Graphic Technical Analysis – How to read a stock market charts

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The main objective of the Graphic Technical Analysis is the analysis of the cyclical behavior of the market.

Prices, in fact, design price patterns, whose recognition allows you to understand what happened in the recent past and what could happen shortly.

 

The theoretical assumption of this type of analysis is that “history tends to repeat itself”.  The movement of prices is the result of a sum of operational decisions.

It reflects, through recurrent and substantially uniform trends, the psychology and behavior of man.

 

Continuation and Inversion figures

 

To be able to assess what might happen in the future, it is necessary to study the past, since.

In the face of similar situations, the reaction of operators will be substantially the same and will, therefore, have similar consequences.

Continuation and Inversion figures

The continuation figures, in Graphic Technical Analysis, constitute a simple pause in the current trend (upward or downward).

Once completed, the market continues in the same direction (upward or downward) as before.

If the trend was upward, prices, after this short consolidation/correction break, will still rip upward.

If the trend were downward, prices would fall further after this brief consolidation/rebound pause.

 

Typical continuation figures are triangles, flags, pennants, and rectangles.

Conversely, the inversion figures cause a reversal of trend (from upward to downward and vice versa).

 

These figures are particularly important since they very often develop within those phases of accumulation and distribution that precede the beginning of a directional movement.

The accumulation phase anticipates the start of a positive trend and therefore causes an upward trend reversal.

 

The distribution phase, on the contrary, anticipates the start of a negative trend and causes a downward trend reversal.

The leading inversion figures are head and shoulders, double/triple top and double/triple bottom, spikes, diamond, and cup&handle.

 

Graphic Technical Analysis: Typical Inversion Figures

The inversion figures, in Graphic Technical Analysis, assume particular relevance, as they cause a significant change of forces in the field.

If prices come from a downward movement, the inversion figure indicates that the market may have reached a significant minimum.

Buyers taking control of the market and creating the conditions for a recovery of absolute consistency.

 

On the contrary, if prices come from an upward movement, the inversion figure signals the formation of a significant maximum.

Sellers taking control of the market and creating the conditions for a decrease of a sure consistency.

Head and Shoulders

The best-known inversion figure is head and shoulders.

This configuration consists of a “head” and two “shoulders,” connected by a trend line called the neckline.

 

Head and Shoulders pattern graphic technical analysis

 

The head and shoulders can be of two types:

Head and Shoulders Bottom

The head and shoulders bottom occurs at the end of a downward movement, and its perfection causes an upward trend reversal.

The downward trend brings the market to a first relative minimum at point A (left shoulder) and, after a short rebound (B), to a minimum at point C (head).

From this last level begins a second bounce, ending at point D.

 

head and shoulders bottom

 

The subsequent weakening leads the market to a new relative minimum (point E), which constitutes the right shoulder.

By not falling below the minimum of point C, the market provides the first demonstration of strength, which is immediately confirmed by the subsequent rise, usually accompanied by an increase in volumes.

 

The neckline that combines the maximum of the first rebound (B) with that of the second (D) highlights a critical resistance.

The overcoming of which not only leads to the completion of the figure but causes an upward reversal.

 

The key level of this figure is the lowest at point E, which, being increasing compared to C, shows that there has been a decrease in downward pressure and a strengthening of the upward pressure on the market.

This minimum indicates that sellers are losing control of the market, while buyers have begun to accumulate positions, anticipating the subsequent rise in prices.

 

The upward trend reversal will be completed later, when prices, exceeding both the D-point maximum and the neckline, will be brought within a positive short-term trend, which will have increasing lows (C-E) and highs.

 

At this stage, all operators will enter the market following trend logic, i.e., waiting for a new trend to be established on the market before opening new positions.

The theoretical target of this figure is obtained by projecting upwards, from the breaking point, the distance between the central head and the neckline.

Head and Shoulders top

The head and shoulders top occurs at the end of an upward movement, and its perfection causes a downward trend reversal.

In Graphic Technical Analysis, the figure develops in this way: the upward trend brings the market to a first relative top at end A and, after a brief correction, to the top of point C (head).

