Other Chart Patterns

Cup and Handle

A cup and handle chart is a bullish continuation pattern in which the upward trend has paused but will continue in an upward direction once the pattern is confirmed.

As you can see in figure above, this price pattern forms what looks like a cup, which is preceded by an upward trend. The handle follows the cup formation and is formed by a generally downward/sideways movement in the security's price. Once the price movement pushes above the resistance lines formed in the handle, the upward trend can continue. There is a wide ranging time frame for this type of pattern, with the span ranging from several months to more than a year.

Rounding Bottom

A rounding bottom, also referred to as a saucer bottom, is a long-term reversal pattern that signals a shift from a downward trend to an upward trend. This pattern is traditionally thought to last anywhere from several months to several years.

A rounding bottom chart pattern looks similar to a cup and handle pattern but without the handle. The long-term nature of this pattern and the lack of a confirmation trigger, such as the handle in the cup and handle, makes it a difficult pattern to trade.

Gaps

A gap in a chart is an empty space between a trading period and the following trading period. This occurs when there is a large difference in prices between two sequential trading periods. For example, if the trading range in one period is between $25 and $30 and the next trading period opens at $40, there will be a large gap on the chart between these two periods. Gap price movements can be found on bar charts and candlestick charts but will not be found on point and figure or basic line charts.

Gaps generally show that something of significance has happened in the security, such as a better-than-expected earnings announcement. There are three main types of gaps, breakaway, runaway (measuring) and exhaustion. A breakaway gap forms at the start of a trend, a runaway gap forms during the middle of a trend and an exhaustion gap forms near the end of a trend.

Chart Patterns : Wedge

The wedge chart pattern can be either a continuation or reversal pattern. It is similar to a symmetrical triangle except that the wedge pattern slants in an upward or downward direction, while the symmetrical triangle generally shows a sideways movement. The other difference is that wedges tend to form over longer periods, usually between three and six months.

The fact that wedges are classified as both continuation and reversal patterns can make reading signals confusing. However, at the most basic level, a falling wedge is bullish and a rising wedge is bearish. In Figure below, we have a falling wedge in which two trendlines are converging in a downward direction. If the price was to rise above the upper trendline, it would form a continuation pattern, while a move below the lower trendline would signal a reversal pattern.

Continuation Wedge (Bullish)

A Continuation Wedge (Bullish) is considered a bullish signal. It indicates a possible continuation of the current uptrend. It consists of two converging trend lines. The trend lines are slanted downward. Unlike the Triangles where the apex is pointed to the right, the apex of this pattern is slanted downwards at an angle. This is because prices edge steadily lower in a converging pattern i.e. there are lower highs and lower lows. A bullish signal occurs when prices break above the upper trendline. Over the weeks or months that this pattern forms the trend appears downward but the long-term range is still upward. Volume should diminish as the pattern forms.

Continuation Wedge (Bearish)

A Continuation Wedge (Bearish) is considered a bearish signal, indicating that the current downtrend may continue. It consists of two converging trend lines. The trend lines are slanted upward. Unlike the Triangles where the apex is pointed to the right, the apex of this pattern is slanted upwards at an angle. This is because prices edge steadily higher in a converging pattern i.e. there are higher highs and higher lows. A bearish signal occurs when prices break below the lower trendline.Over the weeks or months that this pattern forms the trend appears upwards but the long-term range is still downward.

Chart Patterns : Flag And Pennant

These two short-term chart patterns are continuation patterns that are formed when there is a sharp price movement followed by a generally sideways price movement. This pattern is then completed upon another sharp price movement in the same direction as the move that started the trend. The patterns are generally thought to last from one to three weeks.

As you can see in figure above, there is little difference between a pennant and a flag. The main difference between these price movements can be seen in the middle section of the chart pattern. In a pennant, the middle section is characterized by converging trendlines, much like what is seen in a symmetrical triangle. The middle section on the flag pattern, on the other hand, shows a channel pattern, with no convergence between the trendlines. In both cases, the trend is expected to continue when the price moves above the upper trendline.

Flag (Bullish)

A Flag (Bullish) is considered a bullish signal, indicating that the current uptrend may continue. It follows a steep, or nearly vertical rise in price, and consists of two parallel trendlines that form a rectangular flag shape. The Flag can be horizontal (as though the wind is blowing it), however it often has a slight downtrend.The vertical uptrend, that precedes a Flag, may occur because of buyers' reactions to a favorable company earnings announcement, or a new product launch. The sharp price increase is sometimes referred to as the "flagpole" or "mast". The rectangular flag shape is the product of what technical analysts refer to as consolidation. Consolidation occurs when the price seems to bounce between an upper and lower price limit. This might occur, for example, in the days following a positive product announcement, when the excitement is starting to subside, and fewer buyers are willing to pay the high price that was commanded just a few days before. But, at the same time, sellers are unwilling to sell below a lower support limit.
A bullish signal occurs when the price rebounds beyond the upper trendline of the Flag formation, and continues the original upward price movement. This is considered a pattern confirmation.

