Definition and types of pattern used in technical analysis

A pattern refers to a recurring and recognizable arrangement or sequence of elements. It is a regularity or consistency observed in various contexts such as economics, finance, nature, mathematics, language, art and even human behavior.

In the context of technical analysis, patterns specifically refer to recurring formations or structures observed in price charts of financial instruments. These patterns are believed to reflect the collective psychology of market participants and can provide insights into future price movements. Analysts study these patterns to identify potential buying or selling opportunities and make predictions about market trends.

Patterns in technical analysis (TA) are typically formed by plotting price data such as open, high, low and close prices over a specified length of time. Investors attempt to gain an understanding of market sentiment and make informed trading decisions by analyzing the shapes, relationships and characteristics of these patterns.

Types of pattern in technical analysis:

Trend/ Chart Patterns: These patterns indicate the direction of the market trend and include uptrends, downtrends and sideways trends. Three major patterns are in the below by this concept-

• Ascending Triangle: A bullish continuation pattern characterized by a flat top and rising bottom.
• Descending Triangle: A bearish continuation pattern characterized by a flat bottom and declining top.
• Symmetrical Triangle: A neutral pattern characterized by converging trendlines, indicating indecision in the market.

Reversal Patterns: These patterns suggest a potential reversal in the current trend and include patterns such as-

• Head and Shoulders: A bearish reversal pattern consisting of three peaks, with the middle peak (the head) higher than the other two (the shoulders).
• Inverse Head and Shoulders: A bullish reversal pattern that is the opposite of the head and shoulders pattern.
• Double Top/Bottom: A bearish/bullish reversal pattern characterized by two consecutive peaks (top) or troughs (bottom) at approximately the same level.

Continuation Patterns: These patterns suggest a temporary pause in the prevailing trend before it continues. Major continuous patterns are-

• Bull Flag: A bullish continuation pattern formed by a sharp upward price movement (flagpole) followed by a consolidation phase (flag).
• Bear Flag: A bearish continuation pattern formed by a sharp downward price movement (flagpole) followed by a consolidation phase (flag).
• Pennant: A short-term continuation pattern that resembles a symmetrical triangle but has a narrower range and is formed during strong price movements.

Candlestick Patterns: These patterns are derived from Japanese candlestick charts and provide insights into market sentiment.

• Doji: A candlestick pattern where the open and close prices are nearly the same, indicating market indecision.
• Hammer: A bullish reversal pattern characterized by a small body and a long lower shadow, suggesting potential bullish momentum.
• Shooting Star: A bearish reversal pattern with a small body and a long upper shadow, indicating possible bearish pressure.

Harmonic Patterns: These patterns use Fibonacci ratios and specific geometric shapes to identify potential turning points in the market. Examples include the Gartley pattern, Butterfly pattern, Bat Pattern, etc.

• Butterfly Pattern: A bullish or bearish reversal pattern that consists of specific Fibonacci-based ratios.
• Gartley Pattern: A pattern that incorporates both Fibonacci retracement and extension levels to identify potential reversal points.
• Bat Pattern: Another harmonic pattern that seeks to identify potential market reversals.

Fibonacci Patterns: These patterns are based on the Fibonacci sequence and ratios and are used to identify potential support and resistance levels. Examples include Fibonacci retracements and extensions.

These are just a few examples of pattern types used in technical analysis. Analysts often combine multiple patterns and indicators to make informed decisions about buying, selling or holding financial instruments.

Average True Range (ATR) of technical analysis with example and calculation details

Average True Range (ATR) is a technical analysis indicator that measures financial market volatility. This theory was developed by J. Welles Wilder and it is commonly used by analyst and investors to assess the level of price volatility in a particular security or market. ATR takes into account the range between the high and low prices of a stock over a specified length of time and provides an average value that represents the volatility.

How ATR is calculated:

Calculate the True Range (TR) for each period. The TR is the chief of the following three values:

• The difference between high of the current period and low prices.
• The absolute value of the difference between the current period's high and the previous period's close.
• The absolute value of the difference between the current period's low and the previous period's close.
• TR = Max [(High - Low), Abs(High - Previous Close), Abs(Low - Previous Close)]

Calculate the Average True Range (ATR) over a specified length of time. This is done by taking the average of the True Range values over the desired number of periods.