 

head and shoulders top

 

From this last level begins a brief correction, ending at point D. The next rebound leads the market to a new relative top (point E), which constitutes the right shoulder.

Failure to pass the top (point B) is the first sign of weakness, triggering a new correction.

The neckline that combines the minimum of the first correction (B) with that of the second (D) then allows highlighting outstanding support, whose breakage completes the figure and causes a downward trend reversal.

The key level of this figure is the maximum at point E, which, being decreasing compared to C, shows that there has been a decrease in upward pressure on the market and a strengthening of downward pressure.

This maximum indicates that buyers are losing control of the market, while sellers are liquidating their long positions or opening short positions and anticipate the subsequent decline in prices.

The downward trend reversal will be completed at a later date when prices, falling below both the D-point and the neckline lows, will fall within a short-term negative trend.

At this stage, all operators following trend-following logic will enter the market, i.e., waiting for a new trend to emerge on the market before opening new positions (short positions), which in turn will contribute to fuelling the fall in prices.

THE CUP & HANDLE

A particular type of head and shoulder is called Cup & Handle.

 

THE CUP & HANDLE

 

The pattern consists of:

A first rounded formation of an accumulative type the cup.

A second smaller figure the handle.

 

The Cup&Handle occurs at the end of a downward movement, and its refinement causes an upward trend reversal.

The figure develops in this way: the downward trend pushes prices to a first relative minimum (point A), which begins a technical rebound that ends at point B.

 

From this level, then begins a new decline, with prices that, complicit in a decrease in volumes, do not accelerate decisively downwards and fall to a minimum (point C).

From this level, then begins a lateral accumulation process (the cup), in which volumes should gradually increase and favor a rapid recovery, which brings prices to point D.

 

The subsequent weakening leads the market to a new relative minimum (point E), which constitutes the cup handle.

By not falling below the minimum at point C, the market provides a clear demonstration of strength, which is immediately confirmed by the subsequent upturn, usually accompanied by an increase in volumes.

 

The breakout of the maximum at point D provides an upward inversion signal, usually accompanied by a sharp increase in volumes.

At this stage, all operators following trend-following logic will enter the market, i.e., waiting for a new trend to emerge on the market before opening new positions (short positions), which in turn will contribute to fuelling the fall in prices.

 

Double or Triple Bottom and Double or Triple Top

Double and triple bottoms and double and triple tops, on the other hand, are characterized by the substantial coincidence between the maximum prices and the minimum prices recorded during the development of the figure.

Double Bottom and Triple Bottom

Double or Triple bottom occurs at the end of a downward movement and causes an upward reversal of the market.

 

double bottom and triple Bottom price pattern indian stock market in Graphic Technical Analysis,

 

After a first minimum (Minimum 1), the market makes a quick technical rebound to point 2 (Maximum 2).

From this last level begins a new descent, which brings prices back to levels that coincide with the Minimum in point 1.

 

Holding this outstanding support causes an increase in the market.

It will only be the exceeding of the maximum/resistance placed in point 2 that completes the figure of double minimum and sanctioning the beginning of an upward trend.

 

The critical level is the second minimum, that is to say, the one in point 3.

The holding of the level shows that the strength decreased, and there has been an increase in upward pressure.

 

Sellers are losing control of the market, while some buyers have begun to accumulate positions, anticipating the subsequent rise in prices.

Very often, the volumes recorded during this second decline (2 > 3) are lower than the one that brought prices to level A, signaling a more moderate intensity of downward pressure.

 

From a graphical point of view, however, the upward trend reversal will only be completed by exceeding the maximum at point 2.

The theoretical projection of this figure is obtained by projecting upwards, from point 2, the distance between the same point 2 and the minima 1 and 3.

 

The refinement of a double minimum is perfected in five phases:

  • The sealing of the first minimum (Minimum 1), which occurs with high volumes and with several technical oscillators that have descended within the respective oversold areas.
  • The sealing of the second minimum (Minimum 3), which occurs with low volumes and oscillators that are bounced off the oversold areas.
  • The overcoming of the descending trendline that combines the decreasing maxima drawn during the previous downward movement.
  • I am exceeding the maximum between the two minima (Maximum 2).
  • Any pullback towards the previously exceeded maximum (Maximum 2) that from resistance becomes support.

