Trading - Chart Patterns and Indicators | Quizlet

Pattern (5 criteria)

• A pattern is bounded by at least two trend lines (straight or curved)

• All patterns have a combination of entry and exit points

• Patterns can be continuation patterns or reversal patterns

• Patterns are fractal, meaning that they can be seen in any charting

period (weekly, daily, minute, etc.)

• A pattern is not complete or activated until an actual breakout occurs

4 Techniques for Trading Patterns

Breakouts, Entry Stops, Protective Stops, Retracements

Breakout

Violation of a Trend Line, Support or Resistance, or previous reversal point

5 Confirmation filters to determine whether a breakout has taken place

Intrabar, Multiple Closes, Time, Percentage or Point, Money

Intrabar

An intrabar confirmation filter requires price to move a specified distance beyond the breakout level during the bar before the breakout is considered valid.

Example: Resistance is at 20,000 on NQ. Instead of buying the instant price trades at 20,001, you require a 5-point intrabar filter. You enter only if price reaches 20,005 during that bar.

In short: breakout level + required additional movement = confirmed breakout.

Unlike a closing-price filter, you don't need to wait for the bar to close—the confirmation happens intrabar.

Multiple Closes

A multiple-closes confirmation filter requires price to close beyond the breakout level for a specified number of consecutive bars before the breakout is considered valid.

Example: Resistance is at 20,000 and you require 2 closes above resistance:

Bar 1 closes at 20,006 → first confirmation.

Bar 2 closes at 20,012 → second confirmation.

Breakout is now confirmed.

This is more conservative than an intrabar filter because it helps filter out brief moves beyond support/resistance that quickly reverse.

Time

A time confirmation filter requires price to remain beyond the breakout level for a specified amount of time before the breakout is considered valid.

Example: Resistance is at 20,000, with a 5-minute time filter. Price breaks above 20,000 at 10:00 AM and must remain above it until 10:05 AM before the breakout is confirmed.

In short: the longer price holds beyond the level, the more confirmation you have that the breakout is genuine.

Percentage or Point

A percentage or point confirmation filter requires price to move a specified distance beyond the breakout level before the breakout is considered valid.

Example — point filter: Resistance = 20,000, filter = 10 points → breakout confirmed at 20,010.

Example — percentage filter: Resistance = 20,000, filter = 0.1% → breakout confirmed at 20,020.

So instead of entering immediately when resistance is breached, you require an additional X points or X% of movement first.

This is closely related to an intrabar filter; the distinction is that point/percentage describes how the confirmation threshold is measured, while intrabar describes when it can be confirmed (before the bar closes).

Money

A money confirmation filter requires the breakout to move a specified dollar value per contract/share beyond the breakout level before it is considered confirmed.

Example: You require a $100 money filter on one NQ futures contract. Since NQ is $20 per point, $100 corresponds to 5 points.

Resistance = 20,000 → breakout confirmed at 20,005.

So it's essentially a point filter expressed in monetary terms, taking the instrument's dollar value per point into account.

Entry Stops

Buy stop orders are used to

enter trades once the price

breaks out.

False Breakout

Price breaks out but almost

immediately returns back

through its breakout price.

Failed Breakout (Trap)

False breakout occurs and

the price then breaks out in

the opposite direction.

Protective Stops and Types of Placement

Determines the amount of

capital risk before entry and protects capital. Types of placement include Filters, such as percent,

points, or money; Trend line, support or

resistance level with filter

4 Steps for Trading False Breakouts Using Protective Stops

1. Enter on breakout

2. Place protective stop

outside breakout bar

opposite from breakout

direction

3. Place entry stop at same

level (called a "stop and

reverse" order)

4. If price continues in

direction of breakout, profit

from breakout entry; if breakout is false, profit

from stop and reverse

2 Types of Retracements (Counter Trend Correction)

1. Pullback (on breakout down)

2. Throwback (on breakout up)

3 Categories of Multi-Bar Patterns

1. Horizontal Congestion 2. Triangles 3. Other

Common Horizontal Congestion Patterns

Double and Triple

Tops/Bottoms, Rectangles

Common Triangle Patterns

Symmetrical, Ascending and Descending, Wedges

Common Other Patterns

Head and Shoulders, Cup and Handle

6 Common Candlestick Patterns

1. Doji

2. Harami

3. Hanging Man/Hammer

4. Shooting Star/Inverted Hammer

5. Engulfing

6. Dark Cloud/Piercing

4 Common Short-Term Patterns

1. Pennant/Flag

2. Gaps

3. Pipe Bottom

4. Narrow Range

3 Characteristics of the Double Top

1. Two successive peaks separated

by an opposite reversal point

2. Either rounded or pointed peaks

that are usually at roughly the same

price (resistance level)

