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How To Read Advanced Stock Charts and Trading Patterns

How To Read Advanced Stock Charts and Trading Patterns

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Advanced Chart Analysis

Successful stock market investments are based on a thorough analysis of a multitude of
factors. While staying in touch with the news and happenings in the market is
quintessential, examining other important aspects and data is also important. This can be
done by reading charts and understanding their visual cues.

However, it is not as easy as reading the news.

In order to conduct a technical analysis, you need to understand trendlines, patterns, and
much more. You already read about the basics of chart analysis in the previous chapter;
now, in this chapter, we will delve deeper.

Analysing Chart Patterns

It's a fundamental understanding that no trend in the market is perpetual. After following
prolonged, medium, or shorter-duration uptrends or downtrends, the market frequently
undergoes reversals and initiates a movement in the opposite direction of the preceding
one.

During these market transitions, well-defined geometric patterns often emerge on charts.
These serve as reliable indicators of potential price reversals.

Patterns play a crucial role in technical analysis and help traders identify potential trend
reversals or continuations. Various patterns can be observed on price charts, providing
valuable insights into market sentiment.

Trend Reversal Patterns

Trend reversal patterns are chart patterns that suggest a potential change in the prevailing
direction of a financial market's trend. These patterns often emerge after a prolonged move
in one direction and signal a potential shift in sentiment and price direction. Traders and
analysts use these patterns to identify potential entry or exit points in the market. Let's look
at some important trend reversal patterns:

Head and Shoulders:

The Head and Shoulders pattern signifies a bearish reversal pattern that manifests
following an uptrend. This pattern comprises three consecutive peaks, with the
central peak positioned higher than the other two. The middle peak is termed the
"head," while the two flanking peaks are called the "shoulders." The neckline is formed
by connecting the intermediate troughs.

A potential short trade is typically initiated upon a decisive break below the neckline, with a
recommended stop-loss placed above the highest point of the nearest shoulder. The
projected target often equals the distance between the neckline and head, extrapolated
from the breakpoint.

A crucial factor in confirming the strength of the reversal is the volume in the downward
movement of the right shoulder. If the volume is substantial during the decline and the
break occurs with elevated volume, it enhances the conviction for the reversal.

Inverse Head and Shoulders:

It is the opposite of Head and Shoulders and signals a potential reversal of a
downtrend.
This pattern is characterised by three troughs, with the middle trough, or head, being lower
than the two flanking shoulders. The pattern is considered complete when the price breaks
above the neckline.

This formation is generally interpreted as bullish, indicating the possibility of an upward

market trend.

In the above example, you can see the left shoulder, head and right shoulder of a stock
chart.

Continuation Patterns
Continuation patterns suggest a temporary consolidation or pause in an ongoing trend
before the prevailing price movement is likely to resume. Unlike reversal patterns, which
indicate a potential change in trend direction, continuation patterns imply that the existing
trend will likely continue after a brief consolidation or sideways movement. Traders often
use these patterns to anticipate the continuation of an established trend and make
decisions about entering or maintaining positions.

Following are some significant continuation patterns:

Flag Pattern:
It is characterised by an initial strong price movement, often called the flagpole,
followed by a rectangular flag-shaped consolidation. The breakout from this
consolidation typically occurs in the direction of the preceding trend. It offers traders
valuable insights for making informed decisions in the market.

A typical flag pattern is illustrated above.

Pennant Pattern:
The Pennant Pattern is like a flag but with converging trendlines. It forms a small
consolidation after a strong price movement and usually leads to a breakout in the
direction of the existing trend.

Triangle Pattern:
Triangles are widely recognised chart patterns in technical analysis, and they are of
three main types: the symmetrical triangle, ascending triangle, and descending
triangle.

These patterns, constructed differently and carrying distinct implications, typically persist
for several weeks to months, ideally over 12 weeks.

Triangles emerge as consolidation zones following a trending move and are commonly
viewed as continuation patterns which signify a resumption of the prior trend after a
breakout. However, in specific instances, they may act as reversal patterns. These patterns
can manifest in both uptrends and downtrends.

