Chart patterns - part 1

Table of contents
The basics of chart patterns .................................................................................................................... 2
Flags & pennants ..................................................................................................................................... 3
Criteria bullflag: ................................................................................................................................... 3
Criteria bearflag: .................................................................................................................................. 3
Criteria bear-/bull pennant: ................................................................................................................ 3
Trading flags & pennants: ....................................................................................................................... 4
Targets ................................................................................................................................................. 4
Entry .................................................................................................................................................... 4
Triangles .................................................................................................................................................. 5
Criteria ascending triangle: ................................................................................................................. 5
Criteria descending triangle: ............................................................................................................... 5
Criteria symmetrical triangle: .............................................................................................................. 5
Fakeouts .............................................................................................................................................. 6
Trading triangles ...................................................................................................................................... 7
Targets ................................................................................................................................................. 7
Entry .................................................................................................................................................... 7
Wedges .................................................................................................................................................... 8
Criteria rising wedge: .......................................................................................................................... 8
Criteria falling wedge: ......................................................................................................................... 8
How to trade wedges .............................................................................................................................. 9
Targets: ................................................................................................................................................ 9
Entry: ................................................................................................................................................... 9
Head & shoulders .................................................................................................................................. 10
Criteria head and shoulders: ............................................................................................................. 10
Criteria inverse head and shoulders:................................................................................................. 10
How to trade (inverse) head and shoulders .......................................................................................... 11
Targets ............................................................................................................................................... 11
Entry .................................................................................................................................................. 11
Conclusive notes:................................................................................................................................... 12

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The basics of chart patterns
Chart patterns is a very popular form of Technical Analysis. Before we dive in how to identify and
how to use certain patterns, it’s important to know the basic rules about using these.

1) Understanding why they work:

Chart patterns are all about crowd psychology. If enough people see the same chart pattern they will
react in the same way and thus it becomes a bit of a self-fulfilling prophecy. If a lot of people think
the price will go down and all trade like it would, it eventually will. This also correlated with higher
timeframes being more reliable than lower timeframes -> simply because there is a bigger audience
watching the 1H, 4H, daily timeframes over the 1 minute.

2) Do not force the patterns

All patterns have certain requirements which will be discussed per pattern later on in this document.
For the pattern to have validity, it needs to check all the boxes, a common mistake is forcing patterns
where you disobey one or more of the requirements. This would give you a false sense of security
and could lead to big losses. Sidenote: This is the case with all technical analysis (TA), not only chart
patterns.

3) Understanding there are no guarantees

As with every form of TA, it’s never good to view them in isolation. Even the perfect pattern setup
isn’t guaranteed profit. You should look at it like this: hypothetically if we invest in a market with zero
knowledge, it’s 50/50 if you win or not on short term. With proper technical analysis we increase the
chances of being right, BUT IT’S STILL A CHANCE. This is why we learned about risk management &
other trade basics first, they hold true in every trade.

So now the basics are clear, let’s dive in the most common patterns, the more uncommon patterns
will most likely be discussed in later parts. Every pattern we go over will have the same layout: a
bullish variant (where price goes up) & a bearish variant (where price goes down), explanation of all
the requirements of validity, and how to potentially trade them.

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Flags & pennants
We often see these patterns often when there’s big movement in the market, after such a move the
market needs to cool off and (potentially) forming patterns like:

Both flags & pennants are usually continuation patterns, which means its most likely to follow the
trend leading into the pattern (the flagpole). Thus, for bullish flags/pennants it would mean break to
the upside and for bearish flags/pennants it would mean break to the downside.

Criteria bullflag:
- Upward momentum (flagpole)
- Downward channel (flag) forming -> The support & resistance of the channel is being respected
(doesn’t break) with multiple touches -> highs and lower lows.
-Break of the resistance (preferably on high volume)
Volume pattern: Increasing in the flagpole, decreasing in the downward channel

Criteria bearflag:
-Downward momentum (flagpole)
-Upward channel (flag) forming -> The support & resistance of the channel is being respected
(doesn’t break) with multiple touches -> higher highs & higher lows.
-Break of the support (preferably on high volume)
Volume pattern: Increasing in the flagpole and decreasing or equal in the upward channel.

Criteria bear-/bull pennant:

Pennants have the same criteria to be valid as the bear- /bullflags, where they differ is the form of
the flag. We don’t see the upward- or downward channels but we see a little pennant forming that is
eventually broken. More specifically: For the bullish pennant we see higher lows in combination with
lower highs, and for the bearish pennant we see lower highs in combination with higher lows.
Besides that, pennants are usually play out over a lower timeframe than flags.