3. Price must break out of middle

reversal point

How to Calculate Price Target for the Double Top

Take the height from the highest peak to the trough and

then subtracting the amount from the breakout price to the

downside.

3 Characteristics of the Double Bottom

1. Two successive troughs separated

by a peak

2. Either rounded or pointed troughs

that are usually at roughly the same

price (support level)

3. Price must break out of

middle peak

How to Calculate Price Target for the Double Bottom

Take the distance from the troughs to the peak and then

adding that amount from the breakout price to the upside.

2 Characteristics of the Triple Top

1. Three distinct peaks at roughly the

same price level separated by two

intermittent troughs

2. Breakout occurs when price exceeds

the extreme of the intermittent

trough or a trend line connecting

those points; there is often a pullback to retest the troughs

How to Calculate Price Target for the Triple Top

Take the height from the highest peak to the lowest trough

in the pattern. Then subtract that amount from the lowest

trough in the pattern to generate a price target.

4 Characteristics of the Triple Bottom

1. Three distinct troughs at roughly the

same price level separated by two

intermittent peaks at any level

2. Breakout occurs when price exceeds

the extreme of the intermittent peaks

or a trend line connecting those

points; throwback often occurs to retest the peaks

3. Best performance may be after a

sustained decline*

4. An average performance, but watch

for failures*

How to Calculate Price Target for the Triple Bottom

Take the height from the highest peak to the lowest trough

in the pattern. Then add that amount to the highest peak in

the pattern to generate a price target.

5 Characteristics of Rectangles

1. Trading range with support and

resistance levels bounding price

action

2. Slight tilt, similar to horizontal

channel

3. Often has many false breakouts*

4. Things to consider:

‐ Confirm a breakout

‐ "Shortfall" often indicator of eventual

breakout direction

5. Best occurrence may be bottom

breaking upward*

How to Calculate Price Target for the Rectangle

Take the height from the resistance line to the support line. Then either add that amount to the resistance line to generate a price target for an upside breakout, OR subtract that amount from the support line to generate a price target for a downside breakout.

4 Characteristics of the Symmetrical Triangle

1. Bounded by a downward sloping

upper trend line and an upward

sloping lower trend line. Each bound

is a straight trend line

2. Prices must touch each bound at

least twice. Many false breakouts.

Moderately successful in

performance

3. Things to consider:

‐ Confirm a breakout

4. Best occurrence may be upward

breaking out - above average for

all patterns*

How to Calculate Price Target for the Symmetrical Triangle

Take the height from the highest peak in the pattern to the

lowest trough in the pattern. Then either add it (for upward

breakouts) to the breakout price or subtract it (for downward

breakouts) from the breakout price to generate a price target.

4 Characteristics of the Ascending Triangle

1. Bounded by a horizontal upper trend

line and an upward sloping lower

trend line. Each bound is a straight

trend line

2. Prices can break in either direction,

but more commonly upward*; often a throwback/pullback

3. Breakout usually occurs in pattern.

About average failure rates but many

small false breakouts*

4. Post breakout performance average

on upside but above average on

downside*

How to Calculate Price Target for the Ascending Triangle

Take the height from the highest peak in the pattern to the

lowest trough in the pattern. Then either add it (for upward

breakouts) to the breakout price or subtract it (for downward

breakouts) from the breakout price to generate a price target.

3 Characteristics of the Descending Triangle

1. Bounded by two trend lines; the

lower is horizontal and the upper

slopes downward

2. Prices can break in either direction

but most commonly downward*

3. Above-average performance on

upside break; retracements occur

often*

How to Calculate Price Target for the Descending Triangle

Take the height from the highest peak in the pattern to the

lowest trough in the pattern. Then either add it (for upward

breakouts) to the breakout price or subtract it (for downward

breakouts) from the breakout price to generate a price target.

