Section 3: Basic Price Patterns
We can now begin to assign what are traditionally called Classic Price Patterns to areas of consolidation that take place between important support and resistance levels. Beginning with the Rectangle Pattern, one can evaluate the potential for a reversal, or continuation, of the current trend, as well as the measuring implication or magnitude of the next move and whether there exists the possibility of a false signal, or "whipsaw". There are many patterns to learn, but they all share similar characteristics, described below. Price patterns are very useful in both long-term and short-term timeframes.
Price Patterns are generally the result of other basic concepts of Technical Analysis recognized on the chart. They are formed by a combination of important price points and volume levels and how the price action responds following the intersection of these inputs. As such, we first cover the basics of price pattern formation.
Having covered the basic components, let’s dive into the conventional patterns and explore what they have to offer. Remember, patterns are either reversal or continuation patterns, but all should be treated as a potential pattern until confirmation of a breakout occurs.
A special situation arises when prices do not trade continuously, jumping in progression from one price increment to the next and skipping over the prices in between. This typically occurs between the closing and opening of trading on an exchange, when important information is discovered but market participants have to wait to act on it. We refer to such situations as “Gaps” and cover their characteristics, various types and implications for future price movements below.
The combination of two gap types that signals a reversal is the Island Reversal.
Finally, it is important to recognize when price patterns fail.