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Trading flags & pennants:

Targets
Flags and pennants have the same two targets :
-T1 is the distance between the first high and low in the channel, measured from breakout
-T2 is the entire length of the flagpole, measured from breakout

Entry
So when do we enter? There are a few possibilities:
-Enter when we bounce off the support (risky)
These are indicated by the blue circles -> the first blue circle shows why this is a bit of a gamble,
although if you entered here the short term looks good, the price fails to break resistance here and
comes back to the support a third time (second blue circle) which is a lower entry point than we
initially entered. Hence I indicated this as a risky play -> we’re gambling to break the resistance -> if it
doesn’t we most likely will come back to support again -> manage risk accordingly.

-enter when we breakout on resistance (higher % play)

Here we sacrifice a bit of our potential gains (distance from blue to red circle) for actual certainty.
Once the pattern breaks, we confirm the last criteria and can long the breakout with a stop-loss
under the previous breakout (resistance).

-Enter / add to position on potential retest

Retest in this case would be after breaking out of the resistance, IF we come back down to it again
and bounce off it and go up again we flipped our resistance to support. This would be a nice
validation of our pattern. On the other hand we can also fall trough the resistance again and
invalidate the pattern.
Important:
-This is the bullish flag/pennant, the way of calculating the targets is the same for the bearish variant,
only measured from the breakout of the support.
As for the entries it’s the opposite aswell -> we could enter on bounces of the resistance (risky), or
enter on potential breakout (higher % play)
-Price action is often not as smooth as indicated above it just shows how the range should act to
validate the pattern.
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Triangles
Triangles are another continuation pattern, if validated, its most likely to follow the trend leading
into the pattern. If invalidated (failure of the criteria/structure this can be a reversal pattern -> the
price will do the opposite as the trend leading into the pattern.

We have 3 types of triangles:

Here we can see how all three forms of the triangles (ascending/descending/symmetrical) usually
lead to trend continuation. For all the triangles the story is the same, the price plays between
resistance and support for a long time till it eventually gets cornered (it reaches the apex), then
usually we see a break of the structure. For bullish triangles this is when the upper resistance breaks
and for bearish triangles this is when the lower support breaks.

Criteria ascending triangle:

-A horizontal resistance, which means we see similar highs (same price level) -> no higher highs.
-An ascending support, which means we see higher lows
-Once it reaches apex of triangle -> we break upper resistance (preferably on high volume)

Criteria descending triangle:

-A horizontal support, which means we see similar lows (same price level). -> no lower lows
-A descending resistance, which means we see lower highs -> no higher highs
-Once it reaches apex of triangle -> we break support (preferably on high volume)

Criteria symmetrical triangle:

-Ascending support -> we see higher lows -> invalidated on lower lows.
-Descending resistance -> we see lower highs -> Invalidated on higher highs
- Once it reaches apex of triangle -> usually follows trend leading into the triangle.

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Fakeouts
As we’ve said before these patterns USUALLY lead to pattern continuation, but it’s important to
understand that this is not always the case. Triangles have a tendency to have fake break-outs which
can be disastrous for your trade if you play these structures. For instance, let’s look at BTC:

After the crash early may ’21 we saw a rebound back from ~29K. Then when price movement
continued, a descending resistance started to form. All the red dots are places where the price failed
to break this resistance. Before the break-out we’ve seen 9 touches on the resistance, which gave us
a lot of confidence about the placement of our resistance -> it was respected by the market for
weeks.
At the same time, we’ve seen two important touches on the 31K mark, which could lead us to believe
that this would be our support, but with only 2 touches it’s still a bit uncertain, even more so
considering we had our initial breakdown bottom at ~29k.

Then what happened? We actually broke the resistance-> this is where the structure potentially was
invalidated and thus, we speak about a trend reversal. A lot of traders started getting bullish for this
reason and started longing, whereas bears are conservative here because they know a trend reversal
on this break is possible. This eventually fed price even more to eventually top around ~41K. Once we
start heading down, we get at a crucial retest of the resistance we broke out.
Here we have 2 scenario’s:

1) we break the resistance to break back into the triangle and the resistance holds after potential
retests (retest = price comes back up to the resistance again after break into triangle) -> highest %
play is visiting the lows of the triangle.

2) The resistance now becomes support (Resistance-support flip) and we bounce off the support to
confirm invalidation of the pattern and trend reversal -> higher highs are now in sight

Scenario 1 obviously happened and the resistance held after we break back down into the triangle,
we can also see that we eventually tested the lows we’ve seen in early May. This shows how a retest
can be defining for certain breaks, it can confirm or invalidate them.

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Trading triangles
Targets
Triangles have 1 target:
Ascending: The height from lowest low to resistance measured from breakout
Descending: The height from highest high to support measured from breakout
Symmetrical: The width of the pattern -> Highest low to supp (bullish) / lowest low to res (bear)

Entry
As shown with the BTC example above we want to be careful for fake outs in such patterns. The
highest % play would be playing the breakout and then adding to your trade when there’s a potential
retest. If the retest fails, you want to have your stop-loss ready to prevent big losses. If there is no
retest and the pattern validates without it, you still have a successful trade.