3 Characteristics of the Wedge

1. Bounded by two trend lines, each

headed in the same direction; Price

must touch a trend line at least five

times (3 times on one and 2 times on

the other) before a breakout; a pullback often occurs

2. Often occur following a panic

(declining wedge) or bubble

(rising wedge)

3. Performance in both types is below

average, and retracements are

very common*

How to Calculate Price Target for the Wedge

For downward breakout, the lowest trough in the pattern is the price target. For upward breakouts, take the height from the highest peak in the pattern to the lowest trough in the pattern and add that amount to the breakout price for a price target.

6 Characteristics of Head and Shoulders Top

1. Three peaks with center peak higher

than the other two

2. Shoulders should be at approximately

the same level and the head higher

3. Line connecting the two throughs

between the peaks is called

the "neckline"

4. Pattern is only complete on breaking

the neckline

5. Target is the distance from the head to

the neckline projected from the neckline

6. This is a standard pattern for tops and

has one of the lowest failure rates

Head and Shoulders Bottom

Inverted but otherwise

identical to a top pattern, except not as profitable

4 Characteristics of a Cup and Handle (Saucer)

1. Pattern consists of a rounded bottom

(not a "V" bottom), two "lips" at each

end, and a "handle" (similar to a flag

pattern) from the handle

2. Pattern is complete with breakout

above both lips

3. Often have a throwback

4. The pattern's performance ranks

about average for bottom patterns*

How to Calculate Price Target for the Cup and Handle

Take the height of the right cup lip to the bottom of the

cup, then add that amount to the breakout price.

3 Best Multi-Bar Patterns for Generating Upward Signals

1. Descending Triangle 2. Rectangle 3. Pipe Bottom

3 Best Multi-Bar Patterns for Generating Downward Signals

1. Flag 2. Head and Shoulders Top 3. Island Reversal

Pipe Bottom (4 Points)

A Pipe Bottom is a bullish reversal pattern consisting of two consecutive, prominent downward price spikes that bottom at approximately the same price level, typically on a weekly chart.

Example: A stock falls sharply and makes a weekly low at $50. The following week it falls sharply again but bottoms around $50.25, then reverses upward. The two similar lows form the "pipes."

Basic idea: sharp low → second similar sharp low → reversal upward.

It resembles a double bottom, but the two bottoms occur very close together—usually on adjacent bars—and are sharp rather than rounded.

Island Reversal (5 Points)

An Island Reversal is a reversal pattern where a group of price bars becomes isolated from the surrounding price action by gaps on both sides.

Bullish example: Price is falling → gaps down → trades for several bars at the lower level → then gaps up, leaving those bars isolated as an "island."

Bearish example: Price is rising → gaps up → trades for several bars → then gaps down.

Visually: Bullish: decline → ↓ gap → [island] → ↑ gap → rally

The key feature is that the two gaps overlap in price, so the island is separated from the price action before and after it.

3 Characteristics of the Candlestick

1. Traditionally, candlestick patterns are reversal patterns, meaning they

are used to identify when a trend is ending

2. Candlestick patterns are often used with longer-term trends, thus,

upward reversal patterns after a correction in a longer upward trend

show the best performance, and vice versa for downward reversal

patterns in a long downward trend

3. Be careful not to act on a perceived candle pattern until the pattern

has formed and is activated by a breakout in a certain direction

3 Characteristics of the Doji

1. A one-candle pattern formed when the open

and close are the same price, and the high

and low are roughly equidistant from the open

and close

2. Extremely common

3. Indicates indecision in the marketplace and

thus is a possible warning of price change

3 Characteristics of the Harami

1. A two-candle pattern of a large body of either

color followed by a small body of the opposite

color (Top: small black candle within large white candle; Bottom: small white candle within large black candle)

The second body is completely within

the body of the large body and is called a

"spinning top"

