We first looked at stock charts in our Foundations of Stocks and Options Level 1 class post here. Where we introduced you to the various chart types, such as the line chart, the bar chart, and the candlestick chart, which are available for you to use when tracking a company’s performance in the marketplace. Today, we are going to pull back the curtain into the use of candlestick charts and hopefully shine a light on what goes on behind the scenes.
As a technical analysis, we spend a large part of our time studying a company’s candlestick chart. We tend to take a holistic view of the candlesticks, which includes the price action of the candle and the market sentiment which drives the candles. For example, support and resistance points occur on a chart because there is a change or shift in the perspectives of the buyers and sellers. A stock will find support when the price drops to a certain point, and more buyers come in to push the price of the stock higher. It is this idea of what happens behind the scenes that tells us a story regarding how buyers and sellers currently view the company they are trading.
Chart patterns are examples of behavior that form during stock price transitions. These patterns reflect the story behind the price movements of a company’s stock. Some patterns indicate a reversal trend is approaching; however, all chart patterns help us to anticipate future price movement. Some examples of basic chart patterns are V-Tops and Bottoms, Double Tops and Bottoms, and Triple Tops and Bottoms.
V-Tops and Bottoms usually reflect a very sudden change in the direction of a stock. Usually, a stock will travel in one direction for an extended period, either trending up or down. Then it will reverse course and quickly trend in the opposite direction over the course of only one or two days. This reversal usually erases the entirety of the previous up or downtrend.
Since V-Tops and Bottoms happen so fast, they are challenging to trade and predict.
Double Tops and Bottoms are similar to Single Tops and Bottoms; however, the difference is this pattern will hit a point of support or resistance bounce back a little and pushes up against the same point of resistance or support a second time. Then the second attempt will fail, and the stock tends to reverse.
Compared to the V-Tops and Bottoms, the Double Tops and Bottoms are more commonplace and easier to locate and trade. You can use the first bounce back point of support and resistance, aka the neckline, as your entry point, and then watch for increased volume as the stock breaks out.
Whereas Double Tops and Bottoms are similar to V-Tops and Bottoms, Triple Tops and Bottoms are similar to Double Tops and Bottoms, but instead of two points of support and resistance, they have three recognizable attempts to push past the points of support and resistance. This is a strong pattern which signifies the trend has failed to push through established points of support and resistance. As with the Double Tops and Bottoms, you can enter a trade at the neckline, while using increase volume as an indicator the stock will break out.
In closing, this is an introductory look at V based chart patterns that traders can find and use when tracking a company’s stock performance. Once you start training yourself to look for overall patterns like these, you will quickly be able to locate and execute trade setups.
Thank you for reading, and we will see you next week as we discuss our main take away from Foundations of Stocks and Options Level 2 Class 4!