• ATR = Average of TR over a specified period
• For example, let's calculate the ATR for a stock over a 14-day period:
• Day 1: High = Tk. 50, Low = Tk. 45, Previous Close = Tk. 48
• True Range (TR) = Max[(50 - 45), Abs(50 - 48), Abs(45 - 48)] = Max[5, 2, 3] = 5
• Average True Range (ATR) = TR = 5
• Continuing this calculation for the remaining days in the 14-day period will give you the ATR for each day.

The ATR value represents the average volatility of the stock over the specified period. A higher ATR suggests higher volatility indicating larger price swings, while a lower ATR indicates lower volatility and smaller price swings.

Analyst or investors can use ATR in various ways. For example, it can help set stop-loss levels as a wider ATR might require a larger buffer to protect against price fluctuations. Additionally, ATR can be used to determine position sizing with larger ATR values potentially justifying smaller position sizes to account for higher volatility.

It is important to note that, the choice of the period for calculating ATR depends on the investor's preference and the timeframe being analyzed. Common periods include 7, 14 or 21 days but they can be adjusted based on individual trading strategies and preferences.

Indicators used in technical analysis (TA indicators)

TA (Technical Analysis) indicators are very important tools used by investors (analysts) to analyze historical price data and to identify potential trends, patterns and signals in financial markets. These indicators are based on mathematical calculations and are applied to charts to generate visual representations of price movements. These indicators help analysts to identify potential entry and exit points for future trades and provide insights into market conditions.

Commonly used TA indicators are:

• Moving Averages (MA): Moving averages calculate the average price of a stock over a specified length of periods. They help smooth out price fluctuations and identify trends. The two main types are-

1. Simple Moving Average (SMA): It calculates the average price over a specified period, giving equal weight to each data point.
2. Exponential Moving Average (EMA): It assigns more weight to recent price data, making it more responsive to current market conditions.

• Relative Strength Index (RSI): RSI measures the speed and change of price movements. It oscillates between 0 and 100 and indicates whether an asset is overbought (above 70) or oversold (below 30). Traders use RSI to identify potential trend reversals. Commonly used RSI length 14, upper limit 70 and lower limit 30 as pre-designed value of a RSI.

• Moving Average Convergence Divergence (MACD): MACD is a trend-following momentum indicator that consists of two lines- i) the MACD line and ii) the signal line. The MACD line represents the difference between two exponential moving averages while the signal line is a smoothed average of the MACD line. Crossovers between these lines can indicate buy or sell signals.

• Bollinger Bands (BB): Bollinger Bands consist of three lines- i) a middle band (SMA or EMA), ii) an upper band (standard deviation above the middle band) and iii) a lower band (standard deviation below the middle band). These bands help to identify volatility and potential price breakouts. It may indicate overbought conditions when the price touches the upper band while touching the lower band may indicate oversold conditions.

• Stochastic Oscillator: The stochastic oscillator compares the closing price of an asset to its price range over a specified period. It consists of two lines (%K and %D) that fluctuate between 0 and 100. The oscillator signals potential trend reversals when the lines cross above or below certain thresholds (typically 20 and 80).

• Fibonacci Retracement: Fibonacci retracement is based on the Fibonacci sequence and is used to identify potential support and resistance levels. Traders use Fibonacci retracement levels (typically 38.2%, 50% and 61.8%) to determine possible areas where price corrections or reversals may occur.

• Volume: Volume indicators measure the number of shares or contracts traded in a given period. They help confirm the strength of a price movement. High volume during price increases suggests buying pressure while high volume during price decreases suggests selling pressure.

• Average True Range (ATR): ATR measures market volatility by calculating the average range between the high and low prices over a specified period. Traders use ATR to determine stop-loss levels and assess potential price targets.

