There are many reversal patterns that might point to a change in the market trend. However, many of those patterns are built on the following three patterns. So pay close attention to what follows:
1. Head and Shoulders Pattern
The head and shoulders pattern is a bearish trend that usually means that a stock is about to move lower. The pattern is found by finding a stock that has three upward spikes. The middle spike (“head”) is taller than the two spikes (“shoulders”) on either side of it. Take note, though, that within the head and shoulders pattern itself you’ll find a strong support level (called the neckline). When the stock moves below the neckline it will probably continue its downward movement.
Like most patterns, the head and shoulders has an opposite — in this case, the inverse head and shoulders. This pattern is bullish. It looks the same as the regular head and shoulders, except it’s flipped upside down. When an inverse head and shoulders is on your chart, it could mean a rally is coming up. A move above the neckline in this instance would indicate possible future upward movement.
2. Double Top or Bottom
The double top (and its bullish cousin, the double bottom) is one of the easiest technical patterns to pick out. It happens when a stock’s price bounces off the same resistance line twice in a short period of time (or in the case of a double bottom, it bounces off support), and gives strong evidence that the stock is having serious trouble breaking through that barrier.
The double top is usually not a good sign, because it represents a limit on a stock’s upside potential — at least in the short term. A double bottom, on the other hand, is a good thing because it means that there’s a strong support level that the stock’s price will have trouble falling below.
Even more important to look out for is the triple top or bottom, which is a much stronger — and less common — signal to watch out for…
3. Trendline Break
A trendline break occurs when a stock’s price falls below the trending support level (or rises above trending resistance in a downtrend), then bounces off it again as resistance. When this happens, the price has fallen below the trend level and is seeing resistance in trying to make it back up to that level — a very bearish signal.
Use a charting software that allows you to draw trendlines through the closing prices. This would be the easiest place to start. When the stock moves below the trendline or above it, there is a good chance that it will continue in that same direction.
There are many other reversal patterns to consider. The next time we will look at a few Candlestick reversal patterns to aid in trying to find the right stocks to trade at the right time.
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