One of the most widely used tools in trading is technical analysis. Technical analysis allows you to follow a rules-based approach and let’s you know what patterns work best. When you use chart patterns, you could clearly identify potential entries, exits and targets. When you have a plan for trading a stock, it will be a lot easier and help you become a disciplined trader. That said, let’s take a look at some chart patterns our community uses consistently.
These chart patterns are battle-tested
I always get questions about chart patterns, so let’s get right into some technical analysis and look at some patterns I tend to look for.
Now, we’re not talking about a hairstyle here. There are some key features of a flat top pattern. One key feature is there is a key resistance area, which has been tested multiple times. Additionally, you should notice higher lows, coupled with steady or increasing volume. Thereafter, there should be heavy volume in a break above the resistance level. A flat top breakout could be short term and even be long term in nature.
Take a look at this flat top pattern.
Notice how STAAR Surgical Co. (STAA) had multiple tops at the resistance area around $11. Once it broke the $11, it spiked above $12. Thereafter, it tested the $11, and that ultimately became the support area.
This was an example of a “long-term” flat top break out that continued higher.
Cup and handle
The cup and handle pattern is often considered a bullish continuation pattern. In other words, the stock should continue higher after the pattern comes into fruition. There are two components to the pattern, the cup and the handle (just as the name suggests). The cup forms after a stock sells off and starts to rebound. This could also be thought of as a rounded bottom. Once the cup is formed, there’s a trading range that develops on the right hand side, known as the handle. Now, once the stock breaks out of the handle’s range, it signals the stock could breakout and continue higher.
Here’s a look at an example of a cup and handle pattern.
Inverse head and shoulders
A head and shoulders has two forms, one that’s for reversals and one that’s for continuations. Here, we’re looking at a trend reversal, or the inverse head and shoulders. This pattern has a series of three troughs. The lowest trough is the head and the outside troughs are the shoulders. Now, the highest of each trough could be connected to form some resistance, which is known as the neckline.
Forest Laboratories (FRX) formed an inverse head and shoulders pattern here. Once it formed the right shoulder, it tested and broke above the necline. Thereafter, it started to run higher. This is a textbook setup. However, you should keep in mind that chart patterns are not a science and don’t always work. Sometimes you might see the stock break above the neckline, only to reverse and fall lower. That said, if you want to use this pattern, you need to practice risk management and maybe stop out if it falls a certain amount below the neckline.
This chart pattern is considered a short-term continuation pattern. Coils indicate a small period of consolidation before the previous moves continue. Generally, we see a sharp move, either up or down, before we notice a coil.
Here’s a look at Avis Budget Group Inc (CAR).
The lines shown above is the coil. Notice CAR gapped higher, then formed a coil and continued higher.
Here’s a look at Roku Inc. (ROKU) also had a coil pattern after its initial public offering (IPO). It had a strong move up on its first day of trading, then started to consolidate. However, it found some support around $17.50, and gapped higher and just kept running.
The bottom line
You have to pick and choose which chart patterns work for you. For the most part, I scan for these chart patterns when I game plan everyday. Again, technical analysis is an art form, so you need to remain disciplined and have clear entries, exits and targets. If you stay stubborn and a stock breaks a key technical level, you could be in a world of trouble.
Keith Kern brings two decades of trading experience to the LightningAlerts.com chat room, where he acts as a moderator. His strategies and approach to risk management have been proven tried-and-true under any market condition.