Chart Pattern Analysis
13.2 Preconditions for Reliable Chart Pattern Reversals
sixteen main preconditions for a reliable reversal
For a reliable reversal, a significantly clear and obvious trend has to be in effect.
The more extended and pronounced a trend, the more likely will be a potential
reversal. A reversal (or continuation) move is also regarded as more reliable if it
is accompanied by decreasing volume. A bearish chart formation in proximity to
any downside violation of significant trendlines or price barriers is also regarded
as more reliable. The reverse applies for bullish chart patterns.
It should also be noted that bullish reversal formations tend to last longer
than bearish reversal formations, especially in the equity markets. This is because
much more capital and unrealized profit are at risk at market tops as compared
to market bottoms where prices are low and the corresponding capital at risk is
less significant. This discrepancy is less obvious in the commodity markets where
traders and investors trade and invest on very low margins.
Besides studying the individual price behavior associated with each chart pat-
tern, the practitioner should also be aware of the 16 basic price and volume pre-
conditions that are indicative of a potential reversal, namely:- Decrease in price cycle amplitude during a trend
- Decrease in price cycle period during a trend
- Change in bar retracement symmetry during a trend
- Decrease in average bar range during a trend
- Lack of quality of price persistence (price becoming more volatile) during a trend
- Decrease in average bar stochastic ratio during a trend
- Decrease in average candlestick real body to range ratio during a trend
- Changes in angular symmetry and momentum
- Proximity to a price barrier
- Reduction in frequency and decrease in depth of trend‐based oscillations
- Relative size of chart pattern and its duration
- Appearance of a third (exhaustion) gap prior to the formation of a chart pattern
- Completion of the average range for the period under observation
- Overextended price action with respect to a price barrier
- Price accompanied by extremely high or low volume
- Divergence between price and volume and oscillators
If a chart pattern is preceded by any of these 16 preconditions, a potential re-
versal is more likely to occur. These 16 preconditions are discussed in more detail
in Chapter 5.the minimum measuring Objective: the One‐to‐One
price‐target projection Level
Most charts patterns have a minimum price objective or target associated with them,
with the exception of V tops and bottoms. The minimum price objective of most
chart patterns is usually a one‐to‐one projection (1:1) of the height of the pattern