We could also long on support for the bullish variants and gamble that we break resistance -> once
you reach it you got to have your eyes on it because if it doesn’t break, we’re probably seeing
support OR: move your stoploss into the profits like we’ve discussed in trading basics.

For the bearish variants it would be the same but shorting on resistance and hope we break support.

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Wedges
Wedges are reversal patterns, which means the price is likely to do the opposite of the trend leading
into the pattern (reverse from down to up or vice versa).

Again we have two flavors, a bullish (falling) wedge and a bearish (rising) wedge:

Wedges are a bit similar to triangles in the way that they corner price where there will be a breakout
in the apex ultimately. They should be traded with caution; it’s one of the patterns that is often
‘forced’, not respecting its criteria.

Criteria rising wedge:

- Rising resistance & support (higher highs in combination with higher lows)
- At least two or more touches on resistance & support to confirm both lines
- Declining volume pattern -> During the wedge volume is declining
- Break in the apex (preferably on big volume)

Criteria falling wedge:

- Falling resistance & support (lower highs in combination with lower lows)
- At least two or more touches on resistance & support to confirm both lines
- Declining volume pattern -> During the wedge volume is declining
- Break in the apex (preferably on big volume)

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How to trade wedges

Targets:
Wedges have two targets, dependent on how radical the market reacts in the event that it breaks.

Rising wedge:
T1: The highest low within the structure not counting the breakout.
T2: The lowest low within the structure

Falling wedge:
T1: The lowest high within the structure not counting the breakout.
T2: The highest high within the structure

Entry:
Similarly to the patterns we discussed earlier we have a few potential entries:
-Blue: Where we risk shorting or longing into resistance -> moving stop/loss is great to reduce risk
-Green: longing/shorting the break -> if there’s no retest we are still in the trade with potential to hit
our targets
-Yellow: longing/shorting the retest -> here we validate or invalidate the breakout, if validated
(doesn’t break back in wedge) we can add to trade and look for T1 & T2

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Head & shoulders
Head and shoulders are seen as one of the most reliable reversal patterns, which means the price is
likely to do the opposite of the trend leading into the pattern (reverse from down to up or vice
versa).

Important to realize that the head and shoulders pattern can also be tilted as long as we respect the
criteria. Tilted variants are shown in the picture above.

Criteria head and shoulders:

-The neckline is well respected (doesn’t break) by both shoulders and the head, it acts as support.
-The left and right shoulders have approximately the same height.
- OFTEN diminishing volume in right shoulder compared to head/ left shoulder

Criteria inverse head and shoulders:

-The neckline is well respected (doesn’t break) by both shoulders and the head, it acts as resistance
-The left and right shoulders have approximately the same height.
- OFTEN diminishing volume in right shoulder compared to head/ left shoulder

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How to trade (inverse) head and shoulders
Targets
The inverse and regular head and shoulders patterns have 1 target and is calculated in the same way.
T1: Distance from Head to neckline measured from breakout

Entry
Before entering a head and shoulders pattern we always want to wait for the right shoulder to form.
We have a few entry possibilities:
Blue: Here you either short (h&s) or long (I h&s), but it’s a risky play, we can’t really place our stop-
loss in a nice way because we said the shoulders should be approximately the same height.
Green: Here we either short(h&s) or long (I h&s) the breakout, if there’s no retest of the neckline in
the future we’re still in a profitable trade. Stop-loss would be right beneath the neckline ->
invalidates the pattern
Yellow: longing/shorting the retest -> here we validate or invalidate the breakout, if validated
(doesn’t break back in wedge) we can add to trade and look for T1. If we invalidate, we want to get
out of the trade.

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Conclusive notes:
Emphasize the importance of retests:
Although retests aren’t always necessary for a pattern to play out -> some times we reach our targets
without ever retesting, retests can be seen in every pattern we discussed. On the retest we will
validate or invalidate the initial break or invalidate. For instance, we showed with BTC (page 6) -> we
had been in this triangle for weeks so a retest seemed inevitable -> break got invalidated.

Patterns can often change:

Triangles & other long-term patterns are defined over time. The trendlines that are correct are the
ones that are respected by the market for a longer time (have multiple touches).

Use trading view to practice:

Tradingview is a website where you can view charts, pick your favorite stock/crypto and see if u can
identify correct patterns and how you would have traded them and see how it would have played
out.

Most common mistakes of pattern trading:

-Isolated view -> not looking at other market factors that might impact price
-Forcing patterns -> not respecting criteria
-wrong entries (often longing into resistance / shorting into support)
-wrong stop-losses -> For instance not respecting potential retests.

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