Understanding patterns - PART 1Patterns have been in use for as long as technical analysis have existed and are working today also, traders all over the world try to find patterns in chart to anticipate the possibility of the next move for any Index or stock. Pattern have a reason for working this greatly because all the patterns have an underlying psychology behind it and all these are driven by none other than the human emotions that lie behind them.
What are patterns?
According to John J Murphy "Price patterns are pictures or formations, which appear on price charts of stocks or commodities, that can be classified into different categories, and have a predictive value."
Putting it simply these are formations of candles which take a special shape when seen together and give you an idea of the future possible move of any script.
Why do patterns work?
Patterns work because they are the depiction of human emotions in the market and clearly shows what the traders in the market want a stock or commodity to do in a particular timeframe, now it must be odd and you may be thinking that how can a simple pattern or movement of the candles can tell you what is going inside the minds of people. Let me give you an idea so that you understand what is it that I mean by reading the minds of the traders using pattern and understanding what they want a particular stock or commodity to do.
The chart that you see above is hindalco which is listed on NSE.
To understand this let me tell you about the white lines you see, these are called trendlines and are made by connecting highs to highs or lows to lows to get an idea of the trend on current ongoing move or to make a pattern.
The pattern you see above is called ascending triangle pattern and is a bullish structure that when gives a breakout the stock or commodity gives a run for the upside.
Now the answer to the the question why ascending triangle pattern is bullish and how we get to anticipate the future movement lies in the human emotion or psychology that made this pattern in the market and it will also explain how you understand the human emotion in the market depicted as pattern.
This ascending triangle pattern is made by joining two line which I have named as trendline 1/resistance & trendline 2/support.
Trendline 1/Resistance shows us that the bears are not willing to let the price go beyond the levels of 470 and are shorting the stock near that price. Bears are wanting the stock to remain below the 470 price level.
Trendline2/Support tells us that the bulls are buying the stock on higher prices again and again that's the reason the trendline is inclined, bulls are wanting the stock to go up.
Now all of this tells us that right now bulls are more aggressive than the bears as bears are not willing to short below the price of 470 but bulls are ready to buy the stock at higher price and are the reason the price keeps surging up.
There comes a time when both the lines meet and there is no buffer space left between buyers and sellers and the price can now only go in single direction now, so bulls being more aggressive breaks the resistance of 470 and the price moves above it. Now there are two things that are going to happen:
1. More buyers will come in to buy as the resistance is broken making the price rally even more.
2.Short positions will have to be covered for, which will yet again make the price move up.
So that is how a mere pattern of a triangle joined by two line made you see the emotions of the traders inside the market and thus anticipate the future movement of price. Now this concept applies to all of the patterns there are in the market, some will be as simple as this one while others being more complex but all of these will make you a better trader letting you anticipate the movement.
This was the end of Part one of this series in which I'll be trying to make you understand patterns and trade more effectively using them.
The Next part will be the two main categories of pattern which will be in more depth and will actually help you anticipate the prices and add these pattern into your trading style.
If you have read it far enough so please give it a like and do follow me for the next part which I'll try to drop on the next weekend.