Flag (Bearish)

A Flag (Bearish) is considered a bearish signal, indicating that the current downtrend may continue.It follows a steep, or nearly vertical decline in price, and consists of two parallel trendlines that form a rectangular flag shape. The Flag can be horizontal (as though the wind is blowing it), however it often has a slight upward trend. The vertical downtrend, that precedes a Flag, may occur because of buyers' reactions to an unfavorable company announcement, such as a court case, or a sudden and unexpected departure of a CEO. The sharp price decrease is sometimes referred to as the "flagpole" or "mast".

The rectangular flag shape is the product of what technical analysts refer to as consolidation. Consolidation occurs when the price seems to bounce between an upper and lower price limit. The Flag (Bearish) pattern formation reflects the reaction of sellers who are willing to sell at a lower cost, and the influx of buyers who inadvertently drive up the price as they compete to buy at the best possible price.

A bearish signal occurs when the price rebounds beyond the lower trendline of the Flag formation, and continues the original downward price movement. This is considered a pattern confirmation.

Pennant (Bullish)

A Pennant (Bullish) is considered a bullish signal, indicating that the current uptrend may continue. It follows a steep, or nearly vertical rise in price, and consists of two converging trendlines that form a narrow, tapering flag shape. The Pennant shape generally appears as a horizontal shape, rather than one with a downtrend or uptrend. Apart from its shape, the Pennant is similar in all respects to the Flag. The Pennant is also similar to the Symmetrical Triangle or Wedge continuation patterns however; the Pennant is typically shorter in duration and flies horizontally.

Pennant (Bearish)

A Pennant (Bearish) is considered a bearish signal, indicating that the current downtrend may continue. It follows a steep, or nearly vertical fall in price, and consists of two converging trendlines that form a narrow, tapering flag shape. The Pennant shape generally appears as a horizontal shape, rather than one with a downtrend or uptrend. Apart from its shape, the Pennant is similar in all respects to the Flag. The Pennant is also similar to the Symmetrical Triangle or Wedge continuation patterns however; the Pennant is typically shorter in duration and flies horizontally.

Chart Patterns : Triple Tops And Bottoms

Triple tops and triple bottoms are another type of reversal chart pattern in chart analysis. These are not as prevalent in charts as head and shoulders and double tops and bottoms, but they act in a similar fashion. These two chart patterns are formed when the price movement tests a level of support or resistance three times and is unable to break through; this signals a reversal of the prior trend.

Triple Top

The triple top pattern is comprised of three sharp peaks, all at the same level. A triple top occurs when prices are in an uptrend. Prices rise to a resistance level, retreat, return to the resistance level again, retreat, and finally, return to that resistance level for a third time before declining. In a classic triple top, the decline following the third peak marks the beginning of a downtrend. While the three peaks should be sharp and distinct, the lows of the pattern can appear as rounded valleys. The pattern is complete when prices decline below the lowest low in the formation. The lowest low is also called the "confirmation point."

A triple top is considered to be a variation of the head and shoulders top. Often the only thing that differentiates a triple top from a head and shoulders top is the fact that the three peaks that make up the triple top are more or less at the same level. The head and shoulders top displays a higher peak - the "head" - between the two shoulders. According to experts including Murphy, making a distinction between these two patterns is largely academic because they both imply the same thing.They are both "reversal" patterns of an upward trend in a stock. The triple top marks an uptrend in the process of becoming a downtrend.

Triple Bottom

The triple bottom pattern is composed of three sharp lows, all at about the same price level. Prices fall to a support level, rise, fall to that support level again, rise, and finally fall, returning to the support level for a third time before beginning an upward climb. In the classic triple bottom, the upward movement in the price marks the beginning of an uptrend. While the three lows should be sharp and distinct, the highs of the pattern can appear to be rounded. The pattern is complete when prices rise about the highest high in the formation. The highest high is called the "confirmation point."

A triple bottom pattern displays three distinct minor lows at approximately the same price level. The triple bottom is considered to be a variation of the head and shoulders bottom. Like that pattern, the triple bottom is a reversal pattern.The only thing which differentiates a triple bottom from a head and shoulders bottom is the lack of a "head" between the two shoulders. The triple bottom illustrates a downtrend in the process of becoming an uptrend. It is, therefore, vital to the validity of the pattern that it commence with prices moving in a downtrend.

