Chart Patterns Trading – Price Action Patterns Trading Guide

10 years of Chart Patterns trading, analysis and research and I am still as fascinated by them as before. I made sure to constantly remind myself that the only path to successful trading relies solely on technical analysis and price action chart patterns.

This article will go over the 12 most common chart patterns that you will encounter regardless of your trading time frame (intraday to weeks at a time) or financial instrument of choice.

Trading success requires a variety of skills; to get the most out of these 12 best chart patterns for trading, you must develop a paper trading discipline and money management principles.

Table of Contents

• Why Are Chart Patterns Important?
• How Should Chart Patterns Be Used?
• Types of Chart Patterns
• 12 Chart Patterns Every Trader Should Know
• 1. Double Top Chart Pattern
• 2. Double Bottom Chart Pattern
• 3. Head and shoulders
• 4. Flag Chart Pattern
• 5. Pennant Chart Patterns
• 6. Cup and Handle Chart Patterns
• 7. Rounding Top Chart Pattern
• 8. Rounding Bottom Chart Pattern
• 9. Wedge Chart Patterns
• 10. Triangle Chart Patterns
• 11. Rectangle Chart Patterns
• 12. Island Reversals

Recognizing a pattern is not enough; you must also understand the key elements of the trade and how to apply them to your trading style. This is why, in addition to each chart pattern, I have included a section on how to trade.

Don’t just read this blog; put this advice into practice by trading chart patterns, embracing them daily, and profiting from them.

As the Chinese proverb goes –

“Give a man a fish and you feed him for a day. Teach a man to fish and you feed him for a lifetime.”

Why Are Chart Patterns Important?

If you’ve ever wondered what the big players are up to, where the big money is being invested, or what the majority of market participants think about current market scenarios – this is the place to be because chart patterns are smart money’s footprints.

Chart patterns, when studied repeatedly, show that traders’ behavior is the same as it was previously, and even the creation of powerful trading bots and applications is done by traders and people like you and me, so things in the trading world are the same today as they were before.

Many people today will tell you that they prefer computer-driven technical indicators based on complex mathematical formulas, but computer models and so-called sophisticated indicators have yet to consistently outperform pattern recognition as an analysis approach.

So, instead of getting carried away with too much information, stick to the fundamentals and continue to build your equity through chart pattern trading.

How Should Chart Patterns Be Used?

• Before you begin trading chart patterns, you must first understand their details and how to manage trades with them.

• Chart patterns must be studied and analyzed in all timeframes and with proper research you can easily find out which chart patterns are more reliable and under which market conditions.
• Chart patterns and other critical areas such as analysis, trading discipline, execution, and money management skills should be given special attention to increase the likelihood of long-term trading success.
• Chart patterns, when combined with other useful tools such as volume, pivot points, support and resistance and  Fibonacci levels, produce good results. However, you should focus more on developing an overall trading strategy before jumping into trades.

Types of Chart Patterns

There are two types of chart patterns –

1. Continuation Chart Patterns 

Continuation chart patterns indicate a pause in the major trend, which usually represents a short-term profit booking before the market continues in the direction of the trend. Continuation chart patterns are good opportunities because they allow you to ring and trade in the direction of the trend.

Examples – Flag , pennant, triangles,

2. Reversal Chart Patterns 

Reversal chart patterns are important because they tell us when the major trend is about to change. They not only provide a new opportunity to trade a trend that is about to unfold in the opposite direction, but they can also signal the exit of an existing position.

Examples – Double top and bottom, head and shoulders, rounding top and bottom, island reversals

12 Chart Patterns Every Trader Should Know

Technical analysis and chart pattern study will provide you with the edge you seek; many successful traders can easily spot these chart patterns on their charts.

You can benefit from studying these chart patterns and practicing how to trade chart patterns whether you are an intraday trader, positional trader, or investor.

Let’s go over each chart pattern and try to understand it in detail –

1. Double Top Chart Pattern

The double top chart pattern is a bearish reversal chart pattern that resembles an ‘M’ formation with two peaks and a neckline.

Identification:-

Statistics :-

• The average reversal rate is between 55 and 60%.
• The average decline is 18.32%.
• Decline more than 45% is observed in less than 5% of patterns

How To trade Double Top Chart Pattern :-

The most important aspect of trading a double top pattern is identifying it and waiting for the breakout. Always use half position size on the breakout signal, and if prices come back to retest the neckline level, add the remaining half quantity.