• Ichimoku Cloud: The Ichimoku Cloud indicator provides a comprehensive view of potential support, resistance and trend direction. It consists of several components, including the cloud (Kumo), the Tenkan-sen (conversion line) and the Kijun-sen (baseline). The interaction between these elements can help identify trend changes and trading opportunities.

It is important to note that, these indicators should be used in conjunction with other analysis techniques and not relied upon solely for trading decisions. Each indicator has its strengths and weaknesses and it's essential to understand their interpretation and limitations before applying them to real-world trading scenarios.

Price-volume correlation

Price-volume correlation is an important concept in technical analysis (TA) that examines the relationship between price movements and trading volume. It helps investors to understand the strength and validity of price trends and can provide insights into market dynamics.

Definition: Price-volume correlation refers to the degree to which changes in price are accompanied by changes in trading volume. It examines whether there is a consistent relationship between price movements and the corresponding volume of shares, contracts or instrument traded.

Confirmation of Trends: In technical analysis (TA), the principle of 'confirmation' is often used which suggests that price movements should be supported by increasing volume during uptrends or decreasing volume during downtrends. This suggests that a trend is more likely to be valid and sustainable if it is accompanied by an appropriate volume pattern.

• Upward Price Movement with Increasing Volume: It indicates a stronger bullish sentiment and suggesting that more market participants are actively buying the security when prices rise along with an increase in trading volume. This scenario supports the validity of the uptrend. If both price and volume is reverse then it may be a fake move.
• Downward Price Movement with Decreasing Volume: Conversely, it suggests a weaker bearish sentiment and a lack of selling pressure when prices decline while trading volume decreases. This pattern can indicate a potential exhaustion of the downtrend or a consolidation phase.

Divergence: Divergence between price and volume can provide valuable insights as well.

• Bullish Divergence: Bullish divergence occurs when prices are in a downtrend and making lower lows but the volume is decreasing. This can be a sign of selling exhaustion and a potential reversal or a trend change to the upside.
• Bearish Divergence: Bearish divergence occurs when prices are in an uptrend and making higher highs but the volume is diminishing. This can suggest weakening buying pressure and a potential reversal or a trend change to the downside.

Volume Confirmation: Volume can also confirm breakout or breakdown moves. When prices break through important support or resistance levels with significantly higher-than-average volume then it suggests a higher probability of a valid breakout or breakdown. Conversely, if a breakout or breakdown occurs with low volume then it may indicate a false move or lack of conviction in the market.

Considerations: It is important to note that it is not infallible and should be used in conjunction with other technical analysis tools while price-volume correlation can be a useful tool in TA. Market conditions and specific factors affecting a security can influence the significance of price-volume patterns.

Overall, price-volume correlation helps analysts to assess the strength and reliability of price trends and provides insights into market sentiment and dynamics. By examining the relationship between price and volume, investors can make more informed trading decisions and potentially identify potential reversals or trend changes.

Moving average (MA)

Moving average (MA) is a commonly used in technical analysis (TA) as an indicator that helps smooth out price data over a specified period of time. It is used to identify trends, generate trading signals and provide support-resistance levels.

Definition: A moving average (MA) is calculated by taking the average price of a stock or an indicator over a specific number of periods. Each data point in the moving average is equally weighted and as new data becomes available, here the oldest data point is dropped and the newest one is included.

Types of Moving Averages:

• Simple Moving Average (SMA): The simple moving average calculates the average price over a specified length of periods. It gives an equal weight to each period in the calculation.
• Exponential Moving Average (EMA): The exponential moving average gives more weight to recent prices, making it more responsive to recent price changes. It uses a smoothing factor to place higher weight on recent data.
• Weighted Moving Average (WMA): The weighted moving average assigns different weights to each data point in the calculation, typically giving more weight to recent prices.

Time Period: The time period used for calculating the moving average depends on the analyst's preference and the timeframe being analyzed. Common time length include 20, 50, 100 or 200 but it can vary depending on the analyst's strategy and/or present market conditions.

Interpretation: Moving averages are primarily used to identify trends and provide support-resistance levels. It suggests an uptrend when the price is above the moving average and while a price below the moving average indicates a downtrend. Moving average crossovers where shorter-term moving averages cross above or below longer-term moving averages that's are often used as trading signals.