Chart Patterns : Double Tops And Bottoms

This chart pattern is another well-known pattern that signals a trend reversal - it is considered to be one of the most reliable and is commonly used. These patterns are formed after a sustained trend and signal to chartists that the trend is about to reverse. The pattern is created when a price movement tests support or resistance levels twice and is unable to break through. This pattern is often used to signal intermediate and long-term trend reversals. In the case of the double top pattern in the above figure, the price movement has twice tried to move above a certain price level. After two unsuccessful attempts at pushing the price higher, the trend reverses and the price heads lower. In the case of a double bottom (shown on the right), the price movement has tried to go lower twice, but has found support each time. After the second bounce off of the support, the security enters a new trend and heads upward.

Double Top

A double top occurs when prices form two distinct peaks on a chart. A double top is only complete, however, when prices decline below the lowest low - the "valley floor" - of the pattern.
The double top is a reversal pattern of an upward trend in a stock's price. The double top marks an uptrend in the process of becoming a downtrend.

A double top consists of two well-defined, sharp peaks at approximately the same price level. A double top occurs when prices are in an uptrend. Prices rise to a resistance level, retreat, return to the resistance level again before declining. The two tops should be distinct and sharp. The pattern is complete when prices decline below the lowest low in the formation. The lowest low is called the confirmation point.Sometimes called an "M" formation because of the pattern it creates on the chart, the double top is one of the most frequently seen and common of the patterns. Because they seem to be so easy to identify, the double top should be approached with caution by the investor.

According to Schabacker, the double top is a "much misunderstood formation." Many investors assume that, because the double top is such a common pattern, it is consistently reliable. This is not the case. Schabacker estimates that probably not more than a third of them signal reversal and that most patterns which an investor might call a double top are not in fact that formation.2 Bulkowski estimates the double top has a failure rate of 65%. If an investor waits for the breakout, however, the failure rate declines to 17%. The double top is a pattern, therefore, that requires close study for correct identification.

Double Bottom

A double bottom occurs when prices form two distinct lows on a chart. A double bottom is only complete, however, when prices rise above the high end of the point that formed the second low. The double bottom is a reversal pattern of a downward trend in a stock's price. The double bottom marks a downtrend in the process of becoming an uptrend.

A double bottom consists of two well-defined lows at approximately the same price level. Prices fall to a support level, rally and pull back up, then fall to the support level again before increasing. The pattern is complete when prices rally above the highest peak in the formation. The highest peak is called the confirmation point. Sometimes called an "W" formation because of the pattern it creates on the chart, the double top is one of the most frequently seen and common of the patterns. Because they seem to be so easy to identify, the double bottom should be approached with caution by the investor.

According to Schabacker, the double bottom is a "much misunderstood formation." Many investors assume that, because the double bottom is such a common pattern, it is consistently reliable. This is not the case. Bulkowski estimates the double bottom has a failure rate of 64%, which he terms surprisingly high. If an investor waits for a valid breakout, however, the failure rate declines to 3%. The double bottom is a pattern, therefore, that requires close study for correct identification.

Chart Patterns : Head and Shoulders

This is one of the most popular and reliable chart patterns in technical analysis. Head and shoulders is a reversal chart pattern that when formed, signals that the security is likely to move against the previous trend. As you can see in the above figure, there are two versions of the head and shoulders chart pattern. Head and shoulders top (shown on the left) is a chart pattern that is formed at the high of an upward movement and signals that the upward trend is about to end. Head and shoulders bottom, also known as inverse head and shoulders (shown on the right) is the lesser known of the two, but is used to signal a reversal in a downtrend.

Head and Shoulders Top

The Head and Shoulders Top is an extremely popular pattern among investors because it's one of the most reliable of all formations. The classic Head and Shoulders Top looks like a human head with shoulders on either side of the head. A perfect example of the pattern has three sharp high points, created by three successive rallies in the price of the financial instrument.

The first point - the left shoulder - occurs as the price of the financial instrument in a rising market hits a high and then falls back. The second point - the head - happens when prices rise to an even higher high and then fall back again. The third point - the right shoulder - occurs when prices rise again but don't hit the high of the head. Prices then fall back again once they have hit the high of the right shoulder. The shoulders are definitely lower than the head and, in a classic formation, are often roughly equal to one another.

A key element of the pattern is the neckline. The neckline is formed by drawing a line connecting two low price points of the formation. The first low point occurs at the end of the left shoulder and the beginning of the uptrend to the head. The second marks the end of the head and the beginning of the upturn to the right shoulder. The neckline can be horizontal or it can slope up or down. The pattern is complete when the support provided by the neckline is "broken." This occurs when the price of the financial instrument, falling from the high point of the right shoulder, moves below the neckline. Technical analysts will often say that the pattern is not confirmed until the price closes below the neckline - it is not enough for it to trade below the neckline.

