Chart patterns are the foundation of technical analysis, providing a framework for traders to interpret market movements. Basic patterns such as head and shoulders and double tops, will always be critical, but advanced patterns offer key signals that create a competitive advantage for traders!
In this article, we’re going to explore seven advanced chart patterns that can take your trading to the next level:
- Discover complex chart patterns that indicate high-quality trade setups.
- Understanding the psychology behind these patterns leads to better decision-making.
- And include practical strategies to trade these patterns.
Let’s explore these potent patterns and when to apply them within your trading plan.
1. Harmonic Patterns
What Are Harmonic Patterns?
Harmonic patterns are highly structured and based on Fibonacci ratios. These patterns aim to predict future price movements by identifying potential reversal zones.
Key Variants
- Gartley Pattern: Indicates potential trend continuation or reversal.
- Butterfly Pattern: Signals reversals near market extremes.
- Bat Pattern: Similar to the Gartley but with a deeper retracement.
- Crab Pattern: Features an extended price leg for pinpoint accuracy.
How to Trade Them
- Use Fibonacci retracements to identify harmonic patterns.
- Enter trades at the potential reversal zone.
- Place stop-loss orders just outside the pattern’s invalidation point.
Example
If a Gartley pattern forms with retracements at 61.8% and extensions at 127.2%, these Fibonacci levels mark critical entry and exit points.
2. Wyckoff Accumulation and Distribution
What Is the Wyckoff Method?
This method, developed by Richard Wyckoff, identifies accumulation (buying) and distribution (selling) phases in the market. The patterns are based on supply and demand dynamics.
Anatomy of the Pattern
- Accumulation: A sideways range where smart money is buying.
- Distribution: A sideways range where smart money is selling.
How to Trade Them
- Accumulation Phase: Look for breakout opportunities as the market transitions to an uptrend.
- Distribution Phase: Short the market on breakdowns as the market moves into a downtrend.
Example
During the accumulation phase, price forms higher lows within a range. Enter a long trade when the price breaks out of resistance with strong volume.
3. Diamond Pattern
What Is a Diamond Pattern?
The diamond pattern forms when price volatility expands and then contracts, resembling a diamond shape. It typically signals a trend reversal.
How to Spot It
- Identify a broadening formation (higher highs and lower lows) followed by a narrowing range.
- Confirm the breakout direction for trading.
Trading Strategy
- Bearish Reversal: Short the market when the price breaks below the diamond’s support.
- Bullish Reversal: Enter a long position on a breakout above the diamond’s resistance.
Example
If a stock moves from $100 to $120 (broadening) and then consolidates into a diamond, a breakout below $110 could signal a short opportunity with a target at $90.
4. Three Drives Pattern
What Is the Three Drives Pattern?
The three drives pattern consists of three consecutive price moves (or “drives”) in the same direction, followed by a reversal.
How to Spot It
- Each drive completes at a Fibonacci extension level (127.2% or 161.8%).
- Symmetry between the drives and retracements enhances reliability.
Trading Strategy
- Enter a trade in the opposite direction after the third drive completes.
- Use Fibonacci extensions to determine entry and stop-loss levels.
Example
In a bullish three drives pattern, if prices extend to 127.2% on the third drive, this is a potential reversal point for a short trade.
5. Broadening Formation
What Is a Broadening Formation?
Also known as a megaphone pattern, the broadening formation shows increasing volatility, with price making higher highs and lower lows.
Why It Works
This pattern reflects market indecision, often preceding major breakouts or breakdowns.
How to Trade It
- Enter trades in the direction of the breakout.
- Set a stop-loss near the opposite side of the formation.
Example
A stock oscillates between $50 and $70, gradually expanding its range to $40–$80. A breakout above $80 could indicate a strong uptrend with a target of $100.
6. Wolfe Wave
What Is the Wolfe Wave?
The Wolfe wave is a reversal pattern consisting of five waves. It is based on natural market cycles and predicts precise price targets.
Anatomy of the Pattern
- Waves 1 to 4 create a converging channel.
- Wave 5 extends beyond the channel, signaling a reversal.
Trading Strategy
- Identify the fifth wave and draw a line connecting waves 1 and 4.
- Enter a trade when the price reaches the fifth wave.
- Target price = Intersection of the 1–4 line with the extended trendline.
Example
If the Wolfe wave channel is between $100 and $120, and wave 5 reaches $80, the target price would be the point where the 1–4 line projects upward.
7. Island Reversal
What Is an Island Reversal?
An island reversal occurs when a price gap separates a small consolidation area from the prevailing trend, signaling a major reversal.
How to Spot It
- Look for a price gap before and after the consolidation.
- Identify a cluster of candlesticks isolated by the gaps.
Trading Strategy
- Enter a trade in the direction of the gap.
- Place stop-loss orders within the consolidation range.
Example
If a stock gaps down from $100 to $90, consolidates, and then gaps back up above $95, this signals a bullish reversal with a target of $110.
How to Use Advanced Chart Patterns Effectively
Combine with Indicators
Pair these patterns with technical indicators like RSI, MACD, or moving averages for confirmation.
Risk Management
- Use strict stop-loss orders to limit potential losses.
- Avoid over-leveraging and keep risk-to-reward ratios favorable.
Backtesting
Practice identifying and trading these patterns on historical data to improve accuracy.
Trading Psychology
Stay disciplined and avoid forcing trades that don’t align with pattern rules.
Conclusion
However, learning higher level chart patterns could help you dominate trading by reserving things such as harmonic patterns, wyckoff accumulations, diamond formations, three drives, broadening formations, wolfe waves and island reversals. Similar to fibonacci retracements, they each offer valuable insights into market psychology and price action, enabling you to better predict what will happen next.
Once you have learned these patterns, practice combining them with advanced features craftily like volume analysis or Fibonacci retracements for higher accuracy. And it takes practice, but you can hone your craft, and be successful in the markets consistently.
The subsequent stage in your trading adventure may include calculation backtesting to check how these designs perform in different market conditions.