Double Top and Triple Top

Double or triple top, in Graphic Technical Analysis, occurs at the end of an upward movement and can cause a downward reversal of the market.

After a maximum at point 1, the market retracts to the minimum at point 2, the tightness of which allows the market to move closer to the ceiling at point 1.

 

Double Top and Triple Top

 

The inability to pass this last level (Maximum 3) triggers a new correction: the failure of the minimum of point 2 completes the figure of double maximum and establishes the beginning of a downward movement.

The critical level is the second minimum, that is to say, the one in point 3. Failure to pass shows that the bulls have decreased their strength, and there has been an increase in downward pressure.

 

Very often, the rise that pushes the market to a maximum of 3 takes place with lower volumes than the previous impulse that brought the market to a maximum of 1.

Buyers, therefore, are losing control of the market, while some sellers have begun to liquidate positions or are opening short positions, to anticipate the subsequent decline in prices.

 

In Graphic Technical Analysis, however, the downward trend reversal will only be completed by the fall of the minimum to point 2.

The theoretical projection of this figure is obtained by projecting upwards, from point 2, the distance between the same point 2 and the minima 1 and 3.

 

From a graphical point of view, the refinement of a double minimum is perfected in five phases:

  • The attainment of the first maximum (Maximum 1), which occurs with high volumes, and with different technical oscillators that have been brought within the respective areas of hyper shopping.
  • The test on the second maximum (Maximum 3), which takes place with low volumes and oscillators that have come out of the overbought areas.
  • The collapse of the ascending trendline that joins the increasing minima drawn during the previous upward movement.
  • The failure of the minimum between the two maxima (Minimum 2).
  • Any pullback towards the previously yielded minimum (Minimum 2) that from the support becomes resistance.

 

While double minimums and double maximums are frequent, triple minimums and triple maximums are rare.

In the triples, prices should fall for the third time towards the static support of the lows B and C, while in the triples, prices should rise for the third time towards the resistance of the lows B and C.

This behavior can only occur if the market moves within a wide-ranging side channel.

 

Taylor Cycle

Some technical analysts have constructed some analytical methodologies that are based on the repetitive behavior followed by financial markets.

In particular, it has been observed that prices move along a short-term cycle of 3 days.

According to this theory, there would be a movement consisting of a first Buy Day, a second Sell Day, and a third Sell Short Day.

This “rule of three” is also found in other analysis techniques: for example, an ideal correction within a stable directional trend usually lasts three days; according to Elliott’s theory, there are three waves that develop within a primary pattern (1, 3 and 5).

A further application of this concept is the Three Drive to a Top/Three Drive to a Bottom pattern.

This is a popular figure, both on daily and intraday graphs, and shows how very often the market reaches a significant peak after having made three upward pushes and a substantial minimum after having suffered three downward waves.

Some analysts calculate the extent of the various movements using Fibonacci’s retracement and projection percentages.

 

Spikes

Spikes cause a sudden reversal of the trend, without any warning signs. This particular configuration is characterized by the explosion of the volume that accompanies the movement.

It is an extreme situation and, as such, rarely occurs.

 

Spikes can be of two types:

The spike bottom, in which the market is going down with strength and intensity and suddenly, very often as a result of unexpected news, turns rapidly upwards, starting a fast ascent.

 

The spike top occurs when the market, which is rising exponentially, suddenly turns downwards, starting a sharp and massive decline.

 

The spikes, therefore, cause a sudden change in the sentiment on the market:

In the spike bottom, it occurs in a situation of tension and excess pessimism, with many investors who, with the market falling vertically, liquidate their sell-off or panic selling positions out of despair.

Sudden news arrives that turns the market upside down and very often causes a short squeeze, that is, the hasty closure of short positions by those who aimed at a further decline in the market.

In the spike top, there is a situation of excessive optimism, with many investors who, despite the market being rising exponentially, enter the market betting on a further rise in prices.

Suddenly there is news that causes a downward trend reversal, with the market turning downwards: there is, therefore, a rapid and hasty closure of long positions, which fuels the fall in prices.