Head and Shoulders Bottom

The Head and Shoulders bottom is a popular pattern with investors. This pattern marks a reversal of a downward trend in a financial instrument's price.A perfect example of the Head and Shoulders Bottom has three sharp low points created by three successive reactions in the price of the financial instrument. It is essential that this pattern form following a major downtrend in the financial instrument's price. Volume is absolutely crucial to a Head and Shoulders Bottom. An investor will be looking for increasing volumes at the point of breakout. This increased volume definitively marks the end of the pattern and the reversal of a downward trend in the price of a stock.

The first point - the left shoulder - occurs as the price of the financial instrument in a falling market hits a new low and then rises in a minor recovery. The second point - the head happens when prices fall from the high of the left shoulder to an even lower level and then rise again. The third point - the right shoulder - occurs when prices fall again but don't hit the low of the head. Prices then rise again once they have hit the low of the right shoulder. The lows of the shoulders are definitely higher than that of the head and, in a classic formation, are often roughly equal to one another.

The neckline is a key element of this pattern. The neckline is formed by drawing a line connecting the two high price points of the formation. The first high point occurs at the end of the left shoulder and beginning of the downtrend to the head. The second marks the end of the head and the beginning of the downturn to the right shoulder. The neckline usually points down in a Head and Shoulders Bottom, but on rare occasions can slope up.
The pattern is complete when the resistance marked by the neckline is "broken". This occurs when the price of the stock, rising from the low point of the right shoulder moves up through the neckline. Many technical analysts only consider the neckline "broken" if the stock closes above the neckline.

 

Looking at the Chart Above of Fortis Healthcare Ltd.(NSE) for period of  June to December, we see a formation of Head & Shoulders Pattern. The neckline(158) gets started around start of September and the first shoulder gets formed at 170 in mid of September. Then the stock again touches the neckline(158) at the end of September. In October it forms the Head at 177 and again touches the neckline(158) at the end of October. In November it finally forms the second shoulder at 171 and by mid November breaks the neckline(158). The Pattern was giving the target of 140-143(approx 15-18 points down from 158) and it exactly did the same by end of November, touching 142.20 as Intraday Low.

Chart Patterns : Triangles

Triangles are some of the most well-known chart patterns used in technical analysis. The three types of triangles, which vary in construct and implication, are the symmetrical triangle, ascending and descending triangle. These chart patterns are considered to last anywhere from a couple of weeks to several months.

Ascending Triangle

A bullish chart pattern used in technical analysis that is easily recognizable by the distinct shape created by two trendlines. In an ascending triangle, one trendline is drawn horizontally at a level that has historically prevented the price from heading higher, while the second trendline connects a series of increasing troughs. Traders enter into long positions when the price of the asset breaks above the top resistance.

An ascending triangle is generally considered to be a continuation pattern, meaning that it is usually found amid a period of consolidation within an uptrend. Once the breakout occurs, buyers will aggressively send the price of the asset higher, usually on high volume. The most common price target is generally set to be equal to the entry price plus the vertical height of the triangle.

Descending Triangle

A bearish chart pattern used in technical analysis that is created by drawing one trendline that connects a series of lower highs and a second trendline that has historically proven to be a strong level of support. Traders watch for a move below support, as it suggests that downward momentum is building. Once the breakdown occurs, traders enter into short positions and aggressively push the price of the asset lower.

This is a very popular tool among traders because it clearly shows that the demand for an asset is weakening, and when the price breaks below the lower support, it is a clear indication that downside momentum is likely to continue or become stronger. Descending triangles give technical traders the opportunity to make substantial profits over a brief period of time. The most common price targets are generally set to equal the entry price minus the vertical height between the two trendlines.

Symmetrical Triangle

A chart pattern used in technical analysis that is easily recognized by the distinct shape created by two converging trendlines. The pattern is identified by drawing two trendlines that connect a series of sequentially lower peaks and a series of sequentially higher troughs. Both trendlines act as barriers that prevent the price from heading higher or lower, but once the price breaches one of these levels, a sharp movement often follows.

A symmetrical triangle is generally regarded as a period of consolidation before the price moves beyond one of the identified trendlines. A break below the lower trendline is used by technical traders to signal a move lower, while a break above the upper trendline signals the beginning of a move upward.

Chart Patterns

A chart pattern is a distinct formation on a stock chart that creates a trading signal, or a sign of future price movements. Chartists use these patterns to identify current trends and trend reversals and to trigger buy and sell signals.

Earlier we talked about the three assumptions of technical analysis, the third of which was that in technical analysis, history repeats itself. The theory behind chart patters is based on this assumption. The idea is that certain patterns are seen many times, and that these patterns signal a certain high probability move in a stock. Based on the historic trend of a chart pattern setting up a certain price movement, chartists look for these patterns to identify trading opportunities.

While there are general ideas and components to every chart pattern, there is no chart pattern that will tell you with 100% certainty where a security is headed. This creates some leeway and debate as to what a good pattern looks like, and is a major reason why charting is often seen as more of an art than a science.

