It doesn’t matter if you’ve been trading stocks for a long time or you’re just starting out, chart patterns should be a vital tool in your arsenal.
Yes, they’re useful in every market — major indices, forex, and even commodities.
But when it comes to trading penny stocks — that has a lot of technical analysis — chart patterns play a very important role.
That’s why every trader that is serious about spotting market trends and predicting movements, should strive to master the art of recognizing patterns.
Here are 3 important chart patterns to note when using technical analysis to trade penny stocks…
Bull Flag Pattern
This is a very popular and fairly easy-to-identify one that ranks high among my favorite list of patterns.
Why am I always looking out for it? Well, because of its potential in relation to well-defined risk/reward parameters.
Here’s what it looks like:
As the name implies, the price action looks like a flagpole rise in the stock, followed by the stock trading within a narrow range — which forms the flag. At that point, traders are trying to lock in gains, while others are still trying to get into the position for a good price.
Finally, there’s a strong breakout over the consolidation range. This is where the stock rises up above resistance levels at the end of the flag.
There are different variations of this pattern though, like the:
- Bull pennant
- Descending flag pattern
- Flat top breakout pattern
But in any case, these three bull flag patterns are probable signs that the stock may be trying to break out of a consolidation and continue an upward trend in price.
Cup and Handle Chart Pattern
Yes, it looks and sounds like — a teacup!
The “cup and handle” is another popular stock chart pattern that indicates a bullish trend. Just like the previous one, this pattern is also easy to visually recognize…and as a swing trader, I tend to look out for this pattern in stocks that have performed well in recent weeks.
Here’s what it looks like:
The pattern usually pops up when there is a sharp decline in price, immediately followed by a stabilizing period, and then a sharp rally that is similar in size before the decline. It creates a U-shape or the “cup”. The price then moves sideways or drifts downward within a channel—that forms the handle. The cup and handle pattern comes in handy in identifying buying opportunities.
An important point to note is that the handle in the pattern should be smaller than the cup.
Fibonacci Retracement Chart Pattern
At first glance, this strategy sounds a bit more complex than the others, but like most things…if you study it closely, it starts to make sense in no time.
Fibonacci retracement is a technical analysis tool in my arsenal that I frequently rely on for finding areas of support and resistance levels (or reverses in price).
Most traders like to use this strategy with other chart patterns like the bull flag mentioned above or technical indicators like moving averages.
Before we talk about what it looks like, let’s understand where the name comes from.
Fibonacci retracements are calculated from Fibonacci ratios which are derived from the Fibonacci sequence.
Here’s a simple refresher — starting from 0, and 1, the Fibonacci sequence is formed by adding the last two numbers to get the next number.
Which results to 0, 1, 1, 2, 3, 5, 8, 13…till infinity.
Now what’s unique about these set of numbers is that;
Every number in the sequence is roughly 61.8% of the next number in the sequence.
Every number in the sequence is 23.6% of the number after the next two numbers.
Every number in the sequence is approximately 38.2% of the Fibonacci number two steps ahead.
The amazing thing about these ratios is that they’re found practically everywhere — from shells of sea organisms, to plants, and even on atomic levels.
What does all this have to do with trading?
Well, when a stock is trending very strongly in one direction, traders using the Fibonacci indicator believe that the pullback will be equal to one of the percentages within the Fibonacci retracement levels — either 23.6%, 38.2%, or 61.8%.
Here’s a quick example; if a stock’s price jumps from $20 to $21, the pullback is likely to be roughly $0.23, $0.38, or 62 cents.
As you know, a good time to enter a trade is when the stock is going through a pullback.
So if you see a stock drop by 38 cents (a Fibonacci ratio) from say $31 to $30.62, that may be a good opportunity to buy, as the stock will likely bounce back up.
Another example: If it jumps from $40 to $50, then it will be in increments of 10. To calculate the 61.8% Fibonacci level, multiply $10 by 61.8% (10 x 0.618 = 6.18) and subtract the result from $50 to get the 61.8% level ($50 – 6.18 = 43.82).
Please note: As much as the Fibonacci sequence is nice, it’s not always perfect when it comes to predicting trends.
So if the price retraces 100% of the last price wave, that may mean the trend has failed. In which case…Cut your losses quickly!!!
I can’t emphasize this enough! I talked about this mistake in a previous article. Here’s an excerpt from it that is worth mentioning again…
“Most beginners and even experienced traders make the mistake of sticking to positions that aren’t working, hoping it’ll somehow turn out well.
I think it comes from fear of admitting they made a wrong call.
You need to learn to “CUT LOSERS”
Summary
Being able to spot patterns (and enter and exit correctly) can make all the difference in a trader’s journey.
These three patterns — the bull flag, cup and handle, and the Fibonacci retracement — are a must-know for serious traders.
Personally, recognizing continuation patterns like the bull flag helps me better time my entries. While the Fib. retracement is a pattern I occasionally lookout for to uncover support and resistance levels. While the “cup and handle” pattern is something I rely on to spot a bullish trend.
As a final note: These patterns are important, but they’re not the end-all-be-all. As a trader, you have to figure out what works best for you.
While some swear by these patterns, others simply do not like them — and that’s fine too.
In another article, I’ll go into more detail on the ways I enter, manage, and exit trades following these patterns.
What are some of your favorite patterns? Let me know in the comment box below.
