Classic Chart Patterns and How to Read Their Volume

4.1Why Chart Patterns Form

Investors who manage large sums, such as pension funds and mutual funds, would move the price against themselves by placing huge orders at once. They are therefore said to accumulate or distribute gradually over weeks or months, during which the price tends to move within a range. Chart patterns are explained as the shape that this rebalancing of supply and demand leaves on the chart.

Patterns fall broadly into continuation and reversal types. Continuation patterns resume the original direction after a pause within a trend — the cup with handle, triangles and flags, for example. Reversal patterns mark a change to the opposite direction — double bottoms and tops and the head and shoulders are typical.

Every pattern puts weight on two things: changes in volume and the boundary line, called the neckline or pivot. A common view is that, however neat the shape, it is only a candidate pattern until the boundary is broken on volume.

Patterns appear on weekly and hourly charts as well as daily ones. In general, patterns that form over a long time on a longer timeframe are watched by more participants and tend to be followed by larger moves. Small patterns on short timeframes, by contrast, are easily distorted by noise.

• Continuation: cup with handle, triangles, flags and others
• Reversal: double bottoms and tops, head and shoulders and others
• A pattern is considered complete only once its boundary (neckline or pivot) is broken