There are two types of patterns within this area of technical analysis, reversal and continuation. A reversal pattern signals that a prior trend will reverse upon completion of the pattern. A continuation pattern, on the other hand, signals that a trend will continue once the pattern is complete. These patterns can be found over charts of any timeframe.

Chart Types

There are four main types of charts that are used by investors and traders depending on the information that they are seeking and their individual skill levels. The chart types are: the line chart, the bar chart, the candlestick chart and the point and figure chart.

Line Chart

The most basic of the four charts is the line chart because it represents only the closing prices over a set period of time. The line is formed by connecting the closing prices over the time frame. Line charts do not provide visual information of the trading range for the individual points such as the high, low and opening prices. However, the closing price is often considered to be the most important price in stock data compared to the high and low for the day and this is why it is the only value used in line charts.

Bar Charts

The bar chart expands on the line chart by adding several more key pieces of information to each data point. The chart is made up of a series of vertical lines that represent each data point. This vertical line represents the high and low for the trading period, along with the closing price. The close and open are represented on the vertical line by a horizontal dash. The opening price on a bar chart is illustrated by the dash that is located on the left side of the vertical bar. Conversely, the close is represented by the dash on the right. Generally, if the left dash (open) is lower than the right dash (close) then the bar will be shaded black, representing an up period for the stock, which means it has gained value. A bar that is colored red signals that the stock has gone down in value over that period. When this is the case, the dash on the right (close) is lower than the dash on the left (open).

Candlestick Charts

The candlestick chart is similar to a bar chart, but it differs in the way that it is visually constructed. Similar to the bar chart, the candlestick also has a thin vertical line showing the period's trading range. The difference comes in the formation of a wide bar on the vertical line, which illustrates the difference between the open and close. And, like bar charts, candlesticks also rely heavily on the use of colors to explain what has happened during the trading period. A major problem with the candlestick color configuration, however, is that different sites use different standards; therefore, it is important to understand the candlestick configuration used at the chart site you are working with. There are two color constructs for days up and one for days that the price falls. When the price of the stock is up and closes above the opening trade, the candlestick will usually be white or clear. If the stock has traded down for the period, then the candlestick will usually be red or black, depending on the site. If the stock's price has closed above the previous day’s close but below the day's open, the candlestick will be black or filled with the color that is used to indicate an up day.

Point and Figure Charts

The point and figure chart is not well known or used by the average investor but it has had a long history of use dating back to the first technical traders. This type of chart reflects price movements and is not as concerned about time and volume in the formulation of the points. The point and figure chart removes the noise, or insignificant price movements, in the stock, which can distort traders' views of the price trends. These types of charts also try to neutralize the skewing effect that time has on chart analysis.

What Is A Chart?

In technical analysis, charts are similar to the charts that you see in any business setting. A chart is simply a graphical representation of a series of prices over a set time frame. For example, a chart may show a stock's price movement over a one-year period, where each point on the graph represents the closing price for each day the stock is traded.

Chart Properties

There are several things that you should be aware of when looking at a chart, as these factors can affect the information that is provided. They include the time scale, the price scale and the price point properties used.

The Time Scale

The time scale refers to the range of dates at the bottom of the chart, which can vary from decades to seconds. The most frequently used time scales are intraday, daily, weekly, monthly, quarterly and annually. The shorter the time frame, the more detailed the chart. Each data point can represent the closing price of the period or show the open, the high, the low and the close depending on the chart used.

Intraday charts plot price movement within the period of one day. This means that the time scale could be as short as five minutes or could cover the whole trading day from the opening bell to the closing bell. Daily charts are comprised of a series of price movements in which each price point on the chart is a full day’s trading condensed into one point. Again, each point on the graph can be simply the closing price or can entail the open, high, low and close for the stock over the day. These data points are spread out over weekly, monthly and even yearly time scales to monitor both short-term and intermediate trends in price movement.

Weekly, monthly, quarterly and yearly charts are used to analyze longer term trends in the movement of a stock's price. Each data point in these graphs will be a condensed version of what happened over the specified period. So for a weekly chart, each data point will be a representation of the price movement of the week. For example, if you are looking at a chart of weekly data spread over a five-year period and each data point is the closing price for the week, the price that is plotted will be the closing price on the last trading day of the week, which is usually a Friday.

The Price Scale and Price Point Properties

The price scale is on the right-hand side of the chart. It shows a stock's current price and compares it to past data points. This may seem like a simple concept in that the price scale goes from lower prices to higher prices as you move along the scale from the bottom to the top. The problem, however, is in the structure of the scale itself. A scale can either be constructed in a linear (arithmetic) or logarithmic way, and both of these options are available on most charting services.