 

The Diamond Top and the Three Peaks and Dome House

Two new downward reversing figures, in Graphic Technical Analysis, are the Diamond Top and the Three Peaks and Dome House.

The first, although not very frequent, occurs at the end of a medium-term upward trend.

 

Diamond Top price pattern forex eurusd

 

After an absolute increase in prices, they try to stretch further and push themselves to a new high (point A).

From this last level, however, a sudden and abrupt correction begins, which brings the market (point B) below the last increasing minimum designed during the ascent.

 

In the first part of this figure, therefore, volatility is still high and signals a certain nervousness on the part of the operators.

Prices now enter the second part of this figure, which is characterized by a contraction in volatility.

The market draws a symmetrical triangle, characterized by at least a maximum decreasing (point C) and a minimum increase (point D).

 

Before prices reach the apex of this triangle, there is a sharp downward acceleration, leading to a downward trend reversal.

The second figure, on the other hand, was identified by George Lindsay and had a rather complex development.

From a graphical point of view, the market has a first upward phase, in which it draws three peaks that are substantially aligned (Three Peaks) and that therefore constitute a stable area of ​resistance.

 

Failure to pass this area causes a sharp decline, which seems to create a downward trend reversal.

In reality, this decline is a bear trap, because the market does not have the strength to continue its decline and, after building an accumulative base, prices recover quickly and stretch again upwards.

 

After a brief pause in consolidation, there is a new leap forward, which is not, however, very strong.

This second bull trap is, in fact, a bull trap: prices do not have the strength to continue their rise and suddenly turn downwards, thus establishing a dangerous downward trend.

Graphic Technical Analysis: Typical Continuation Figures

The continuation figures, in Graphic Technical Analysis, are particularly important, as they discharge, for a short period, the volatility present on the market and create the conditions for a new impulsive movement of the trend following type.

 

Triangles

Triangles are short consolidation breaks that develop within a definite upward or downward trend.

They can be identified by drawing special trendlines that combine the highs and lows that produce within the figure.

 

triangle price patter indian stock market in Graphic Technical Analysis

 

The development of the triangle is characterized by a reduction in volumes and a contraction in volatility.

 

The volumes are reduced because the market, which comes from a directional phase, takes a settling break:

If the trend is upward, the pause is generated only by physiological profit taking by those operators who had previously entered the market upwards and, satisfied with the benefits obtained, close part of their positions.

If the trend is downward, however, the pause is generated only by the closing of short positions by those operators who had previously entered the market downwards and, satisfied with the profits obtained, perform short hedges.

 

Volatility shrinks because, within the triangle, prices move in an increasingly narrow range.

This trend causes a reduction in volatility and creates the conditions for the subsequent impulsive movement.

 

From a theoretical point of view, shortly before prices reach the apex of the triangle, there will be a new breakout, with prices that will stretch decisively in the direction of the primary trend.

 

In Graphic Technical Analysis, the triangle can be of three types:

Symmetrical: it is characterized by the convergence of two trendlines, which combine respectively the decreasing maxima and the increasing minima that develop within the triangle.

Ascending: where the upper trendline is flat, while the lower trendline is climbing. The former combines substantially coincident maxima, while the latter combines increasing minima.

Descending: where the upper trendline is dropping, while the lower trendline is flat.

 

The first combines decreasing maxima, while the second combines substantially coincident minima.

The triangle is a pause for reflection that does not change the strength of the forces in the field.

For this reason, volumes must remain low and indicate that buyers still control the market.

 

An increase in volumes could be suspicious and, in some cases, could lead to a reversal of the trend.

A further element of reflection concerns the volatility compression that occurs within the triangle: to carry out a directional impulse.

The market must start from a situation of low volatility. This is the essential prerequisite for starting a new directional movement, which very often begins with rapid acceleration (for example, a breakout candle that takes the form of a Long white or a Long black). From an operational viewpoint.

 

If the market comes from a positive trend, the bullish signal is provided by the upward breakage of the upper trendline.

If the market comes from a negative trend, the downside signal is provided by the failure of the lower trendline.

 

Once the triangle is broken upwards or downwards, operators who follow the trend following logic will enter the market.

