How To Recognize Chart Patterns

  • March 24, 2001
  • Brice Wightman

One of
the most important tools used by traders is the chart pattern. If you
read the daily commentaries of Haggerty, Cooper, Kaltbaum, Yordanoff, Kwong,
etc., you’ll find that every single one incorporates chart patterns into his
analysis. The common misconception is that
chart patterns are highly subjective. How is it, then, that a master trader is
able to recognize the same patterns over and over again? How can they possibly
trade profitably if there are not some rigid, consistent properties that are
seen every time?

My premise is that chart
patterns can be “de-subjectified,” and I will show you how to read
them, using swings.

Think of it this way: Children,
when they learn to draw people and animals, start with stick figures. Once they
understand the basic anatomy of using stick figures, the rest falls into place.
Likewise, once you understand the schematic in swing form, it will become very
easy to recognize so-called “complex” patterns.

First of all, what is a swing
point? In a nutshell, it’s a high bar surrounded by lower bars. Figure
1 shows how a trend changes
direction at a swing point (high bar).

Figure
1:  Swing Point showing change in trend

Swing points, as you know, are
used to draw trendlines. Figure 2
is a chart of Home Depot
(
HD |
Quote |
Chart |
News |
PowerRating) showing both an uptrend and a downtrend
drawn from swing highs and lows. Note again how the short-term trend changes at
each swing point. This is pretty basic, obvious stuff.

Figure
2:  Trendlines drawn using swing points

To help identify patterns more
easily, swing charts can be drawn, connecting swing highs and lows. Figure
3 is a chart of BEA Systems
(
BEAS |
Quote |
Chart |
News |
PowerRating). What pattern do you see?

Figure 3

The head-and-shoulders pattern becomes much more
apparent when a swing chart is created (Figure 4).  A
head-and-shoulders pattern has three main swing points: the left shoulder, the
head, and the right shoulder. In this example, “stick” figures outline
the head-and-shoulders pattern.

Figure 4: 
Swing Chart

Figure 5 shows
the relationship between the three swing points: A < B > C. Points A and C
are approximately  equal.

Figure 5: 
Swing point relationships in head-and-shoulders pattern

The stick men are at work again in Figure
6, showing an inverted head and shoulders this time. Note how the two
shoulders are approximately equal and are equidistant from the head.

Figure 6: Swing
chart showing inverted head and shoulders 

Sticks form a “W” or double bottom (Figure
7).

Figure 7: 
Swing Chart showing “W” or double bottom

A very simple stick pattern: the “V” (Figure
8).

Figure 8: 
Swing chart showing “V” bottom

Stick figures can alert you to tops also. See Figure
9, double top.

Figure 9:  
Swing Chart showing double top

There you have it: stick men at work, helping you
with your chart pattern identification. Use them until you can easily spot these
patterns quickly.

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