If a price scale is constructed using a linear scale, the space between each price point (10, 20, 30, 40) is separated by an equal amount. A price move from 10 to 20 on a linear scale is the same distance on the chart as a move from 40 to 50. In other words, the price scale measures moves in absolute terms and does not show the effects of percent change.

If a price scale is in logarithmic terms, then the distance between points will be equal in terms of percent change. A price change from 10 to 20 is a 100% increase in the price while a move from 40 to 50 is only a 25% change, even though they are represented by the same distance on a linear scale. On a logarithmic scale, the distance of the 100% price change from 10 to 20 will not be the same as the 25% change from 40 to 50. In this case, the move from 10 to 20 is represented by a larger space one the chart, while the move from 40 to 50, is represented by a smaller space because, percentage-wise, it indicates a smaller move.

The Importance Of Volume In Technical Analysis

What is Volume?

Volume is simply the number of shares or contracts that trade over a given period of time, usually a day. The higher the volume, the more active the security. To determine the movement of the volume (up or down), chartists look at the volume bars that can usually be found at the bottom of any chart. Volume bars illustrate how many shares have traded per period and show trends in the same way that prices do.

Why Volume is Important?

Volume is an important aspect of technical analysis because it is used to confirm trends and chart patterns. Any price movement up or down with relatively high volume is seen as a stronger, more relevant move than a similar move with weak volume. Therefore, if you are looking at a large price movement, you should also examine the volume to see whether it tells the same story.Say, for example, that a stock jumps 5% in one trading day after being in a long downtrend. Is this a sign of a trend reversal? This is where volume helps traders. If volume is high during the day relative to the average daily volume, it is a sign that the reversal is probably for real. On the other hand, if the volume is below average, there may not be enough conviction to support a true trend reversal.

Volume should move with the trend. If prices are moving in an upward trend, volume should increase (and vice versa). If the previous relationship between volume and price movements starts to deteriorate, it is usually a sign of weakness in the trend. For example, if the stock is in an uptrend but the up trading days are marked with lower volume, it is a sign that the trend is starting to lose its legs and may soon end. When volume tells a different story, it is a case of divergence, which refers to a contradiction between two different indicators. The simplest example of divergence is a clear upward trend on declining volume.

Volume and Chart Patterns

The other use of volume is to confirm chart patterns. Patterns such as head and shoulders, triangles, flags and other price patterns can be confirmed with volume, a process which we'll describe in more detail later in this tutorial. In most chart patterns, there are several pivotal points that are vital to what the chart is able to convey to chartists. Basically, if the volume is not there to confirm the pivotal moments of a chart pattern, the quality of the signal formed by the pattern is weakened.

Volume Precedes Price

Another important idea in technical analysis is that price is preceded by volume. Volume is closely monitored by technicians and chartists to form ideas on upcoming trend reversals. If volume is starting to decrease in an uptrend, it is usually a sign that the upward run is about to end.

Support And Resistance

Once you understand the concept of a trend, the next major concept is that of support and resistance. You'll often hear technical analysts talk about the ongoing battle between the bulls and the bears, or the struggle between buyers (demand) and sellers (supply). This is revealed by the prices a security seldom moves above (resistance) or below (support).

Why Does it Happen?

These support and resistance levels are seen as important in terms of market psychology and supply and demand. Support and resistance levels are the levels at which a lot of traders are willing to buy the stock (in the case of a support) or sell it (in the case of resistance). When these trendlines are broken, the supply and demand and the psychology behind the stock's movements is thought to have shifted, in which case new levels of support and resistance will likely be established.

Round Numbers and Support and Resistance

One type of universal support and resistance that tends to be seen across a large number of securities is round numbers. Round numbers like 10, 20, 35, 50, 100 and 1,000 tend be important in support and resistance levels because they often represent the major psychological turning points at which many traders will make buy or sell decisions. Buyers will often purchase large amounts of stock once the price starts to fall toward a major round number such as 50, which makes it more difficult for shares to fall below the level. On the other hand, sellers start to sell off a stock as it moves toward a round number peak, making it difficult to move past this upper level as well. It is the increased buying and selling pressure at these levels that makes them important points of support and resistance and, in many cases, major psychological points as well.

Role Reversal

Once a resistance or support level is broken, its role is reversed. If the price falls below a support level, that level will become resistance. If the price rises above a resistance level, it will often become support. As the price moves past a level of support or resistance, it is thought that supply and demand has shifted, causing the breached level to reverse its role. For a true reversal to occur, however, it is important that the price make a strong move through either the support or resistance.

The Importance of Support and Resistance

Support and resistance analysis is an important part of trends because it can be used to make trading decisions and identify when a trend is reversing. For example, if a trader identifies an important level of resistance that has been tested several times but never broken, he or she may decide to take profits as the security moves toward this point because it is unlikely that it will move past this level.