Lagging Indicator: It is important to note that, moving averages are lagging indicators since they are based on past price data. They may not provide timely signals in rapidly changing markets or during periods of high volatility. So have to be more careful in the volatile market.

Multiple Moving Averages: Traders often use multiple moving averages simultaneously to generate more robust trading signals.

• For example, a popular strategy involves using a shorter-term moving average (e.g. 20 or 50-period) and a longer-term moving average (e.g. 200-period) and considering the crossover of these two averages as a signal.

Moving Average Convergence Divergence (MACD): MACD is also a popular indicator derived from moving averages. It subtracts a longer-term EMA from a shorter-term EMA to generate trading signals based on the convergence and divergence of these two averages.

Therefore, moving averages are versatile indicators that can be applied to various markets and timeframes. Analysts often combine them with other technical analysis tools to develop their trading strategies. It is important to test and validate by other trading strategies before using it in live trading.

Breakouts in technical analysis

Breakout is a common term of technical analysis (TA) that refers to a price movement of a stock, that breaks above or below a significant level of support or resistance often with increased volume. In short, a breakout refers to a significant price movement that happens when the price of an asset surpasses a certain level of resistance or support. This can be a strong signal of a potential trend reversal or continuation of an asset.

Examples of breakout patterns:

Bullish breakout: A bullish breakout occurs when the price of an asset breaks above a significant level of resistance. This can be a strong signal of a potential trend reversal, with buyers entering the market and pushing the price higher. It's also known as 'Resistance Breakout'.

• For example, if the price of a stock has been trading in a range between Tk. 50 and Tk. 60 for several months or a certain period of time, a breakout above Tk. 60 could signal a bullish trend or resistance breakout.

Bearish breakout: A bearish breakout occurs when the price of an asset breaks below a significant level of support. This can be a strong signal of a potential trend reversal with sellers entering the market and pushing the price lower. It's also known as 'Support Breakout'.

• For example, if the price of a stock has been trading in a range between Tk. 50 and Tk. 60 for several months or a certain period of time, a breakout below Tk. 50 could signal a bearish trend or support breakout.

Triangle breakout: A triangle breakout occurs when the price of a stock breaks above or below a triangle pattern. This pattern is formed by drawing two trend lines, one connecting the higher highs (HH) and another connecting the higher lows (HL). When the price breaks above the upper trend line then it signals a bullish breakout and when it breaks below the lower trend line then it signals a bearish breakout.

Head and shoulders breakout: A head and shoulders breakout happens when the price of an asset breaks below the neckline of a head and shoulders pattern. This pattern is formed by a peak (the head) between two smaller peaks (the shoulders) with a neckline connecting the lows. When the price breaks below the neckline, it signals a bearish breakout with sellers entering the market and pushing the price lower.

Trendline Breakout: Trendlines are drawn on a price chart to connect a series of highs or lows representing the trend direction. A trendline breakout occurs when the price breaks above a downtrend line or below an uptrend line indicating a potential reversal in the trend.

• For example, if a stock has been in a downward trend and the price breaks above the downtrend line it could be a bullish signal and called downward trendline breakout.

Moving Average Breakout: Moving averages (MA) are most commonly used technical indicators that smooth out price data over a specific period length like- 20, 50, 200 etc. A moving average breakout takes place when the price moves above or below of a moving average, suggesting a potential change in the trend.

• For example, if a stock's price crosses above its 50-day moving average, it may be considered a bullish breakout. On the other hand, if the price crosses below the moving average then it may be considered a bearish breakout.

It is important to note that, breakouts are not unfailing signals and can sometimes result in false moves or fake breakouts. Analysts, traders or investors often use additional technical analysis tools and indicators to confirm breakouts and make informed or gnostic decisions.

Support and resistance

Support and resistance are key concepts in technical analysis (TA) that help analysts, traders or investors to identify levels on a price chart where the price is likely to encounter barriers to its movement.