2. Although common belief is that the harami is

a reversal pattern, many report that is has the

potential of breaking either way

3. A variation that has a doji instead of a spinning

top as the second candle has equally average

performance and random breakout*

4 Characteristics of the Hanging Man and Hammer

1. One-candle patterns differentiated by the color

of the body. Each pattern has a high that

coincides with either the opening or closing

price

2. Hanging man, thought to be a continuation

pattern, actually breaks in either direction

randomly with a slight upward bias. Its overall

performance is below average*

3. Hammers occur relatively frequently but have

below-average performance*

4. Hanging Men often occur at the top of a trend and are often black; hammers occur at the bottom of a trend and are always white

3 Characteristics of the Shooting Star and Inverted Hammer

A one-candle inverted hanging man or hammer

pattern. Hammers by themselves have white

bodies and shooting stars have black bodies

• As a one-candle pattern, the shooting star has

average performance. The same is true for the

single inverted hammer*

3. Inverted hammers occur at the top of a trend and are often black; inverted hammers occur at the bottom of a pattern and are usually white

2 Characteristics of Engulfing

1. A two-bar pattern in which the second bar

body completely engulfs the first bar body; top: small white candle that is then engulfed by large black candle; bottom: small black candle that is then engulfed by large white candle

2. A bottom engulfing pattern, with a short black

body followed by a tall white body, is thought

to be an upward reversal pattern and actually

has very good performance on a downward

breakout in a downward trend

4 Characteristics of the Dark Cloud Cover and Piercing Line

1. The dark cloud cover is a two-bar pattern where

the second bar closes higher than the first and

is black versus white in the first bar; top: white candle then black; bottom: black candle then white

2. The piercing line is the opposite of the dark

cloud cover in that the second bar is white and

lower than the first bar which is black

3. The dark cloud is thought to be a downward

reversing pattern

4. The piercing line pattern is thought to be an

upward reversing pattern*

3 Characteristics of the Pennant/Flag

1. Pennant and flag patterns are

variations of the same pattern

2. These patterns are often preceded by

a steep, sharp price change, up or

down, and form a short consolidation

that appears like a triangle or flag.

Generally, the pattern slopes slightly

in the direction opposite from the

trend

3. The breakout in either direction is

often followed by a move that equals

the earlier steep, sharp price change

into the pattern

How to Calculate Target Price for the Pennant/Flag

Take the height from the start of the "flag pole" to the

highest peak in the pennant. Add that amount to the

bottom of the pennant for an upward price target.

8 Characteristics of Gaps

1. Definition - no trading (gap)

at specific prices

2. Gaps can be considered

"up" or "down"

3. Gaps are caused by

appreciable changes

in supply and demand

from one close to the

following open

4. Gaps are generally profitable on

breakouts from patterns, trends,

support or resistance

5. A method of trading a gap is the

"explosion gap pivot." It assures

that the gap is valid

6. After the gap, wait for

"throwback." If throwback "covers"

the gap, no action. If the

throwback stops, this is called the

"pivot low." Place buy entry above

high of the gap bar

7. "Pivot" is the lowest level of the

post-gap breakout

8. Protective stops initially placed at

gap low and then below pivot low

3 Characteristics of the Two-Bar Reversal Button or Pipe Bottom

1. Two bars and occurs at the end of a large

trend, up or down trend. Ideally, the first bar,

in a bottom pattern, closes at the low, and the

second bar closes in the upper half of the range.

It is more reliable in weekly data

2. Bar ranges are larger than preceding

bar ranges

3. Action occurs on breakout through second bar

How to Calculate Price Target for the Two-Bar Reversal Button or Pipe Bottom

Take the height from the taller of the two bars to the lower

of the two bars. Add that amount to the taller of the two

bars to get a price target.

5 Characteristics of Volatility Patterns

1. Dull activity is known as "low volatility." New

trends often begin from periods of low volatility

2. One way to look at volatility is to observe the

relationship between price bars

3. "Range" is the spread between high and low in

a price bar

4. If a bar is followed by a bar with less range,

volatility is declining; the second bar is called a

"narrow range" bar

5. When this second bar's range is contained

within the range of its preceding bar, it is called

an "inside bar."

3 Characteristics of Narrow Range

1. One low volatility pattern is called a "Narrow

Range" pattern and consists of a bar with a

range narrower than its preceding bars

2. The graph shows a four-bar, Narrow Range

pattern (NR4) with four bars, the fourth bar

having a narrower range than the preceding

three bars

3. The breakout occurs on a break above or below

the high or low of the narrow range

Technical Indicator Definition

A mathematical calculation based on historic price or volume.