Support and resistance levels both test and confirm trends and need to be monitored by anyone who uses technical analysis. As long as the price of the share remains between these levels of support and resistance, the trend is likely to continue. It is important to note, however, that a break beyond a level of support or resistance does not always have to be a reversal. For example, if prices moved above the resistance levels of an upward trending channel, the trend has accelerated, not reversed. This means that the price appreciation is expected to be faster than it was in the channel.

Being aware of these important support and resistance points should affect the way that you trade a stock. Traders should avoid placing orders at these major points, as the area around them is usually marked by a lot of volatility. If you feel confident about making a trade near a support or resistance level, it is important that you follow this simple rule: do not place orders directly at the support or resistance level. This is because in many cases, the price never actually reaches the whole number, but flirts with it instead. So if you're bullish on a stock that is moving toward an important support level, do not place the trade at the support level. Instead, place it above the support level, but within a few points. On the other hand, if you are placing stops or short selling, set up your trade price at or below the level of support.

TrendLenghts, Trendlines and Channels.

Trend Lengths

Along with three trend directions, there are three trend classifications. A trend of any direction can be classified as a long-term trend, intermediate trend or a short-term trend. In terms of the stock market, a major trend is generally categorized as one lasting longer than a year. An intermediate trend is considered to last between one and three months and a near-term trend is anything less than a month. A long-term trend is composed of several intermediate trends, which often move against the direction of the major trend. If the major trend is upward and there is a downward correction in price movement followed by a continuation of the uptrend, the correction is considered to be an intermediate trend. The short-term trends are components of both major and intermediate trends.

When analyzing trends, it is important that the chart is constructed to best reflect the type of trend being analyzed. To help identify long-term trends, weekly charts or daily charts spanning a five-year period are used by chartists to get a better idea of the long-term trend. Daily data charts are best used when analyzing both intermediate and short-term trends. It is also important to remember that the longer the trend, the more important it is; for example, a one-month trend is not as significant as a five-year trend.

Trendlines

A trendline is a simple charting technique that adds a line to a chart to represent the trend in the market or a stock. Drawing a trendline is as simple as drawing a straight line that follows a general trend. These lines are used to clearly show the trend and are also used in the identification of trend reversals.An upward trendline is drawn at the lows of an upward trend. This line represents the support the stock has every time it moves from a high to a low. This type of trendline helps traders to anticipate the point at which a stock's price will begin moving upwards again. Similarly, a downward trendline is drawn at the highs of the downward trend. This line represents the resistance level that a stock faces every time the price moves from a low to a high.

Channels

A channel, or channel lines, is the addition of two parallel trendlines that act as strong areas of support and resistance. The upper trendline connects a series of highs, while the lower trendline connects a series of lows. A channel can slope upward, downward or sideways but, regardless of the direction, the interpretation remains the same. Traders will expect a given security to trade between the two levels of support and resistance until it breaks beyond one of the levels, in which case traders can expect a sharp move in the direction of the break. Along with clearly displaying the trend, channels are mainly used to illustrate important areas of support and resistance.

Use of Trend in Technical Analysis

One of the most important concepts in technical analysis is that of trend. The meaning in finance isn't all that different from the general definition of the term - a trend is really nothing more than the general direction in which a security or market is headed. In any given chart, you will probably notice that prices do not tend to move in a straight line in any direction, but rather in a series of highs and lows. In technical analysis, it is the movement of the highs and lows that constitutes a trend.

Types of Trend

There are three types of trend:

1.) Uptrends - A formal uptrend is when each successive peak and trough is higher than the ones found earlier in the trend. It describes the price movement of a financial asset when the overall direction is upward. The goal of most technical traders is to identify a strong uptrend and to profit from it until it reverses. Selling an asset once it has failed to create a new peak or trough is one of the best ways to avoid the large losses that can result from a reversed trend. Many technical traders will also draw trendlines to identify an uptrend and will use this tool as a guide for when to sell as it can also be an early indication of a trend reversal.

2.) Downtrends - A formal downtrend occurs when each successive peak and trough is lower than the ones found earlier in the trend. It describes the price movement of a financial asset when the overall direction is downward. Many traders seek to avoid downtrends because they can drastically affect the value of any investment. A downtrend can last for minutes, days, weeks, months or even years so identifying a downtrend early is very important. Once a downtrend has been established (series of lower peaks) a trader should be very cautious about entering into any new long positions.

3.) Sideways Trend - A sideways trend is often regarded as a period of consolidation before the price continues in the direction of the previous move. It describes the horizontal price movement that occurs when the forces of supply and demand are nearly equal. A sideways price trend is also commonly known as a "horizontal trend". Sideways trend is generally a result of the price traveling between strong levels of support and resistance. It is not uncommon to see a horizontal trend dominate the price action of a specific asset for a prolonged period before starting a move higher or lower. Brief consolidation is often needed during large price runs, as it is nearly impossible for such large price moves to sustain themselves over the longer term.

