In the last two updates on Price Pattern we looked at the major
patterns that the market presents us with. These included patterns such
as Head and Shoulders, the Rounding or Cup and Handle pattern,
Triangles and rectangles etc (see Price Patterns 1 and 2 for details).
In this section, we shall take up the smaller price patterns, which
occur frequently and are of considerable use in trend interpretation
especially for short-term traders.
They are basically variants
of the same patterns but over a smaller time frame. One of the first
points to be realized is that Minor patterns will occur in the shorter
term trends and are therefore likely to be found in Daily and Intra day
charts. These patterns are NOT to be looked for in the higher degree
charts like Weekly and Monthly charts.
As a matter of
convenience, we have also included Gaps in this discussion, as it is
more a part of the daily charts than the higher term charts.
GAPS
Price gaps occur when there is
some extra emotion generated about a stock overnight or intra day. As a
result of this extra emotion, people rush in to buy or sell at certain
price levels, which are beyond the price levels last seen. Traders are
in such a hurry to execute that they willingly let go of several points
from the last close. This creates a pocket of price area where no
trading occurs. For example, if a stock closes at 360 today and there
is some fresh development overnight, which makes everyone bullish, and
then there will be a rush of buy orders tomorrow. But there may be no
sellers at 360 and the bunched up buy orders will prevent any trade
below this level. A seller may emerge only around say, 365 and the
first trade will take place there. This will leave an untraded price
area between 360 and 365 that will appear as a gap on the price charts.
As
explained above gaps occur when some sudden new development occurs
which is deemed to affect the trend either positively or negatively.
The appearance of a gap on the charts is therefore a sign of warning of
a possible change in the trend status. It will either accelerate or
reverse. In order that we may understand gaps better they have been
classified as follows :
Normal gap :
These are gaps
caused by non-emotional factors such as dividends and other benefits
that companies dole out. They have no significance. |
Breakaway gap :
This is
gapped move past a zone of congestion or a price pattern, which leads
to the end of that phase of the trend. The gap will start a new trend
in the direction of the trend. |
Run-away gap :
This leads to
strengthening of the trend that is launched by the earlier gap and
therefore this would be the second gap in the sequence. Sometimes there
are more than one run away gaps when the trend strength is very high. |
Exhaustion gap :
This is the
last gap in the sequence and ends the rapid acceleration in the trend.
Many times it is difficult to find the exhaustion gap on the charts as
the prices form the gap and reverse the same day. So the only way to
spot is to check the previous high and the current open and this is
where the gap will be. The reversal will carry the prices below the
opening gap up and therefore the price bar may look like a normal one.
It requires some training to be able to catch the exhaustion gap. |
In
the chart above a few break away or common gaps are shown. Note the
marking EG signifying an exhaustion gap. Note that the prices open
above the previous day high and then moved slightly higher before
selling emerged to close the gap the same day. There are no run away
gaps in this chart example. If there were more than one gap in
succession, the second one would be called the run away gap.
Gaps are generally seen around price patterns and most of these show a resolution with an upside or downside gap.
Gaps
act as future support (during reactions in an up trend) and resistance
(during rallies in downtrends). If the gap area is wide, then the mid
point of the gap too acts as a support or resistance.
A gap that is immediately closed i.e. prices trade back into the gap area loses its trend signaling significance.
Flags and Pennants
These are small
rectangles (flags) or triangles (pennants) that form on daily charts
(mostly) and weekly charts (occasionally). They are part of a fast
moving market and therefore signify – as the larger patterns convey – a
temporary halt in the trend that will be resumed. The flag or pennant
is seen only in the fast paced area of the trend. Therefore, the
formation of a short term rectangle or triangle, has to be preceded by
a rapid, almost vertical rise which is called the “flag” of the pole
and following this rapid rise, the prices consolidate for a few days in
a narrow range. If the consolidation occurs in the form of a rectangle,
then it is known as a flag, if in the form of a triangle, then it is
known as a pennant.
Volume
patterns within flags and pennant remains the same as in rectangles and
triangles. They should be high during the formation of the pole of the
flag and then dry off while the flag is being formed.
Usually,
the number of days taken to form the flag or pennant consolidation
should not take more than twice the time taken to form the pole. If it
extends beyond that, the pattern is more likely to fail.
Inside Days
When the trading
range of one day is completely enclosed within the trading range of the
earlier day, the pattern is known as an Inside day i.e. the current bar
is completely “inside” the previous bar. This type of trading pattern
indicates confusion or lack of decisiveness among the participating
people in the market. One should therefore be on the look out for a
move beyond the levels of the Inside day and the trend is resumed in
that direction of the breakout. |
Outside Day
This is the
opposite of an inside day. The entire range of trading for today is
beyond the entire range of the previous day. This shows that the market
has had a volatile but decisive day. Usually, one finds outside day
patterns at the end of long moves or at the end of a congestion. A new
trend usually emerges from this pattern. This kind of pattern is also
sometimes known as a Reversal bar. If the prices fall to a new low and
then rise up sharply to form an Outside day with a close near the top
and beyond the previous day close, it is also known as a Key Reversal
Day. |
Narrow Range Day
Sometimes
stocks will reduce volatility to such a level that the range for the
day (i.e. the distance between High and Low) is quite small. Such days
are known as a Narrow Range day. They generally indicate a state of
confusion or indecision. Normally, narrow range (NR) days following
days of volatility or sustained trended movement is a signal that the
trend is about to reverse. Usually referred to as NR4 or NR7 (narrowest
range in four or seven trading sessions) they can be used as a good
trend change detection patterns. |
Dynamite Triangle
These are small
coil shaped formations lasting three days and are composed of two
inside day patterns. That is, one inside day followed by another
smaller inside day, giving the appearance of a coil. The name is given
because, this pattern shows the presence of high indecision and market
seldom remains in this state. Hence, we usually see a rather explosive
breakout from such a pattern. A gapped breakout is a must from such
patterns. The jump, as the name conveys, has to be explosive. And that
can happen only with a gap
 |
 |
    |
  |
| Inside Day |
Outside Day |
Narrow Range |
Dynamite Triangle |
One day and Island Reversal
Though
these are being clubbed with the minor patterns, their significance is
more long term than the others discussed earlier. They are seen at the
end of long or strong moves and completely reverse the trend in the
other direction. They are not seen often and therefore when seen,
should be respected. A One day Reversal is formed when the market moves
in one direction, gaps away from the price levels in the same
directions the next day but on the third day, the prices once again gap
back in the reverse direction, leaving one isolated bar at the end
which is away from all the price action.
An Island Reversal
pattern occurs when a similar action as above occurs except that the
after the first gap, there are several days in the same area
below/above the gap followed by a fresh gap in the new direction. This
leaves several bars between two gaps (in opposite directions) and so
the pattern is called an Island Reversal.
The following charts will explain the concept.
|