Chart Pattern Analysis
■ (^) Flags
■ (^) Diamond formations, which require the formation of four trendlines
Once the two (or four) trendlines encapsulating any of these patterns are
formed, the pattern is complete and no breakout is required.
Chart formations that are considered complete or confirmed once gaps are
formed are the top and bottom island formations. A top island formation requires a
gap up followed by a gap down in price for completion. In similar fashion, a bottom
island formation requires a gap down followed by a gap up in price for completion.
Finally, chart patterns that are considered complete or confirmed once they
are obvious or visually discernible include V tops and V bottoms. These patterns
cannot be confirmed until they become obvious, that is, they can only be clearly
identified in hindsight.
price filters associated with Chart pattern Completion
For a valid pattern completion or confirmation via the penetration of trendlines or
price levels associated with significant inflection points, a close beyond the trendline
or price level is usually employed. For intraday or intra‐period penetrations, a price fil-
ter based on one of the following may be employed to determine pattern completion:
■ (^) A minimum percentage of price move
■ (^) A minimum fixed dollar, pip, or point move
■ (^) A minimum move based on some multiple of standard deviation or average
true range (ATR)
For pattern completion or confirmation via the formation of two or more
trendlines, trendlines should be drawn based on significantly clear and obvious
peaks for downtrending lines and troughs for uptrending lines. A pattern is said
to be tentative until it is confirmed.
Chart pattern failure
In order for a chart pattern to fail, it must be first completed or confirmed. Techni-
cally, a pattern does not exist until it is confirmed. A completed chart pattern is
said to have failed if price moves in a direction opposite to the expected follow-
through action. For example, a head and shoulders formation cannot fail unless
it is first completed via a valid neckline violation. Once a valid violation has oc-
curred, price is expected to move in the direction of the neckline breakout. If it
does not, the pattern is said to have failed.
The main problem with determining whether failure has occurred is a ques-
tion of degree. An example will help clarify this issue. Traders A and B selected
one percent and three percent breakout filters, respectively. Assume that price ex-
tended beyond the neckline by two percent and immediately reversed in the oppo-
site direction, extending beyond the right shoulder. Has the chart pattern failed?
It would be classified as a failure as far as Trader A is concerned since according
to Trader A’s filter setting, the chart pattern was completed but failed to follow