Support:

Support refers to a price level at which buying pressure is expected to be strong enough to prevent the price from falling further. It is seen as a floor beneath the price where demand for the asset is anticipated to exceed supply that causing the price to reverse or 'bounce' upwards.

Support levels are often identified as previous lows or areas where the price has historically found buying interest.

Resistance:

Resistance is just the opposite of support. It refers to a price level at which selling pressure is expected to be strong enough to prevent the price from rising further. It is seen as a ceiling above the price where supply of the asset is expected to exceed demand that causing the price to reverse or 'pull-back' downwards.

Resistance levels are often identified as previous highs or areas where the price has historically encountered selling pressure.

Support and resistance levels can be identified by using various methods and tools like:

• Horizontal lines: Analysts can draw horizontal lines on a price chart to point out key levels of support and resistance based on previous price reactions. These levels can act as reference points for future price movements.
• Trendlines: Trendlines are diagonal lines drawn on a price chart to connect consecutive high prices or low prices. They can act as areas of support (in the case of an upward trendline) or resistance (in the case of a downward trendline) as the price approaches them.
• Moving averages: Moving averages (MA) such as the 20-day, 50-day or 200-day moving average are popular technical indicators used to identify dynamic support and resistance levels. When the price approaches a moving average, it can act as a support or resistance level, depending on the direction of the moving average.
• Pivot points: Pivot points are calculated based on the previous day's price action and can help identify potential support and resistance levels for the current trading day. Traders use pivot points along with other technical indicators to determine potential price reversals or breakouts.

Support and resistance levels are significant because they provide analysts with important reference points for making future trade decisions. Analysts often look for opportunities to enter trades near support levels with the expectation that the price will bounce higher and they may consider selling or taking profits near resistance levels with the anticipation of a price reversal. These levels can also be used to set stop-loss (SL) orders or take-profit (TP) targets to manage risk and optimize trade outcomes.

Advantages of technical analysis (TA)

Technical analysis (TA) is a method used by analysts, traders and investors to analyze financial markets to making future trade decisions based on historical data like price and volume. While it has its critics but there are many advantages to using technical analysis:

1. Price and trend identification: Technical analysis helps analysts, traders to identify price patterns, trends and market behavior. By studying historical price charts, traders can identify patterns like support and resistance levels, trendlines, chart patterns and more indicators. This information helps traders to understand the overall direction of a market or a particular security.

2. Timing of entry and exit points: Technical analysis can help analysts to determine optimal entry and exit points for trades. Analysts can identify potential reversal or continuation patterns by analyzing charts and indicators which can assist in timing their trades. Technical indicators such as moving averages, relative strength index (RSI) or stochastic oscillator can provide signals for potential entry or exit points.

3. Risk management: Technical analysis helps analysts to manage risk by setting appropriate stop-loss (SL) levels and take-profit (TP) targets. Traders or analysts can use support and resistance levels, trendlines or volatility indicators to determine where to place stop-loss (SL) orders to limit potential losses. Technical analysis also provides insights into potential price targets allowing traders to set realistic take-profit (TP) targets.

4. Market psychology: Technical analysis takes into account market psychology and investor sentiment. It recognizes that market participants' emotions such as fear and greed can influence price movements. Analysts can gain insights into market sentiment and make more informed trading decisions by studying chart patterns and indicators.

5. Applicability to various markets: Technical analysis can be applied to various financial markets including stocks, commodities, currencies, bonds and cryptocurrencies. The underlying principles of technical analysis remain the same across different markets, allowing analysts to use similar tools and techniques to analyze price movements everywhere.

6. Efficient use of information: Technical analysis focuses solely on price and volume data rather than analyzing fundamental factors such as company economic or financials indicators. This makes it a more efficient method for analysts who want to make quick trading decisions without delving into comprehensive fundamental analysis.

7. Widely used by market participants: Technical analysis is widely used by analysts, traders and investors leading to self-fulfilling predictions. It can create buying or selling pressure, resulting in price movements that align with those indicators or patterns when a significant number of market participants follow certain technical indicators or patterns.

