the hAnDbook of teChniCAl AnAlysisthe real building blocks of Chart patterns:
the Underlying behavioral Component
Chart patterns are a consequence of human behavior. They are a direct result of
knowledge‐based bias at work in the markets. Market participants tend to place
buy orders above a price barrier and sell orders below it. This learned behavior
is therefore responsible for making a barrier resistant to price. When price ap-
proaches any overlay barrier such as a trendline, channel, percentage band, Ichi-
moku overlay, or moving average, it will initially encounter orders that inhibit
further price movement incident upon it. This causes a reaction in the form of
pullback from the barrier. These reactions explain why chart patterns exist. Price
tends to rebound off price barriers and in the process forms trendlines, triangles,
channels, wedges, pennants, and flags. For a more detailed discussion on the trade
and behavioral mechanisms underlying these reactions, refer to Chapter 25.
two Conditions for Determining reversal or
Continuation of Chart patterns
In order to determine whether a chart pattern is a reversal or continuation pat-
tern, two pieces of information are required, namely:
■ (^) The intrinsic sentiment associated with the pattern
■ (^) The direction of the existing trend (trend sentiment)
A bullish chart pattern in an uptrend and a bearish chart pattern in a down-
trend are regarded as continuation patterns. A bearish chart pattern in an uptrend
and a bullish chart pattern in a downtrend are regarded as reversal patterns. Trend
sentiment is bullish for uptrends and bearish for downtrends. Therefore, we may
also state that:
■ (^) When the intrinsic and trend sentiments agree (that is, both bullish or bearish),
the chart pattern is regarded as a continuation pattern.
■ (^) When the intrinsic and trend sentiments disagrees, the chart pattern is regarded
as a reversal pattern.
The following can be said about intrinsically neutral chart patterns like the
symmetrical triangle and horizontal channel:
■ (^) They are generally considered to be reversal patterns if they occur in proxim-
ity to previous market tops or bottoms (being neutral in sentiment, they tend
to adopt external or extrinsic sentiment, which in this case is bearish at previ-
ous market tops and bullish at previous market bottoms).
■ (^) They are generally considered to be reversal patterns if they occur in proxim-
ity to a projected cycle extreme.
■ (^) They are generally considered continuation patterns if they occur near the
midpoint of a price cycle.