Investment: Technical Analysis basics 6

Pattern Analysis

Note:
This here is the last instalment of technical analysis basics, then after that we can move on to other financial topics :)
Also, thanks to Richard Schabacker (1932 Technical Analysis and Stock Market Profits), Edwards and Magee, and John Murphy.


There are thousands of market participants selling and buying securities for many reasons, motives and positions: love of return, hope of gain, fear of loss, short-covering, hedging, stop-loss triggers, price target triggers, fundamental analysis, technical analysis, broker recommendations, and more. Trying to figure out here why participants are buying and selling can be daunting. Chart patterns place buying and selling into perspective by consolidating supply and demand into a concise picture. As a complete visual record of trading, chart patterns provide a framework to analyze the “bulls and bears”, to analyze prices. Hence chart patterns and technical analysis together can help us determine the true picture. In many ways, chart patterns are more complex trend lines.

Chart pattern analysis can be used to make short-term or long-term forecasts. The data can be intraday, daily, weekly or monthly and the patterns can be, again, as short as one day or as long as many years. Gaps and outside reversals may form in one single trading session, while broadening tops and dormant bottoms may take months to form.

Technical analysis can at times be science and, then again at other times, more art. In addition, price pattern recognition is open to interpretation, which is subject to personal bias. To defend against bias and confirm pattern interpretations, other aspects of technical analysis should be employed to verify or refute the conclusions once again. While many price patterns may seem similar, no two patterns are exactly alike. False breakouts and exceptions are all part of the game here. Hence, careful constant study is required here for successful chart analysis.

Two basic tenets of technical analysis are that prices trend and that history repeats itself. An uptrend indicates that demand is in control here, and a downtrend that supply is in control. As the balance shifts, a pattern emerges. The vast majority of chart patterns fall into two main groups: reversal and continuation.

Reversal patterns indicate a change of trend. Continuation patterns indicate a pause in trend and indicate that the previous direction will resume after a while. However, just because a pattern forms after a significant advance or decline does not mean it is a reversal pattern. Many patterns can be classified as either reversal or continuation. Much depends on the previous price action, volume, and more, as the pattern evolves. This is where the science of technical analysis becomes an art.

In summary, for technical analysis, the keys to successful chart pattern analysis are dedication (learn, learn, learn), focus (limit charts, indicators and methods to those you know well), and consistency (maintain your charts regularly and study them often).

In conclusion, a paragraph from Schabacker:

“The science of chart reading, however, is not as easy as the mere memorizing of certain patterns and pictures and recalling what they generally forecast. Any general stock chart is a combination of countless different patterns and its accurate analysis depends upon constant study, long experience and knowledge of all the fine points, both technical and fundamental, and, above all, the ability to weigh opposing indications against each other, to appraise the entire picture in the light of its most minute and composite details as well as in the recognition of any certain and memorized formula.”