2. Double Bottom Chart Pattern

The double bottom chart pattern is the inverse of the double top chart pattern; it resembles a ‘W’ formation, signals a bullish reversal, and appears after a downtrend.

Identification:-

Statistics :-

• The average reversal rate is between 55 and 60%.
• The average rise is 24%.
• Rise more than 45% is observed in less than 11% to 15% of patterns.

How To trade Double Bottom Chart Pattern :-

Once a valid double bottom chart pattern is identified, wait for the price to cross and close above the neckline. Sometimes prices come back to retest the neckline support, and sometimes the breakout is very strong and prices continue to move high, so it is best to use money management to get the best risk-reward ratio.

3. Head and shoulders

Head and shoulders pattern signal bearish reversal while inverse head and shoulders signal bullish reversal.

Both patterns have one large peak (head) and two smaller peaks (shoulders) and could be easily identified.

Identification:-

Statistics :-

• Average reversal rate is 55%
• Average price decline 29%
• Decline of more than 45% in less than 5% of trades

How To trade Head and Shoulders Pattern :-

The head and shoulders pattern breakout trading strategy is very good for trading this pattern, as it uses volume and price action at the neckline breakout to provide a reliable hint of reversal validity.

4. Flag Chart Pattern

A flag chart pattern is formed by price congestion within narrow parallel lines during an uptrend or downtrend.

The flag chart pattern is one of the most common and successful chart patterns. 

Identification:-

Statistics :-

• The average winning rate in a bull market is 58.34%, while it is 50% in a bear market.
• The average price change following the pattern is 17% to 23%.
• Price change of more than 45% in less than 12% of trades

How To trade Flag Pattern :-

Trading flag chart patterns is fairly simple and straightforward; once identified, simply wait for a breakout and enter when prices close above one of the trendlines forming the pattern.

5. Pennant Chart Patterns

Two converging trend lines in a very short time span form a pennant pattern. Pennant patterns, like flag patterns, are continuation chart patterns.

As per the back test research report bullish pennant is the most profitable chart pattern.

Identification:-

Statistics :-

• Over a twelve-month period, the average net gain is around 50%.
• Average winning rate of 58.34% 
• After pattern formation, the average price change is around 23%.

How To trade Pennant Pattern :-

When prices close above the boundary of the bullish chart pattern or below the boundary of the bearish pennant chart pattern, a position in the direction of the major trend can be taken with a very favorable risk reward.

6. Cup and Handle Chart Patterns

Cup and handle looks exactly how it sounds – a cup with a small handle to the right.

It signals a short term bullish continuation.

Identification:-

Statistics :-

• Average continuation rate is 40% to 50%
• Average rise is 34%
• On average 28% of patterns rise more than 45% 

How To trade Cup and Handle Chart Pattern :-

Wait for the cup and handle pattern to fully unfold, then plan your trade and wait for prices to close at least 4-5% above this structure.

Once price crosses this range, place your entry and trail stop loss until price targets are met.

7. Rounding Top Chart Pattern

Rounding top, also known as the “inverse saucer” pattern, is a long-term trend reversal signal that is frequently used for a bearish entry for positional trades.

Rounding top has a distinct feature of peaks forming within the pattern, resembling an inverted bowl, which distinguishes it from triple bottom patterns.

Identification:-

Statistics :-

• Average reversal rate is 53% to 56%
• Average decline is 31%
• On average 7% of patterns fall more than 45% 

How To trade Rounding Top Chart Pattern :-

When prices approach the pattern’s support level, patiently observe the price action. Keep in mind that not every rounding top pattern results in a reversal, especially during a strong bull market, and that many of these patterns result in upward trend continuation.

If prices break through the support level with sufficient volume and momentum, a short trade can be initiated, with positions added gradually as prices fall.

8. Rounding Bottom Chart Pattern

Rounding bottom is also known as “saucer bottom,” and it is a long-term bullish reversal pattern. When the market is in a downtrend, it takes time to reverse the trend, and if a “bowl” like pattern emerges during this time, it is referred to as a rounding bottom pattern.

Identification:-

Statistics :-

• Average reversal rate is 53% to 55%
• Average rise is 31%
• On average, 25% of patterns fall more than 45% 

How to trade the Rounding Bottom Chart Pattern :-

If traded correctly, the rounding bottom pattern is a very good reversal pattern that can result in huge profits. However, it is critical that the pattern is spotted at the right time and that entry is placed only once prices rise a certain percentage above the resistance level created by the pattern.