5 Types of Technical Indicators

1. Trend Indicators 2. Momentum Indicators 3. Volume Indicators 4. Volatility Indicators 5. Support and Resistance Indicator

Simple Moving Average (TI) Definition

SMA is the easiest moving

average to construct. It is

calculated as the average price

over the specified period. The

average is called "moving"

because it is plotted on the

chart bar by bar, forming a line

that moves along the chart as

the average value changes.

Determining a Trend Direction with SMA (2 Points)

1. If the SMA is positively sloping, the trend is up.

2. If the SMA is negatively sloping, the trend is down.

Determining Trend Duration with SMA (3 Points)

1. 200-bar SMAs are common proxies for long-term trends.

2. 50-bar SMAs are typically used to gauge intermediate trends.

3. Shorter-period SMAs can be used to determine short-term trends.

Determining Trading Signals via price crosses with SMA (2 Points)

1. When prices cross above the SMA, you may want to go long or cover short.

2. When prices cross below the SMA, you may want to go short or exit long.

Cover Short Definition

Buy back shares that were previously borrowed or sold short

Exit Long Definition

Sell a stock you previously purchased

Using Moving Average Crossovers to Generate Trading Signals (2 Points)

1. When a more sensitive

(faster) SMA crosses

above a less sensitive

(slower) SMA from below,

it is considered bullish.

2. When a more sensitive

(faster) SMA crosses

below a less sensitive

(slower) SMA from above,

it is considered bearish.

Exponential Moving Average (TI) Definition

The EMA measures trend

direction over a period of time.

It applies more weight to data

that is more current. Because of

its unique calculation, EMA will

follow prices more closely than

a corresponding SMA.

Identifying Trends Earlier with EMA (1 Point)

Use the same rules that apply to SMAs when interpreting EMAs. Keep in mind that EMAs are generally more sensitive to nearer-term price movement.

Determining Trend Direction with EMA (1 Point)

When the EMA rises, you may want to consider buying when prices dip near or just below the EMA. When the EMA falls, you may consider selling when prices rally toward or just above the EMA.

Indicating Support and Resistance Areas with EMA

A rising EMA tends to support the price action, while a falling EMA tends to provide resistance to price action.

How Does EMA React to Pullback and Subsequent Rallies vs. SMA

It reacts faster to pullbacks and subsequent rallies than SMA; A 30-day chart is a good way to see examples of this

Moving Average Convergence/Divergence (TI) Definition

MACD is a momentum oscillator primarily used to trade trends.

How is the MACD line Calculated?

MACD is calculated by subtracting the 26-period EMA from the 12-period EMA.

How is the MACD Signal Line Calculated?

The signal line is calculated by taking a 9-period EMA of the MACD line itself

Standard MACD Formula on Trading Platforms

MACD (12, 26, 9)

Determining Bullish or Bearish Movement with MACD (3 Points)

1. MACD crossing above the zero line is considered bullish, while

crossing below the zero line is bearish. When MACD turns up from

below the zero line, it is considered bullish. When it turns down from

above the zero line, it is considered bearish.

2. When the MACD line crosses from below to above the signal line, the indicator is considered bullish. The further below the zero line this cross occurs, the stronger the signal.

3. When the MACD line crosses from above to below the signal line, the indicator is considered bearish. The further above the zero line this cross occurs, the stronger the signal.

Why are bullish MACD crossovers considered stronger when they occur below the zero line, and vice-versa?

When the MACD line is below the zero line, the longer-term EMA is higher than the shorter-term. A bearish crossover is considered stronger when it happens above the zero line because above the line, the shorter-term EMA is higher than the longer-term.

MACD Histogram Definition (3 Points)

- The bar graph that represents the distance between the MACD line and the signal line.

- At convergence, there are no lines

- Histogram = MACD line - Signal line

Indications of Momentum Above and Below the MACD Zero Line (2 Points)

- Above the zero line: MACD is above the signal and upward (green) momentum is accelerating.

- Below the zero line: MACD is below the signal line and downward momentum is accelerating

What Does the Average Directional Movement Index (TI) do?