It is important to note that technical analysis also has limitations while it has great advantages. Technical analysis does not take into account fundamental factors such as company earnings or economic data or other financial factors which can have a significant impact on prices. Additionally, historical price patterns may not always repeat in the future and relying solely on technical analysis can be risky.

Therefore, many analysts, traders combine technical analysis with other forms of analysis such as fundamental analysis that called techno-fundamental analysis to make more well-rounded trading decisions for future trade.

Trendline used in technical analysis

A trendline is a graphical tool used in technical analysis (TA) to represent the direction and slope of a trend. It is created by connecting a series of significant price points on a chart such as the highs or lows of the price movement. Trendlines help analysts and traders visually identify and validate the presence of a trend whether it's an uptrend or a downtrend.

To draw a trendline, typically needs at least two points but more points can be used to increase the validity and reliability of the trendline. In an uptrend, a trendline is drawn by connecting the successive higher lows (HL) while in a downtrend, it is drawn by connecting the successive lower highs (LH). The resulting line acts as a visual representation of the trend and provides a reference for potential future price movements of stocks.

Trend lines can be drawn on different time frames like from intraday charts to monthly charts. It can signal a potential change in the trend and may provide a trading opportunity when a trend line is broken.

Trendlines can serve multiple purposes in technical analysis (TA):

1. Trend Identification: Trendlines help identify the prevailing trend in the market whether it is upward, downward or sideways. They provide a clear visual representation of the price direction of stocks.

2. Support and Resistance Levels: Trendlines can act as support or resistance levels where the price tends to bounce off or find resistance near the trendline. Analysts and traders often look for price reactions at trendlines as potential entry or exit points.

3. Trend Reversals: A break or violation of a trendline may indicate a potential trend reversal. Traders and analysts watch for such breaks as signals of a possible change in market sentiment.

4. Trend Strength: The slope or angle of a trendline can provide insights into the strength of the trend. Steeper trendlines indicate a stronger trend while flatter trendlines may suggest a weaker or more gradual trend.

It is important to note that, trendlines should be used in conjunction with other technical analysis tools and indicators to validate trading decisions. They are subjective and can be subject to interpretation. So it is essential to consider other factors and market conditions before relying solely on trendlines for trading decisions, means that analysts and traders often use additional technical indicators and chart patterns to confirm the trend and to make more informed trading decisions before trade.

Definition and types of trend

In technical analysis (TA), a trend refers to the general direction in which the price of an asset is moving over a given period of time. Understanding and identifying trends is crucial in TA as it helps traders and analysts make predictions about future price movements of stocks.

Here are some common types of trends in technical analysis:

1. Uptrend: An uptrend occurs when the price of an asset consistently moves higher over a time. It is characterized by a series of higher highs (HH) and higher lows (HL). Uptrends indicate a bullish market sentiment with buyers in control and demand outpacing supply.

2. Downtrend: A downtrend happens when the price of an asset consistently moves lower over a time. It is characterized by a series of lower highs (LH) and lower lows (LL). Downtrends indicate a bearish market sentiment with sellers in control and supply exceeding demands.

3. Sideways or Range-bound Trend: A sideways or range-bound trend occurs when the price of an asset moves within a relatively narrow range without making significant higher highs (HH) or lower lows (LL). In this type of trend, the market is considered to be consolidating and neither sellers nor buyers have a clear advantage.

4. Reversal Trend: A reversal trend refers to a change in the direction of the price movement. It indicates a shift from an existing trend to a new trend. For example, an uptrend may reverse into a downtrend or just vice versa. Reversal trends can be identified through price action signals, chart patterns, technical indicators etc.

5. Trendless or Choppy Market: A trendless or choppy market is characterized by erratic and unpredictable price movements without a clear trend in either direction. In such market conditions, it can be challenging to identify a reliable trend and traders may employ different strategies or focus on shorter term trading opportunities.

It is important to note that, trends can exist across various timeframes, ranging from short term intraday trends to long term trends spanning days, months or even years. Analysts and traders use different tools such as trendlines, oscillators, moving averages etc. to identify and confirm trends and make informed trading decisions based on their technical analysis.