INVEST IN YOURSELF: The basic chart patterns that all traders should understand

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Breaks, runs, flags and pennants. It could be some kind of sporting competition, and in fact it is to some, but not a particularly athletic one.

These terms are for analysing stock-market charts and are a must for most technical traders.

The fundamental trading term is a trendline, which shows the direction of trend of a stock or index. Uptrends are created by drawing a line through a series of the high points on an ascending trough. Downtrends are formed by drawing a line through a series of descending lower highs. Put simply, it can show the level of support or resistance for a stock rising or falling beyond a certain price.

Generally speaking, trading price rises that approach a downtrend line, and falls in prices approaching an uptrend line, are often considered good times to buy or sell stock in the same direction of a trend, without actually breaching the line. So much so that many traders have automated programs to action these kinds of movements.

When this is not what happens though, it could be a technical break, a source of excitement for traders and commentators alike.

A break usually occurs when a stock price breaches its previous level of resistance and heads higher, rather than breaking below and heading south. When the opposite occurs, it is sometimes is known as a breakdown.

Technical breaks can occur for a number of reasons, including news of significant currency or commodity changes, news of forward orders, significant executive changes, or in recent times, computer algorithms that misinterpret data.

There are also a series of widely followed patterns that can theoretically show the breaks, or at least show some kind of change in trend. In no particular order, here are some of the most followed.

Head and shoulders

This is a popular pattern, which through a series of peaks and troughs, shows first a rise in stock price to form the left shoulder, before a declining and then rebounding to form the head, then declining to form the right shoulder. Once that shoulder is formed the price may fall again.

This pattern can mark a top and also a downside price target, making it popular with technical traders.

An inverse pattern known as the head and shoulders bottom can also occur and forms usually during a downward trend, where-by the pattern would show a person upside down rather than standing up.

Double bottom and double top

This is similar to head and shoulders in the sense that it is capturing peaks and troughs but it only has two points. When a stock price reaches at the same level twice, it can indicate it has reached either a top or bottom.

Saucers

As the name might suggest, show a gradual turn from a downtrend to sideways, and then to a gradual uptrend, looking much like a cup or saucer.

The saucer usually coincides with low volume during the sideways trend. Unfortunately this trend is usually much easier to spot retrospectively than at the time, making it more difficult to trade on.

Cup and handle

A similar looking pattern is the cup and handle, but in this situation there is rounded curves toward a shorter bottom and rounded curves back up. Once the price point reaches the right hand high-side of the cup, it may suggest a technical break, where the price may again slide, representing the handle.

Flags and pennants

When there is a sharp price movement followed by generally sideways (pennant) or slightly triangular (flag) price movement, followed by a price break in the same direction as the initial sharp price movement it could be a flag or pennant.

As you can see, there are many charts and patterns available to traders. The use of them is, at best, an art – certainly not a science – but as you develop as a trader they can be useful tools for your analysis.

The right mentor matters

From video tutorials to how-to guides, CommSec’s array of training resources can help you trade with confidence. For more share trading basics watch ‘Timing the market’ at www.commsec.com.au/investinyourself

IMPORTANT INFORMATION AND DISCLAIMERS: The information contained in this article is of a general nature and is not intended to be nor should it be considered as professional advice. You should not act on the basis of anything contained in this article without first obtaining specific professional advice. Commonwealth Securities Limited ABN 60 067 254 399 AFSL 238814 (“CommSec”) is a wholly owned, but not guaranteed, subsidiary of the Commonwealth Bank of Australia ABN 48 123 123 124 AFSL 23945 and both entities are incorporated in Australia with limited liability. To the extent permitted by law, its related bodies corporate, employees and contractors accepts no liability or responsibility to any persons for any loss which may be incurred or suffered as a result of acting on or refraining from acting as a result of anything contained in this article. CommSec is not responsible for third party websites or articles. They do not necessarily reflect the opinions of CommSec, nor does CommSec confirm their accuracy.

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