bounce. The bounce in our chart here reached all the way back to the neckline.

Bear Flag

The bear flag chart pattern occurs in a downtrend. It is constructed by buyers stepping in at some level thinking that the stock has reached an attractive level and has now a good value. As the stock slowly rises, stock owners that missed selling at higher levels now getting out and push the stock slightly lower.

New buyers manage to push it up higher until sellers again get out at higher prices. Finally volume dries out and it becomes obvious that enthusiasm about the stock is absent and the downtrend continues.

Entry points for a bear flag are at the break of the lower trendline on good volume. A trowback can occur and bring the stock price back to the lower trendline which is now resistance. At this point, additional short positions can be established, as well as at the break of the lowpoint before the pattern established.

Descending Triangle

Descending triangles are usually formed in a downtrend. Some support level is reached where buyers are to be found. Traders realize this and start bidding the stock up. Now holders at higher prices find the bounce attractive to cut their losses and start selling into the bounce, pushing prices back to support where buyers are waiting. This scenario repeats itself, with a weakening effenct, thus creating the downsloping trendline.

Finally the buyers are done buying and volume dries up. Make matters worse, stop orders are now positioned below the support trendline from those trades that initiated positions during the flag building period.

Short selling point would be at a break of support which is the lower trendline on volume. A second chance to enter or add to positions can come at a throwback to this line.

NOTE: Most of the pattern presented can be used in opposite direction by mirroring the chart pattern. For example, the cup and handle formation mirrored (upside down) can be used in bear market to enter positions.

We also want to emphasize on failures. Every pattern and its setup has the potential for failures. A good indication whether the setup has a good chance of success is volume. Volume is conviction and is needed for successful followthru. If volume is absent, be cauious and have stop loss orders in place.

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