Who was waiting for a signal from the market that the consolidation pause had ended and a new directional movement began?

 

It should be noted that anticipation of the direction of the breakout can come by analyzing the volumes of the candles that make up the triangle.

High volumes in the black candles that develop within a triangle could anticipate a downward breakout.

 

On the contrary, high volumes in white candles that develop within a triangle could anticipate an upward breakout.

In these cases, therefore, the triangle could become an inversion figure.

 

Wedges

The wedge is an irregular triangle whose two sides converge with different slopes, thus taking the form of a wedge.

 

Wedges price pattern forex gbpusd

 

Its inclination is generally opposed to the direction of the trend itself:

An upward wedge rising wedge in a negative trend has downward implications.

 

A descending wedge falling wedge in a positive trend has upward implications.

The opposite inclination to the trend unites wedges to flags and is a significant difference compared to ascending and descending triangles.

 

The wedge, like the triangle, is characterized by a decrease in volumes and confirms that prices are only taking a physiological break within the primary trend.

 

Flags, pennants, and rectangles

Flags, pennants, and boxes are also short consolidation breaks, which occur on the market after the latter has made a strong directional movement.

 

Flags

Flags are short-term movements, delimited by two parallel trendlines that have an inclination opposite to the previous trend.

In an upward trend, bull-flag is negatively inclined.

 

Flag chart pattern indian stock market Graphic Technical Analysis

 

Prices, after a quick upturn, undergo a correction with decreasing volumes, indicating that the decline is triggered only by physiological profit-taking.

When prices exceed the top trendline of the flag, a new bullish signal is provided.

 

In a bear-flag downward trend, it is positively inclined.

Prices, which have suffered a sharp decline, make a rapid technical rebound with decreasing volumes, indicating that the recovery is triggered only by the closure of short positions.

 

When prices yield the lower trendline of the flag, a new downward signal is provided.

Two converging trendlines bound pennants and their development are very similar to that of symmetrical triangles.

 

The difference between the two figures depends on the time horizon: the pennants have a faster development than that of the triangles.

They are short settling breaks that the market takes after a rapid upward acceleration or after a sharp downward surge.

Rectangles

The rectangles are characterized by a lateral trend, with the prices moving in a trading range bounded by two horizontal trendlines.

The upper horizontal trendline acts as static resistance, while the lower horizontal trendline acts as static support.

 

rectangle chart pattern

 

It is the classic lateral consolidation movement, in which there is a substantial balance between buyer strength and seller strength.

 

It is important to note that, within this figure, the volumes must be contained and indicate that:

If the market comes from an upward movement, a physiological settling pause is occurring, in which buyers have reduced their consistency. Still, there is a lack of downward pressure that can trigger a decrease in absolute consistency.

 

If the market comes from a downward movement, there is a settling pause, in which the sellers have reduced their consistency.

Still, there is no upward pressure that can trigger a recovery of absolute consistency. An increase in volumes within the rectangle could instead highlight the presence of a phase of distribution or accumulation.

 

This scenario, creating the conditions for a possible reversal of the trend.

 

Flags, pennants, and rectangles indicate that the market, which comes from a directional phase, is pausing for reflection, triggered by physiological profit-taking.

It has been highlighted that volumes must remain low and confirm that the market is still controlled by one of the two forces on the ground.

 

Flags, pennants, and rectangles, as well as triangles, also cause a contraction in volatility, an indispensable prerequisite for further directional movement.

This new impulse starts very often with an acceleration bar, which signals the resumption of the primary trend.

 

If the market comes from a positive direction, the bullish signal will be provided by the upward breakage of the upper trendline, which combines the highs that have developed within the various figures.

If the market comes from a negative trend, the downside signal is provided by the collapse of the lower trendline.

 

 

 

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My name is Luca. I grew up in Italy. I have a degree in law and I’m an independent trader since 2007. I’m a systematic trader and sometimes, I trade using options strategies with US ETFs and Stocks.I have built hundreds of automated trading systems and indicators for TradeStation, MultiCharts and MetaTrader.I started this blog in 2017 to share what I learned in the financial market.

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