Fundamental Vs. Technical Analysis

Technical analysis and fundamental analysis are the two main schools of thought in the financial markets. As we've mentioned, technical analysis looks at the price movement of a security and uses this data to predict its future price movements. Fundamental analysis, on the other hand, looks at economic factors, known as fundamentals. Let's get into the details of how these two approaches differ.

The Differences

Charts vs. Financial Statements - At the most basic level, a technical analyst approaches a security from the charts, while a fundamental analyst starts with the financial statements.

By looking at the balance sheet, cash flow statement and income statement, a fundamental analyst tries to determine a company's value. In financial terms, an analyst attempts to measure a company's intrinsic value. In this approach, investment decisions are fairly easy to make - if the price of a stock trades below its intrinsic value, it's a good investment.

Technical traders, on the other hand, believe there is no reason to analyze a company's fundamentals because these are all accounted for in the stock's price. Technicians believe that all the information they need about a stock can be found in its charts.

Time Horizon - Fundamental analysis takes a relatively long-term approach to analyzing the market compared to technical analysis. While technical analysis can be used on a timeframe of weeks, days or even minutes, fundamental analysis often looks at data over a number of years.

The different timeframes that these two approaches use is a result of the nature of the investing style to which they each adhere. It can take a long time for a company's value to be reflected in the market, so when a fundamental analyst estimates intrinsic value, a gain is not realized until the stock's market price rises to its "correct" value. This type of investing is called value investing and assumes that the short-term market is wrong, but that the price of a particular stock will correct itself over the long run. This "long run" can represent a timeframe of as long as several years, in some cases.

Furthermore, the numbers that a fundamentalist analyzes are only released over long periods of time. Financial statements are filed quarterly and changes in earnings per share don't emerge on a daily basis like price and volume information. Also remember that fundamentals are the actual characteristics of a business. New management can't implement sweeping changes overnight and it takes time to create new products, marketing campaigns, supply chains, etc. Part of the reason that fundamental analysts use a long-term timeframe, therefore, is because the data they use to analyze a stock is generated much more slowly than the price and volume data used by technical analysts.

Trading Versus Investing - Not only is technical analysis more short term in nature that fundamental analysis, but the goals of a purchase (or sale) of a stock are usually different for each approach. In general, technical analysis is used for a trade, whereas fundamental analysis is used to make an investment. Investors buy assets they believe can increase in value, while traders buy assets they believe they can sell to somebody else at a greater price. The line between a trade and an investment can be blurry, but it does characterize a difference between the two schools.

Basic Assumptions of Technical Analysis

The field of technical analysis is based on three assumptions :

1. The Market Discounts Everything

A major criticism of technical analysis is that it only considers price movement, ignoring the fundamental factors of the company. However, technical analysis assumes that, at any given time, a stock's price reflects everything that has or could affect the company - including fundamental factors. Technical analysts believe that the company's fundamentals, along with broader economic factors and market psychology, are all priced into the stock, removing the need to actually consider these factors separately. This only leaves the analysis of price movement, which technical theory views as a product of the supply and demand for a particular stock in the market.

2. Price Moves in Trends

In technical analysis, price movements are believed to follow trends. This means that after a trend has been established, the future price movement is more likely to be in the same direction as the trend than to be against it. Most technical trading strategies are based on this assumption.

3. History Tends To Repeat Itself

Another important idea in technical analysis is that history tends to repeat itself, mainly in terms of price movement. The repetitive nature of price movements is attributed to market psychology; in other words, market participants tend to provide a consistent reaction to similar market stimuli over time. Technical analysis uses chart patterns to analyze market movements and understand trends. Although many of these charts have been used for more than 100 years, they are still believed to be relevant because they illustrate patterns in price movements that often repeat themselves.

Introduction to Technical Analysis

The methods used to analyze securities and make investment decisions fall into two very broad categories: fundamental analysis and technical analysis. Fundamental analysis involves analyzing the characteristics of a company in order to estimate its value. Technical analysis takes a completely different approach; it doesn't care one bit about the "value" of a company or a commodity. It is a method of evaluating securities by analyzing statistics generated by market activity, such as past prices and volume. Technical analysts believe that the historical performance of stocks and markets are indications of future performance.

Despite all the fancy and exotic tools it employs, technical analysis really just studies supply and demand in a market in an attempt to determine what direction, or trend, will continue in the future. In other words, technical analysis attempts to understand the emotions in the market by studying the market itself, as opposed to its components. If you understand the benefits and limitations of technical analysis, it can give you a new set of tools or skills that will enable you to be a better trader or investor.