ADX can be used to help

measure the overall strength

of a trend.

4 Characteristics of ADX

1. A strong trend is present when ADX is above 25;

no trend is present when ADX is below 20.

2. If the ADX is declining, it could indicate that the current trend

is weakening.

3. If the ADX is rising, it could indicate a strengthening trend.

4. The ADX indicator incorporates two different components in its

construction which are commonly plotted along with the ADX.

‐ Positive Directional Indicator (+DMI) shows the difference between today's

high price and yesterday's high price. These values are then added up from

the past 14 periods and then plotted.

‐ Negative Directional Indicator (-DMI) shows the difference between today's

low price and yesterday's low price. These values are then summed up from

the past 14 periods and plotted.

4 Characteristics of the Stochastic Oscillator

1. Generally, the area above 80 indicates an overbought region, while

the area below 20 is considered an oversold region.

2. A sell signal is given when the oscillator is above the 80 level and

then crosses back below 80. Conversely, a buy signal is given when

the oscillator is below 20 and then crosses back above 20.

3. A crossover signal occurs when the two lines cross in the overbought

or oversold region.

4. Divergences form when a new high or low in price is not confirmed

by the Stochastic Oscillator.

* Divergences between price and oscillators can also generate signals.

Formulas for fast Stochastic Oscillator and Slow Stochastic Oscillator - Which provides the cleaner signal?

Fast Stochastic: 14, 1, 3

Slow Stochastic: 14, 3, 3 (provides cleaner signals)

What are the two lines of the Stochastic Oscillator and what do they do?

%K line: the fast/main line that measures where the current close sits relative to the recent high-low range; usually calculated over 14 periods.

%D line: the slower signal line and a smoother version of %K; most commonly a 3-period SMA of %K

What do overbought and oversold signals on the chart indicate?

Price movement in the short term.

4 General Rules of Volume Theory

1. Increasing volume reinforces the trend direction 2. Declining volume diminishes the trend direction 3. A price peak or trough on ultra-high volume is often an important reversal point in a trend.

What is true about oscillators during trend markets?

Oversold or overbought can last for days or weeks; in a strong bull trend, 50 or 40 is the oversold zone where buyers step back in; 50 or 60 is overbought where sellers step back in during bear trends. This is called indicator Embedding

Stochastic Oscillator (MI)

The Stochastic Oscillator is a

momentum indicator that

shows the location of the close

relative to the high-low range

over a set number of periods.

The indicator can range from 0

to 100. Stochastic Oscillators

are most effective in broad

trading ranges or slow moving

trends.

What is a common occurrence with ADX in an uptrend, but not a requirement?

+DMI is greater than -DMI

Key signal to look for when using ADX

Look for places where ADX crosses below 25 and -DMI has crossed above +DMI at about the same time, and vice-versa

What does Relative Strength Index (MI) do?

RSI measures the speed and change of price movements

4 Characteristics of the RSI

1. The RSI oscillates from zero and 100. Traditionally, the RSI is

considered overbought when above 70 and oversold when below 30.

2. In an uptrend or bull market, the RSI tends to remain in the 40-90

range with the 40-50 zone acting as support.

3. During a downtrend or bear market, the RSI tends to stay in the

10-60 range with the 50-60 zone acting as resistance.

4. If underlying prices make a new high or low that isn't confirmed by

the RSI, this divergence can signal a price reversal. Core mechanic: Momentum shifts before price

Divergence Caveat

Divergence is not an immediate trigger and should be confirmed by stochastic crossovers, break of trendline, etc., or 2nd price peak/trough w/ RSI mismatch.

What does On Balance Volume (Volume Indicator) do?

OBV measures buying and

selling pressure as a cumulative

indicator that adds volume on

up days and subtracts volume

on down days.

25

3 Characteristics of OBV

1. The actual value of the OBV is unimportant; concentrate on its

direction.

2. When price continues to make higher peaks and OBV fails to make

higher peaks, the upward trend is likely to stall or fail. This is called a

negative divergence.

3. When price continues to make lower troughs and OBV fails to make

lower troughs, the downward trend is likely to stall or fail. This is

called a positive divergence

What is an Up Day with OBV, and what defines it

Current close is higher than previous; OBV = previous OBV + today's volume