Most traders conduct technical analysis by looking for chart patterns and employing technical indicators. Technical indicators are statistical tools for assessing price fluctuations and the momentum that underpins them. On the other hand, chart patterns are frequently used to gauge market sentiment at specific price points. Traders can employ these patterns to predict future price movements, but they should always be used together with indicators and other types of analysis.
What are chart patterns?
Chart patterns are essentially recognizable patterns on a price chart. These patterns pop out of the page once you draw trend lines on a price chart. These trend lines act as psychological limits. Trendlines on which prices have reacted severally in the past make for the most valid patterns. Similarly, when you notice a spike in volume as price approaches a trendline, it shows the trendline is valid and is likely to hold.
Popular chart formations in crypto
1. Head and shoulders pattern
This is an easy-to-spot pattern that requires no complex indicators to point out. It manifests as three peaks occurring nearby. The first and third peaks will typically be lower than the middle peak. These two peaks form the left and right shoulders, respectively. The middle peak, which is the highest of them all, is referred to as the head. The troughs between these shoulders and the head form the neckline.
Usually, a head and shoulders pattern points to a trend reversal in the works. Typically, upon spotting the pattern, most traders tend to place their stop losses just above the pattern’s head. Take profit levels are placed at a point below the neckline equidistant to the uppermost tip of the head.
In the example above, we see a typical head and shoulders pattern in a daily ETHUSD chart. Following the pattern, the prevalent bullish run turned bearish.
2. Double top and double bottom pattern
When prices in an uptrend reach a swing high, then drop to form a trough before returning to the uptrend to hit close to the previous swing high, a double top pattern is produced. This is usually a bearish indicator. Prices generally begin a negative trend after the second high. The pattern is verified when candlesticks close below the trough between the two tops, necessitating the opening of short positions.
A double bottom pattern is a polar opposite. Prices will establish a swing low on a downtrend, then begin a small upswing to form a high before returning to the downtrend. The second decline usually ends in a trough that is close to the preceding swing low. Prices then reverse to form an uptrend, which is confirmed when candlesticks close above the peak between the two bottoms.
In the example above, we see a double top pattern manifest in a daily BTCUSD chart, after which the prevailing bullish trend was reversed into a downtrend.
3. Rising and falling wedges
Rising wedges manifest as candlestick highs and lows both form a rising slope. Typically, the slope of the lows will be steeper than that of the highs so that the two slopes can eventually converge at a point. Falling wedges, on the other hand, are when both highs and lows form declining slopes. In falling wedges, the slope of the highs will usually be steeper so that it converges with the slope of the lows at a later point.
Usually, the way to trade a rising or falling wedge is to wait for the breakout. Prices could break out in any direction, and once they do, they tend to embark on long trends. On most occasions, prices will break out in the direction of the wedge, but this is not always the case.
In the example above, we see a rising wedge in the ETHUSD daily chart, after which prices broke out downwards.
4. Ascending and descending triangles
These triangle patterns usually point to a trend continuation. An ascending triangle is formed by joining swing highs using a horizontal trendline, which acts as resistance. Swing lows are joined using a diagonal trendline that acts as support. This support trendline usually converges with the horizontal resistance to form a triangle. Ultimately, prices break through the resistance to carry on the bullish trend.
A descending triangle is formed during a downtrend. Swing lows are joined using a horizontal trendline that provides support. The swing highs are joined by a sloping trendline, which acts as resistance. Soon, prices break out of their support and decline further, signifying the continuation of the downtrend.
The example above shows a descending triangle pattern on an ETHUSD daily chart. You can see how prices broke past the support to continue the downtrend.
5. Price channels
Price channels are patterns formed by connecting swing highs and swing lows with two parallel trendlines. These trendlines act as support and resistance as the price fluctuates between them for prolonged periods of time.
During such periods, traders may choose to buy low and sell high whenever prices approach these trendlines. Alternatively, they may open a trade in the direction of the prevailing trend and wait for a breakout. Prices may break out from this pattern in either direction.
In the above example, Ethereum prices were held in a channel for more than two months, during which there was a false downward breakout that was attempted. Eventually, prices broke out upwards in early July.
Traders and analysts rely on technical analysis to forecast crypto price moves. Chart patterns are one among many components of technical analysis. Chart patterns in crypto trading number in hundreds, but we have narrowed it down to the top five. For optimal results, traders should combine these patterns with other methods of analysis.