Now that we have learned the basics of technical analysis and multi time frame analysis the next thing we will look at is chart patterns in the forex, futures and stock markets. Chart patterns are what technical traders look for on historical price charts to help them determine what the current supply and demand forces are, and how prices may be affected as a result.

In our previous lessons on trends and
support and resistance, we have already identified several of the most basic chart patterns which traders use to place trades. As you remember from these lessons, some of the more common patterns are up trends (bullish pattern), which when we view on a chart we identify with a potential buying opportunity, and down trends (bearish pattern), which we identify as potential selling opportunities.

Although support and resistance are not classified as chart patterns there are many chart patterns which are associated with identifying support and resistance, and we will start by examining the most basic of these patterns.

Double Tops:

A double top is a reversal chart pattern which is defined by a chart where a financial instrument makes a run up to a particular level, then drops back from that level, then makes a second run at that level, and then finally drops back off again.

Currency Chart Example of a Double Top:


In its most basic sense what the double top pattern is saying about supply and demand forces is that demand is out pacing supply (buyers are winning) up to the first top causing prices to rise, and then the equation flips and demand is no longer out pacing supply (sellers are winning) causing prices to fall. After then falling back the buyers make another run at the same price and then after failing to break that level for a second time, sellers take control and keep the upper hand causing prices to sell of even more dramatically after the second top than they did after the first. For double bottoms the reverse is true.


A double bottom is also a reversal pattern in the futures, forex, or stock markets which is the exact opposite of a double top. To form a double bottom a financial instrument makes a run down to a particular level, then trades up from that level then makes a second run down to at or near the same level as the first bottom, and then finally trades back up again

Chart Example of a Double Bottom:



You can also see the connection here between the double top and double bottom pattern, and support and resistance as the double top forms resistance and the double bottom forms support.

Double Top Forms Resistance:



Double Bottom Forms Support:


That completes our lesson for today. You should now have a good understanding of the basics of chart patterns and of two of the more common patterns, double tops and double bottoms and most likely have already started to think about how one might integrate these into their trading strategy. In tomorrow's lesson we will go over the exact details of a common strategy used to trade double tops and double bottoms in the stock, futures and forex markets.

As always if you have any questions comments please feel free to leave them in the comments section below, and have a great day!

Hi,
i wana know the best practice of trendlines do u me the best way to solve this problem.thanx

Hi Nadi,

Welcome to the community.

There is a good post on trend lines and support and resistance here.

Best Regards,
Dave

Hi! I have been eyeing a certain company. (I dont know if I can give that info here) It was in a long downtrend, formed a double bottom in April & has been going strong ever since. The 5, 10, 20, 50, and 100 EMA's are all lined up and still in convergence on every chart.

my questions are... I see double tops/bottoms create a HUGE incline and a HUGE decline. What is a good way of determining the momentum it will create? (power in the movement to remain in the direction)

And how can it be determined if a company is out of a downtrend? If it has been rising for a month, that would be a sustained rally right? It's just one sudden rise on a 6 month and yearly chart. I avoid the purchase because I feel that I might join at the wrong time, although all the EMA's are lining up & converging perfectly.


Francesca xxx

Hi Francesca,

All the stuff that we talk about on the forum is for educational purposes so you can feel free to post the stock you are talking about if you would like.

I think many would agree with you that double bottoms and double tops are good reversal patterns. In general as far as a way to try and tell how much momentum a move will have after a pattern is formed many traders will look at the length of time and force with which the original pattern was formed.

So for example if you have a double top on the daily chart that was formed over a short period of time with lots of momentum then I think most traders would look for the reversal off the pattern to come with similar momentum.

Another thing that I think traders look at here is how significant the support/resistance levels are which are in the way of the reversal of the pattern. If there are many strong points of support below a double top or many strong instances of resistance above a double bottom, then I think most traders would agree that the market is more likely to stall around those levels than if there are not.

The only way that I am aware of to tell if a company is out of a downtrend is to first define the downtrend you are looking at. This could be done a variety of ways the most popular of which would be by drawing a trendline. Then once that trendline is broken then the instrument you are looking at has broken the downtrend.

There are two things to keep in mind here:

1. There can be multiple trends so most traders will look to define the long term, intermediate term, and short term trend. The longer the timeframe the trendline is drawn on generally the more significant it is seen to be.

2. When a trend is broken this does not neccessarily mean that a new trend has begun. For a new trend to have begun you have to define the new trend using trendlines or one of the other methods available.

For more information on this and how to draw trendlines see the below links:

Drawing Trendlines : Trader Mike

More on Trendlines : Trader Mike

Afraid to Trade.com Blog » Assessing the Validity of Trendlines

If there are any other questions or comments related to this please feel free to post them below.

Best Regards,
Dave