Wedge​Pattern:
It forms when the price consolidates between converging trendlines, creating a
pattern that resembles a wedge. There are two main types of wedges:

Rising Wedge:
It occurs during an uptrend. The price consolidates between two upward trend lines,
creating a narrowing pattern. Despite the upward trend, the rising wedge signals
potential weakness. It suggests that the upward momentum is slowing down, and a
trend reversal or a significant correction is possible.

Falling Wedge:

It occurs during a downtrend. The price consolidates between two trend lines that
slope downward, forming a narrowing pattern. In the context of a downtrend, the
falling wedge indicates a potential bullish reversal. It suggests that selling pressure is
decreasing, and there might be a shift towards a new uptrend.

Candlestick Patterns

Candlestick charts provide insights into short-term price movements and market
psychology.

Doji:
A Doji represents indecision in the market. It is characterised by equal opening and
closing prices, creating a small or non-existent body. The Doji indicates a potential
reversal or continuation, depending on the surrounding candles.

Hammer:

The Hammer is a single candlestick bullish reversal pattern occurring after a

prolonged downtrend. It ideally involves a gap-down opening where bears attempt to
push the price lower. Bulls overpower bears, causing the price to close near the
opening with a small body, a substantially lower shadow (at least twice the length of
the body), and a negligible upper shadow. A green-coloured body signals more bullish
strength. Confirmation occurs with a gap-up opening or the price exceeding the
hammer's high within the next few days. A valid hammer, without confirmation, lacks
significance. A buy trade can be considered if the price surpasses the hammer's high,
with a stop loss below its low.
 Inverted Hammer:

The Inverted Hammer is a single candlestick pattern that typically occurs after a
downtrend and signals a potential bullish reversal. It has a small real body near the low
of the candle. The upper shadow is long, at least twice the length of the body. The
lower shadow is very short or non-existent.

The Inverted Hammer suggests that bears initially took control but were later overpowered
by bulls. The resulting candle should have a small body, red or green, the upper wick should
be at least twice the candle's body, and the lower shadow should be small or negligible. If
the body is green, it is relatively more bullish than red.
 Hanging Man:

The Hanging Man is a bearish reversal pattern characterised by a single candlestick. It

emerges following a sustained upward movement and shares similarities with the
Hammer pattern, with the key distinction being its occurrence at the conclusion of an
uptrend. The features of the Hanging Man pattern include a small body at the upper
part (either red or green) and a lower shadow that is at least twice the length of the
body, accompanied by a very small or nonexistent upper shadow. The bearish
sentiment intensifies if the body is red.

Confirmation of the Hanging Man pattern occurs when the price descends below the
candle's low. Upon confirmation, traders might initiate a short trade, placing a stop-loss
above the candle's high. It's noteworthy that the Hanging Man is the bearish counterpart of
the Bullish Inverted Hammer.
Shooting Star:

A Shooting Star is the reverse image of a hammer candle. Bulls initially drive the price
higher, but bears take control later, resulting in a candle with a small body, a
significant upper shadow and a minimal or negligible lower shadow.

Engulfing Patterns:

Bullish Engulfing:

The Bullish Engulfing pattern occurs during a downtrend. It consists of two

candlesticks. The first one is a smaller bearish (red) candle, followed by a larger
 bullish (green) candle that engulfs the entire body of the previous candle. This
pattern suggests a shift in market sentiment from bearish to bullish. The large
bullish candle signals that buyers have overwhelmed sellers, leading to a
potential reversal in the downtrend.

Bearish Engulfing:
The Bearish Engulfing pattern unfolds in an uptrend. Similar to its bullish
counterpart, it comprises two candlesticks. The first one is a smaller bullish
(green) candle, followed by a larger bearish (red) candle that engulfs the entire
body of the previous candle. This pattern indicates a reversal of the prevailing
uptrend. The substantial bearish candle reflects a takeover by sellers and signals
a potential shift from bullish to bearish sentiment.

Using Multiple Charts on the Screen

Using multiple charts simultaneously allows traders to compare different datasets or view
the same asset across various time frames. You can choose multi-chart layouts as these
allow you to monitor multiple markets or strategies simultaneously. This feature is
especially useful for conducting a comparative analysis, managing multiple trades, or
performing multi-timeframe analysis. It enables you to gain a comprehensive view of
market conditions.

