Chart Patterns
(Part II)
Reversal Pattern
Reversal patterns are important technical analysis tools
used by traders and analysts in the financial markets,
such as stocks. These patterns are used to identify
potential trend reversals in price movements, signaling a
shift in the prevailing market direction. Reversal patterns
suggest that the current trend may be coming to an end
and could be followed by a new trend in the opposite
direction.
Advantages of Trading Reversals
1. Early Entry into New Trends: Reversal patterns can provide traders with early signals of
potential trend changes. By identifying reversals early, traders have the opportunity to enter
new trends at their inception, potentially maximizing profits by riding the trend from its early
stages.
2. Higher Reward-to-Risk Ratios: Reversal patterns often allow traders to enter trades with
relatively tight stop-loss levels, which can lead to higher reward-to-risk ratios. A well-placed
stop-loss near the pattern's breakout point or the pattern's opposite side can limit potential
losses while offering the potential for larger gains if the reversal occurs as expected.
3. Useful for Short-Term Traders: Reversal patterns are particularly appealing to short-term
traders who seek quick profits within a relatively short time frame. These traders can take
advantage of the swift price movements that often accompany trend reversals.
4. Potential for Sharp Moves: Reversal patterns can lead to strong price movements as the
market transitions from one trend to another. These sharp moves can result in substantial
profits for traders who correctly identify and capitalize on the reversal.
Double Top
This is a bearish reversal pattern
where the price reaches a
significant peak, experiences a
retracement from high selling
pressure and rallies again,
attempting to reach the previous
high. Here, the price fails to surpass
the previous peak and that point
becomes the resistance level. Enter
the trade when the neckline is
broken and keep stop loss slightly
above the resistance. Here your risk
to reward ratio will be 1:1.
Double Bottom
A double bottom pattern is a bullish
reversal pattern that occurs after a
downtrend and suggests a potential
trend reversal. Contrary to a
Double-Top, this pattern has two
roughly equal lows (support level)
joined by either a rally or a sideways
trend. The pattern starts with a
significant low, bounces off the support
level and revisits it to form a second
low.Enter the trade when the neckline is
broken and keep stop loss slightly
below the support. Here your risk to
reward ratio will be 1:1.
Head and Shoulders
The head and shoulders pattern indicates a
trend reversal from bullish to bearish. It is
called due to its resemblance to a head with
two shoulders. The pattern, however,
wouldn’t be an exact replica of the
structure—it will only resemble the structure
to an extent. The left shoulder is the first
peak of the pattern, the head is the second
and the highest peak and the right shoulder
is the third peak resembling the left
shoulder. In this pattern the target is equal
to the dept from the neckline to the head
and the stop loss should slightly above the
right shoulder.
Inverse Head and Shoulders
Inverse Head and Shoulders signals a
potential trend reversal from a
downward trend to an upward trend in
the price of a security or asset. The
pattern resembles the shape of a
person’s head and two shoulders in an
inverted position, with three consistent
lows and peaks. The chart aims to
identify a potential reversal in a
downtrend, indicating a possible bullish
trend. In this pattern the target is equal to
the dept from the neckline to the head and
the stop loss should slightly below the right
shoulder.