The most common and reliable percentage level is 5%.

9. Wedge Chart Patterns

Wedges are short term to medium term bullish or bearish continuation as well as reversal patterns. Wedges form when two trend lines converge and price action remains within the boundaries of these trendlines for an extended period of time.

1. Rising wedges during an uptrend indicate a bearish reversal.
2. Rising wedge during downtrend signal signal bearish continuation
3. A falling wedge during an uptrend indicates a bullish continuation.
4. A falling wedge during a downtrend indicates a bullish reversal. 

Identification:-

Statistics :-

• Average reversal rate is 56% while continuation rate is  60%
• Average change after pattern is 29%
• On average 27% of patterns fall more than 45%

How to Trade Wedges :-

Trading wedges are very much similar to trading flags, with only difference is stop loss becomes very wide in case of wedges with the same technique and hence it is advised to use ATR as stop loss level (usually 1 ATR) to get a better risk reward.

Another thing to consider is the type of wedge, as rising and falling wedges in uptrends and downtrends provide different types of opportunities.

10. Triangle Chart Patterns

Triangle chart patterns show prices moving within a narrow range in such a way that volatility decreases over time.

There are three types of triangle patterns –

1. Ascending Triangles
2. Descending triangles
3. Symmetrical triangles

Triangle patterns can indicate reversal or continuation depending on which side the breakout occurred.

Identification:-

Statistics :-

• Average winning rate is 65%. 
• Average rise is around 35% ( for continuations).
• Average decline is around 30% ( for reversals).

How To trade Triangles Chart Pattern :-

The most important trading tip for triangle patterns is timing; many traders fall victim to false breakouts and enter before confirmation.

To avoid this, you must wait for confirmation of a breakout and for momentum to build before entering a trade. This will undoubtedly result in some late entries, but it will keep your winning rate and confidence high.

11. Rectangle Chart Patterns

Rectangles are the most commonly used and important chart patterns. A rectangle chart pattern is said to form when price consolidates for a medium to long period of time between two horizontal trendlines.

Rectangles, while similar to flag patterns in appearance, are not the same in terms of duration; rectangles form as a result of long-term price consolidation.

Rectangles can also indicate continuation or reversal depending on which side of the breakout occurred.

Identification:-

Statistics :-

• Average probability of profit is around 69% 
• Average rise or decline 37%
• 20% upside breakouts results in more than 45% of price rise.

How To trade Rectangles Chart Patterns :-

Rectangle patterns are very useful for breakout trading; when price breaks out of consolidation and moves higher or lower from the trendlines forming the rectangle pattern, always take trade in direction of breakout and use proper money management for position sizing; very often retest of pattern boundary is observed and thus should be taken into account while placing trade; the rest of the trading tactics are similar to other chart patterns.

12. Island Reversals

Island reversal patterns are short-term bearish reversal patterns in which prices gap up to the formation and then gap down to the same price level within a short period of time, resulting in the formation of an island.

Identification:-

Statistics :-

• Average reversal rate is 62%.
• Average decline after reversal is around 17%.
• Average drawdown of more than 45% witnessed in less than 5% of trades.

How To trade Island Reversal Pattern :-

Once a pattern is identified, do not enter the trade on the day of the gap down; instead, wait for the next candlestick to enter the trade. The reason for this is simple: sometimes gaps tend to fill, and once the gap is filled, the island reversal chart pattern is invalidated.

If the gap is not filled within a day or two, make a short entry and stop loss should be above the median of the gap.

Summary

• Chart patterns are most important part of price action trading & technical analysis 
• Chart pattern trading is a profitable and professional way of entering trades.
• Chart patterns are divided into continuation and reversal patterns.
• Every chart pattern has its own statistics and average win rate; however, it should be noted that no chart pattern is always successful.
• Chart pattern trading is footprint of smart money, many traders use chart patterns to get a clue of what big size market participants are up to
• To improve results and risk-reward ratios, chart patterns are frequently combined with trendlines, support and resistance, and volume.
• Chart patterns can be traded alone or in combination with other indicators.
• Before getting into actual trading it is wise to practice and paper trade chart patterns to remove possibility of trading errors.

Free Chart Patterns Trading pdf

Chart Patterns Trading Infographic