How To Use Multi Charts on Angel One?

Open the chart of a particular asset on the Angel One website.

Simply click on the multi-charts icon to the left of ‘Save’.

Click on each of the sub-charts and choose the asset from the Watchlist.

You can also standardise certain variables such as interval, time, symbol, etc., across the
charts.

Tracking Orders from Charts

Placing and tracking orders directly from charts enhances the trading experience by
allowing you to set entry and exit points visually. Using this functionality, you can drag-
and-drop order levels on the chart, adjust stop losses and take profits visually. You can also
see pending and executed orders overlaid on the price action. This lets you make quick
decisions based on chart patterns and market movements.

Using Technical Indicators

Once you have a detailed view of charts, the next step is to delve deeper into technical
analysis. Technical indicators are very important for this process. These analytical tools
offer valuable insights into market behaviour and help traders identify trends, momentum
changes, and potential price movements.

Utilising technical indicators simplifies price information, offers trend signals, and signals
potential reversals. These strategies are adaptable across various time frames, and their
parameters can be customised to align with each trader's specific preferences.

There are two fundamental types of indicators used:

Overlays:
Overlays use the same scale as prices, appearing on the stock chart alongside price
movements. They provide insights into trends and potential reversal points by
overlaying on price charts. Moving averages, Bollinger Bands, and Fibonacci lines are
some examples of Overlays.

Oscillators:
Oscillators, in contrast, oscillate between a local minimum and maximum and are
plotted above or below a price chart. They offer indications of overbought or oversold
conditions, aiding in spotting potential reversals. Stochastic oscillators and RSI are
the most commonly used indicators.

Looking for Divergence

Divergence refers to the situation when the price movement of an asset deviates from the
movement of technical indicators. It can provide important signals about the strength of a
trend or the potential for a reversal.

Positive Divergence:

Occurs when the price forms lower lows, but the indicator (e.g., RSI or
MACD) forms higher lows.

Suggests that while prices are moving lower, the momentum behind the
decline is weakening.

Potential indication of a forthcoming reversal or a slowdown in the

downtrend.

Negative Divergence:

Occurs when the price creates higher highs, but the indicator forms lower highs.

This indicates that although prices are rising, momentum is decreasing.

 It may signal a potential reversal or a weakening uptrend.

Observing divergence can be a valuable tool for traders to anticipate changes in market
sentiment and potential shifts in price direction. It's important to use divergence analysis
with other technical and fundamental factors for a more comprehensive understanding of
the market conditions.

Analysing Volume
Volume is another critical aspect of technical analysis. Incorporating volume analysis into
stock chart reading provides valuable insights into the strength and sustainability of price
movements. Traders and investors can use volume patterns to make more informed
decisions and validate the reliability of identified trends.

Volume refers to the number of shares or contracts traded in a security during a specific
period. It is usually displayed as vertical bars at the bottom of a price chart, with each bar
corresponding to the volume for a given period.

A Volume Surge is a significant increase in volume that often accompanies notable price
movements and indicates increased market interest. On the other hand, a volume downturn
is the decrease in volume during a price change. It may suggest weakening interest and
potential reversals.

An important point regarding volume is that traded volume in absolute terms, has no
significance. When we talk about higher or lower volume, it is relative to average volume
over certain periods.

Learning price volume analysis involves understanding how the price movement of a
financial asset is related to the volume of trades. The following table shows their
correlation.

Price Volume Interpretation

↗Increases ↗ Increases Uptrend may go a greater distance. Look for long entries

↘
↗Increases Uptrend not supported by Volume. Exit a long position.
Decreases

Decreases ↗ Increases Downtrend supported by volume. Look for short entries

A downtrend is not supported by the volume. Exit short

↘Decreases ↘Decreases
entry upon further sign of reversal

Wrapping up
Technical indicators and other tools add valuable insights to chart analysis. Successful
chart reading requires technical skills, strategic thinking, and staying updated on market
changes. Our next chapter will explore support and resistance in detail to aid this further.

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