Chart patterns that turn

Bigger shapes

So far you've looked at patterns made of one, two or three candles. Now zoom out. When you look at dozens of candles together, they can make bigger shapes. These are called chart patterns.

This lesson covers patterns that can mark a reversal, where a trend turns around.

The double top: an M

A double top happens after a climb. Price hits a high, dips, climbs back to about the same high, and fails again. Drawn out, it looks like the letter M.

The story: buyers tried twice to break the ceiling and failed both times. The second try often comes with less energy.

The low point between the two tops is called the neckline. This is the most important part. A double top is not finished until price breaks below the neckline. Until then, it's just a ceiling that held twice, and price might still break up through it.

The double bottom: a W

A double bottom is the mirror image. After a fall, price hits a low, bounces, falls back to about the same low, and holds again. It looks like a W. Sellers tried twice to break the floor and failed.

Here the neckline is the peak between the two bottoms. The pattern is complete when price breaks above it.

Head and shoulders

Head and shoulders is one of the most famous chart patterns. It shows up after an uptrend and has three peaks:

1. Left shoulder: a peak.
2. Head: a higher peak.
3. Right shoulder: a lower peak, about as high as the left shoulder.

Think about the stairs from the trend lesson. The head was a higher high. But the right shoulder is a lower high. The uptrend's staircase is breaking.

The neckline connects the dips between the peaks. When price breaks below it, many traders treat the pattern as complete.

There's also an inverse (upside-down) head and shoulders at the end of a downtrend. Three dips, the middle one the deepest, and a neckline above.

Measuring a target

Some traders measure the distance from the top of the pattern down to the neckline, then use that same distance below the neckline as a rough guess of how far price might fall. For example, if a double top sits at $60 and the neckline is at $54, that's $6, so they'd look at about $48. It's a guess, not a promise. Price often falls short, or goes much further.

What goes wrong

• Seeing it too early. Two peaks don't make a double top until the neckline breaks. Lots of "double tops" turn into breakouts up.
• Failed patterns. Price sometimes breaks the neckline, then turns right back. Chart patterns fail often.
• Shapes in the clouds. If you stare at charts long enough, you'll see heads and shoulders everywhere. The clear, obvious ones are the ones worth noticing.

Remember

• Double top (M): two highs at the same price after a climb. Double bottom (W): two lows after a fall.
• Head and shoulders: three peaks, the middle one tallest, and a lower right shoulder.
• A pattern isn't finished until price breaks the neckline.
• Targets are rough guesses, and patterns fail often.