Identifying breakouts using chart patterns

A chart pattern is a shape within a price chart that helps to suggest what prices might do next, based on what they have done in the past. Chart patterns are the basis of technical analysis and require a trader to know exactly what they are looking at, as well as what they are looking for.

There are several common chart patterns that traders look for when scanning the charts for breakout trading opportunities. They include triangles/pennant; range/sideways consolidations; and head and shoulders/inverse head and shoulders.

• Triangles/pennants: Triangle and pennant patterns can show a temporary pause or consolidation in the price before a potential breakout or breakdown. This means that after the pattern completes, the price will continue in the trend direction it was moving before the pattern appeared. In breakout trading, traders may look for symmetrical triangles, which can be spotted when trendlines converge so that the highs and lows are forming a triangle shape. A pennant is similar to a symmetrical triangle but shorter in duration, so it resembles a small symmetrical triangle
• Range/sideways consolidations: These patterns happen when the price moves within a horizontal channel, bouncing between a defined support and resistance level, which may suggest a period of indecision in the market (sometimes after a strong move). Similar to symmetrical triangles, they mark a consolidation period in the current trend before the price continues to move higher or lower
• Head and shoulders/inverse head and shoulders: These are reversal patterns that show a potential change in trend. The regular head and shoulders pattern signals a potential trend reversal from bullish to bearish, while the inverse head and shoulders suggest a reversal from bearish to bullish. To spot the head and shoulders pattern, traders will look for three peaks on the price chart: a higher peak (head) between two lower peaks (shoulders). The "neckline" is a line drawn through the lows of the shoulders and a breakdown below the neckline confirms the pattern. The inverse head and shoulders pattern is similar, but the other way around, with three troughs on the price chart: a lower trough (head) between two higher troughs (shoulders) and the neckline drawn through the highs of the shoulders. A breakout above the neckline confirms the pattern

The most important thing to remember when using chart patterns is that they are not foolproof, nor a guarantee that a market will move in that predicted direction. Chart patterns are merely an indication of what might happen to an asset’s price.

Use chart patterns together with other technical analysis tools and indicators, and implement smart risk management.