In the world of trading, understanding chart patterns can improve the accuracy of your market insights and help you to make better trading decisions. Technical analysis (TA) for charts can also allow you to better see trend lines and breakouts thus making it possible to predict the direction of markets with some degree of certainty. Of course, chart patterns can never perfectly predict market movements: however, they can help you make intelligent estimates with which you can better assess risk.
There are a few chart patterns that have been proven time and time again to be statistically significant. So, let’s talk about those and how you can best apply them to your cryptocurrency trading.
Bull Flags and Bear Flags
When looking at the daily or 4H chart, you can see general market trends by mapping bullish and bearish flags.
A bullish flag is a short-term pattern that marks a period of consolidation before the next leg up. After a bullish rise (i.e. the “flagpole”) there is a period of consolidation (the “flag”). This sideways movement can be seen on the daily or 4H chart and gets tighter and tighter in its highs and lows until it breaks upward again to continue to bullish trend.
A bearish flag is the same idea. After a bearish decline, there is again a period of consolidation with the bands getting tighter and tighter until it breaks further downward.
Generally speaking, bearish and bullish flags are hard to predict but should be considered along with general market sentiment. As a trader, you should be aware that every bullish or bearish trend needs a “cool off” period of consolidation. This “cool off” period is the flag which precedes the next leg up or down.
As we know, bearish and bullish markets don’t last forever. When bullish or bearish periods of price action end, and the market turns in the opposite direction, that’s referred to as a reversal.
In bearish markets, a reversal into bull territory is referred to as a bullish reversal. Similarly, in bullish markets, a reversal into bear territory is referred to as a bearish reversal.
A double-bottom, a double-top, head and shoulders top (or its inverse) can all be indicators of a possible reversal.
The Head and Shoulders Pattern
The head and shoulders pattern is among the most well-known in technical analysis. Generally speaking, the formation of a head and shoulders is an indicator that a bearish reversal is to be expected.
How to identify a head and shoulders pattern:
- A head and shoulders pattern is made up of three “peaks”: the two “shoulders”
which are on the same horizontal line and a “head,” or the center which is above the two shoulders.
- The “neckline” between the two shoulders is the line that you should be monitoring. It is a key support area.
- A drop under the neckline after the completion of a head and shoulders pattern is an indication that a bearish trend will follow.
- To identify this pattern, you should be looking at 4-hour or daily charts.
There is also the less-common reverse head and shoulders pattern which would indicate a bullish reversal. It is simply the opposite of the aforementioned pattern.
When following a bullish trend, it’s hard to know when to exit because there’s always the hunch it might go even higher. By understanding double-top patterns, however, you are able to be statistically more accurate in estimating where the top might be for a particular bullish trend.
One of the most common and recognizable chart patterns, a double-top occurs when the price increases and then meets resistance.
How to identify a double-top pattern:
- When a bullish trend tries to test a particular price level, gets rejected, moves sideways, and then tests that same price level again but fails to go higher.
- Generally, if a rally fails to break an established resistance twice, traders can expect prices to fall.
- To identify this pattern, you should be looking at the 4-hour charts.
Inversely, technical analysts have also seen something similar play out as a double-bottom where a bearish trend bounces off a resistance line twice, meaning that it will likely break upwards.
Cup and Handle Pattern
A cup and handle pattern is seen as a bullish indicator. Generally viewed as a bull flag, a breakout upward follows the creation of this pattern.
How to identify a cup and handle pattern:
- First, identify the “cup” which takes a “U” shape.
- Then, there is the “handle” which comes after the “U” shape as a slight dip.
- Completion of the cup and handle formation follows a further upward trend, potentially signaling a reversal if there is a bearish market.
- To identify this pattern, you should be looking at the daily chart. Bear in mind, however, that cup and handles are relatively rare and often misidentified.
Aside from market patterns, there are two other indicators that should be used by any trader.
- Relative Strength Index (RSI): an indicator of momentum, the RSI demonstrates whether an asset is overbought or oversold on a scale of 0 to 100. Generally speaking, an RSI under 30 means an asset is oversold; over 70 means it is overbought. Looking at RSI is a good way to better predict reversals.
- Moving Average Convergence-Divergence (MACD): one of the most popular of technical indicators, MACD will tell you where the centerline of the market is (i.e. the point where the two moving averages are equal)l. Rather than look at the price, MACD tells you what the direction of movement is. MACD can be positive (bullish moving average) or negative (bearish moving average).
RSI and MACD should be considered along with chart patterns to best assess whether or not a market’s bearish or bullish momentum is established.
Although there is some validity with technical analysis, it should always be used with caution: this is because, frankly, if the asset you are charting does not have good fundamentals to begin with, all your technical analysis could prove to be useless. Always keep that in mind—happy trading!