When a candlestick chart forms a specific figure, it may sometimes indicate future price movements. This is known as a chart pattern. Chart patterns include reversal patterns (trend reversals) and consolidation patterns (trend continuation). This article focuses on the reversal patterns.
Peaks and troughs in reversal patterns
When a candlestick chart forms a specific figure, it may sometimes indicate future price movements. This is known as a chart pattern. Chart patterns include reversal patterns (trend reversals) and consolidation patterns (trend continuation).
Reversal patterns mainly appear in areas of highs and lows. When they emerge, they suggest that the previous trend may reverse, signalling a potential strategy for taking countertrend actions.
In this article, we will discuss how to use this pattern for identifying market high and low conditions.
Reversal patterns
V-Shaped reversal or Inverse V-Shaped reversal
The V-Shape or inverse V-Shape of this pattern represents a sudden drop followed by a sudden rise or sudden rise followed by a sudden drop.
Double Top or Double Bottom
A pattern resembling the letters M (Double Top) or W (Double Bottom) forms. A reversal occurs after setting two equal levels of highs/lows, forming two tops or bottoms.
Triple Top or Triple Bottom
This occurs after the chart establishes three equal highs or lows (forming three tops or bottoms), signalling a reversal.
Head and Shoulders or Head and Shoulders Bottom
A Triple Top or Triple Bottom variation, with a protruding central peak or bottom.
Round Top or Bottom
The chart exhibits a more rounded bowl-shaped pattern rather than sharp angular peaks.
In Figure 1, we can see that a major reversal pattern has emerged. Whether the trend is major or minor, this type of pattern is likely to appear at its turning points.
Figure 1. Reversal patterns
Price ranges in reversal patterns
Patterns like Double Top, Triple Top, Head and Shoulders, and their inverse formations can be used to predict the extent of price changes that may occur after a trend reversal. The common aspect among these patterns is the neckline.
In the Head and Shoulders pattern in Figure 2, the left and right tops represent the shoulders, the middle top represents the head, and the horizontal line starting from the bottom of this head is called the neckline (found in other patterns like Double Top).
In this case, pay attention to the price range between the peak of the chart pattern (point A) and the neckline (point B). When we extend this price range downwards from point B to point C, we get the downward movement's target point.
Figure 2. Head and Shoulders price range
Key takeaways
Reversal patterns
Reversal patterns mainly appear in areas of highs and lows. When these patterns emerge, they suggest that the previous trend may reverse, signaling a potential strategy for taking counter-directional actions. This is a key concept in technical analysis.
Common reversal patterns:
- V-Shaped Reversal or Inverse V-Shaped Reversal
- Double Top or Double Bottom
- Triple Top or Triple Bottom
- Head & Shoulders or Head & Shoulders Bottom
- Round Top or Round Bottom
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