Investors using technical analysis use stock chart patterns to identify buy and sell points. Thomas N. Bulkowski’s reviewed 53 chart patterns in his book Encyclopedia of Chart Patterns (Wiley Trading). Other technical analysis books list some of the same stock patterns and then add their own. Many investors have their favorite chart patterns that they understand and have worked for them in the past. Others use patterns they have encountered in the past without knowing whether the work well or not. What are the best performing stock patterns?
Bulkowski’s Chart Pattern Study
As an investor, Bulkowski recognized that even when the fundamentals said the stock was a buy, often the price would fall rather than rise. After spending some time with Technical Analysis of Stocks and Commodities, a magazine that focuses on technical analysis, he realized that stock chart patterns offered additional tools for investors. Like many investors who use technical analysis, he found that many patterns work “most of the time”. As an engineer, Bulkowski wanted to know what this really meant. He was unable to find any specific research that gave him the statistics of success and failure of any chart patterns. Frustrated, he wrote the book mentioned above that includes the statistics on how to identify a chart pattern, while measuring success and failures. As a tool, this book is well worth its cost, as it helps you identify stock chart patterns. More importantly, it provides you an analysis of the success and failure of the chart patterns over a five-year period from 1991 through 1996.
Best Stock Chart Patterns for Bulls
Bulkowski performed an in depth analysis of each pattern. Through this analysis, he identified the best performing bull patterns and the best performing bear patterns based on a composite score that included average gain, likely gain, and failure rates. In his analysis, he only focused on stocks. Market indexes were not analyzed.
The best stock chart patterns for bulls in alphabetical order are:
- Ascending Triangles
- Double Bottoms
- Falling Wedges
- Reverse Head and Shoulders Pattern
- Rectangle Tops, up breakout
- Rounding Bottoms
- Rounding Tops
- Symmetrical Bottoms Triangles within a downtrend, up breakout
Best Stock Chart Patterns for Bears
The best stock chart patterns for bears in alphabetical order are:
- Broadening Bottoms, down breakout
- Broadening Formations, Right-angled and descending
- Broadening Tops, down, breakout
- Descending Scallops
- Descending Triangles
- Head and Shoulder Tops
- Rectangle Bottoms, down breakout
- Symmetrical Triangles, down breakout
Why Stock Chart Patterns Work
Investors use chart patterns seek to identify stock market trends and reversals. The objective is to use price patterns to identify the points where buying overcomes selling for a move up or where selling overcomes buying for a move down. Chart patterns interpret investor behavior using price changes as the indicator. For example, many investors bought stock of XYZ Company on a news announcement at $30 per share. Since then the price of these shares fell after the news to $20 frustrating the investors who bought at $30. Finally, the price begins to climb again. As the price nears or reaches $30, many of the investors who bought at $30 see an opportunity sell so they breakeven. This increased selling causes the price to turn back down. Later the price resumes its climb to the $30 price level, where it once again encounters new selling. Once again, the price retreats to a lower level. On the next try to climb through $30, the price is able to push through as new buying volume encourages additional buyers to join overcoming the selling pressure. As a result, the price overcomes the resistance at $30 and climbs further. Throughout this price action, investor behavior can be identified using the price activity.
Stock chart patterns offer investors affective tools to identify buy and sell points of a company’s stock. Stock chart patterns offer a method for investors to interpret the movement of a company’s stock, identifying buy and sell points. Based on a comprehensive study by Thomas Bulkowski investors have an important tool to improve their trading investing experience. Investors who use the best stock chart patterns to time their entry and exit from a position have an advantage over those the solely rely on fundamental analysis.
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