As we have observed, when the market reaches significant support or resistance levels, it often rebounds or breaks through (except for false breakouts, of course). Clearly, if you can predict the market's direction, you can reap substantial profits.
Unfortunately, the market is unpredictable, but the benefit of technical analysis is that various chart patterns often recur. If you can learn to identify such patterns, such as when they begin to form, you can often gather clues about the next price movement.
Remember that such patterns are by no means foolproof and can only serve as a guide to the market's future direction.
Double Tops and Double Bottoms
Double tops and double bottoms are reversal patterns that indicate a sustained trend may be about to reverse.
After two consecutive waves of highs followed by retreats, two peaks form on the chart, commonly referred to as a double top. The low point between these two highs is called the 'neckline,' and the pattern breaks through this level to reach its peak.
In this case, the second top does not exceed the initial high. This indicates that the uptrend may be about to end and could reverse. If you intend to trade based on this pattern, you can look to make short trades below the neckline when the pattern is fully formed (especially if another pattern may be forming, such as a 'triple top' - see below).
Trading using patterns like double tops has the advantage of having price targets. In other words, you can predict the potential drop after the price breaks the neckline. The drop is usually equivalent to the distance from the neckline to the peak, as shown in the figure above.
The principle of a double bottom is the same as that of a double top, but in the opposite direction. A double bottom indicates a reversal from a sustained downtrend to an uptrend.
Triple Tops and Triple Bottoms
Triple tops and triple bottoms are roughly the same as double tops and double bottoms, except that the market reverses after touching the support or resistance level three times instead of two.
Head and Shoulders Top
This is another type of pattern that indicates a trend reversal. Very similar to the triple top, the head and shoulders pattern has one peak (shoulder), followed by a higher peak (head), and then a lower peak (another shoulder). As shown in the figure below:
The neckline forms between the two troughs on either side of the head. If the neckline slopes downwards, it releases a stronger reversal signal. You can calculate the target price based on the distance between the head and the neckline: this distance is the target drop from the breakout point.
It is worth noting that the head and shoulders pattern only fully forms after breaking the neckline. At this point, the target is formed.
The principle of the head and shoulders bottom pattern is the same, just in the opposite direction.
