Investors determine price patterns - which rise, fall and sometimes move horizontally - with buying enthusiasm in a bull market, driving prices higher, and create a bear market with strong selling, sending prices lower. A rising price pattern is developed in the market or an individual stock by having more buyers than sellers, so the price or index rises, creating an uptrend.

From this rising phase, one or two things will happen next. Either the rising trend will plateau or become horizontal in nature, or the trend will become completely reversed and head downward. This creates a falling phase of the price pattern. In the case of the horizontal pattern or plateauing effect, the number of buyers to sellers remains somewhat equal in numbers and therefore the price remains somewhat flat. If the number of sellers begins to rise over the number of new buyers, then the falling phase comes into play and a downward trend is clearly recognizable.

Price patterns are broken down into two different types: reversal and continuation. In order to truly find your game in technical analysis, you need to clearly determine the difference between the two, and predict the type as it is forming, not after it has formed. To understand price patterns it helps to understand trends and trendlines.

It is the reversal price pattern that determines a change in the trendline. And it is the recognition of the continuation price pattern that a chartist must use in determining that an uptrend is continuing and not plateauing or reversing altogether. It is points of resistance that often signal a slowdown in the upward movement of an issue and thus create either a horizontal or a falling price pattern. Technicians agree that one should always assume, when looking at trends, that the prevailing trend exists will remain until the opposite trend is proven to have taken over and cause a reversal.
Volume tells us a lot about price patterns and trend reversals as it plays an important role in many indicators.

In his book "Technical Analysis of the Financial Markets", John J. Murphy writes some important information to bear in mind when studying various patterns. To him these are the "preliminary points that are common to all of these reversal patterns":

1. A prerequisite for any reversal pattern is the existence of a prior trend.
2. The first signal of an impending trend reversal is often the breaking of an important trendline.
3. The larger the pattern, the greater the subsequent move.
4. Topping patterns are usually shorter in duration and more volatile than bottoms.
5. Bottoms usually have smaller price ranges and take longer to build.
6. Volume is usually more important on the upside.
   

We explain these points throughout this four-part series on price patterns. To conclude this first part, here is a chart of Nortel Networks: what do you see on the chart as far as price pattern reversal and how volume might play into this scenario?
 

Chart Created with Tradestation

Here are the other parts of this series: In part 2 we look at head-and-shoulder (HS)patterns;  in part 3, we continue the study of HS patterns and their relationship with volume; and in part 4, we look at triple and double tops and bottoms.

by Investopedia Staff, (Contact Author | Biography)

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