Chart Patterns: Head and Shoulders, Triangles, Flags

Chart patterns are recurring shapes on price charts that traders have observed to precede directional moves. They are not inevitable, but they appear frequently enough that many traders act on them—which makes them self-fulfilling to some degree.

Head and Shoulders

A head and shoulders pattern forms when a stock makes three peaks: a left shoulder (high), a head (higher high), and a right shoulder (high again, but lower than the head). A horizontal line drawn through the lows of the two shoulders is called the neckline. When price breaks below the neckline, it's traditionally interpreted as a reversal from uptrend to downtrend. The profit target is often estimated by measuring the distance from the head to the neckline and projecting it downward from the neckline break level.

Triangles

A triangle forms when price is moving in a narrower and narrower range—the highs are getting lower, the lows are getting higher, and the distance between them shrinks toward a point. This squeeze represents indecision; as the point approaches, a breakout usually follows, and the direction of that breakout often carries the next significant move. A break of the upper trend line is a buy signal; a break of the lower trend line is a sell signal.

Flags

A flag is a brief consolidation (a pause) in an otherwise trending move. A stock rallies sharply, then moves sideways or slightly counter to the trend for a few days or weeks, then resumes the original trend. Traders watch for flags as a chance to add to a position—you buy the dip in an uptrend, knowing that the flag is usually just a rest before the move continues.

• Patterns are tools for identifying high-probability setups, not guarantees.
• A pattern's validity increases if it appears on multiple timeframes.
• Volume confirmation strengthens the signal.
• A pattern that 'should' happen sometimes doesn't—always use a stop loss.