Editor’s note: This article was first published in January 2013. The closing scenarios it mentions, Spain declaring bankruptcy and the European Union disappearing, reflect the euro-crisis climate of that time.
In the previous article we looked at the easiest chart patterns to spot. Now let’s move on to some patterns that are a little more complex.
6. Cones
A cone is a kind of channel or wedge that keeps narrowing. Most technical analysts call it a symmetrical triangle; personally, I call it a cone. The stock makes lower highs and higher lows. Volatility practically disappears, trading volume usually falls, and as the cone narrows, the stock has to break either up or down. In the end, this pattern usually predicts a continuation of the previous trend. In other words, if the stock was in a downtrend, it will keep falling when the cone closes, and if it was in an uptrend, it will probably keep rising. Even so, because trading volume dries up, it’s a dangerous pattern: there will always be a greater chance of it turning down if the rest of the index or its sector doesn’t follow.
7. Ascending triangle
In an ascending triangle, the stock makes higher lows while the highs stay at the same level. As with the cone, when this pattern closes the stock has to break out one way or the other, and after the pattern it has formed (with its higher lows), it generally continues upwards. Some of you may ask: couldn’t those repeated touches of the flat upper line be considered a double or triple top? As we said before, for a double top to be valid, at least three weeks must pass, and for a pattern to count as a triangle, it has to take almost a month to form.
8. Descending triangle
The same pattern as the ascending triangle, but inverted. In this case, the stock makes lower highs while its lows don’t go below a horizontal line. When the cone closes, it tends to break down.
9. Continuation wedge
Wedges are the most deceptive chart patterns and the hardest to detect. To start with, they look like a channel (which we talked about in the previous article). The difference is that a channel forms the stock’s primary trend, whereas a wedge occurs within the secondary trend. Let’s say a wedge forms inside a channel, and that sometimes throws us off, especially if we lose sight of the primary trend. Wedges are also deceptive because they suggest the stock is making higher highs and higher lows (a clear uptrend), yet they almost always end up turning the other way.
It’s called a continuation wedge because in this case the stock had been falling, and while the pattern was forming, it looked as if the share price was switching to an uptrend. In the end the stock breaks down, and that’s when you remember it was a wedge.
10. Reversal wedge
In the same way, this wedge makes lower highs and lower lows (a clear downtrend), and in the end the stock breaks out upwards. With this pattern the trend reverses, at least in the short term, because, as we said earlier, a wedge is a pattern within a trend, whether that trend is up or down.
A side note: many traders, when they get bored of intraday trading, take up poker, because for traders and poker players alike, it’s all about patterns (two pair, full house, straight flush…), statistics and maths.
For those of us who don’t plan to trade intraday, but rather to do trend trading or invest for the medium or long term, recognising these patterns can help us choose the right moment to buy and limit our short-term risks.
If we’re clear about which channel we’re in and how close we are to support or resistance levels, we can tilt the odds of success in the stock market in our favour. But remember: if tomorrow they announced that Spain was declaring bankruptcy, that the European Union was disappearing or that the United States was going under, it wouldn’t matter whether there was a head and shoulders, wedges, triangles or apricots, because all of that cancels out the patterns and technical analysis itself.
Featured image: Guts Gaming, CC BY 2.0, via Wikimedia Commons.
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