Chart pattern allows a trader to interpret the market actions, judge a stock based on its price moment, and predict which direction the stock is moving for the short term. For a beginner, reading a stock chart may be difficult, but it is really not rocket science. Just like any other skill in life, chart reading is something you can acquire by practicing.
Fortunately, there are established chart patterns traders already developed since the beginning of the stock market. These patterns will help a new trader get a head start and learn to find his or her own unique patterns.
However, there are too many stock patterns out there that may overwhelm a beginner. In this article, we are going to list the top 5 stock chart patterns that are useful for penny stock traders.
#1 Support and Resistance
Support and resistance is one of the most basic yet important concepts in chart reading and technical analysis.
Let's take a look at the following IGC stock to explain what support and resistance are.
What is support?
In mid-August, the stock made a new high of $4.5 and then retraced for the next couple of weeks. The stock managed to stay above $1 in the following few months. $1 is what we call support. Each time the stock got closer to $1, it bounced right back.
It is reasonable to assume that whenever the stock approaches $1, it triggers a buy signal.
What is resistance?
At the same time, IGC failed to trade above $1.68 for the recent months. Therefore, $1.68 is the resistance for IGC. If a trader buys the IGC when it gets to $1, then he would sell the stock whenever it gets closer to $1.68.
Some stocks may trade in a price range for months or even years. The longer the stock trades in the range, the stronger the support and resistance are.
When a stock price drops below the support level, the support becomes the new resistance. Likewise, when a stock price goes above the resistance level, the resistance becomes the new support.
#2 Double Bottom Pattern
Double bottom is a bullish reversal pattern that signals a stock may already be trading at the bottom and the trend could soon be reversed.
Below is how a double bottom looks like and how it is formed.
In a negative trend, a stock reaches a bottom and then rallies without breaking the previous resistance. The stock then falls to the previous bottom (support) and fails to drop further. The stock rallies again and breaks its previous resistance, a double bottom pattern has established.
Let's take a look at a real chart of the double bottom pattern.
The stock IDEX dropped to a new low in late September. The stock then rose to resistance before falling again without breaking the previous low in early November. The stock then rallies again and breaks through the previous resistance which is when the double bottom pattern is officially formed.
Traders who recognized the double bottom pattern and went long on this trade would have captained great profits within a week, where the stock went from $1.15 to an intraday high of $4.75.
#3 Ascending Triangle Pattern
The Ascending Triangle Pattern is another powerful chart pattern that every trader should know. It occurs on an uptrend and indicates a continuation of the current trend.
Below is how the ascending triangle looks like and how it is formed.
Stock is moving up and forms an ascending triangle. The stock price then consolidates within the triangle before breaking out and goes high.
The ascending triangle indicates the stock may keep going in a positive direction, and it is time to buy the stock or add to an existing long position.
It would be a bad idea to short a stock when an ascending triangle forms.
Let's study the recent example of OBLG. The stock forms an ascending triangle from late July through early November.
$5 is the resistance level for OBLG and each time the stock moved closer to the $5 level, it pulled back until the break out on November 30. The stock rallies above the $5 resistance level on that same day and moves to an intraday high of $12.25.
Remember, a stock that breaks out of resistance, the resistance becomes the new support, so $5 is the support for OBLG.
#4 Triple Bottom Pattern
The triple bottom is an extension of the double bottom pattern. The triple bottom pattern doesn't occur as often as the double bottom but offers an even stronger signal.
Following is how the triple bottom pattern is formed.
A stock is in a downtrend
The stock reaches a bottom and then rallies without breaking the previous resistance.
Repeats step 2
When the stock rallies for the 3rd time, it rises above and breaks it's previous resistance
A triple bottom pattern has established.
I couldn't find a real example for the triple bottom pattern, so I will use the same stock IGC that I showed earlier for the support and resistance.
IGC hit a new high in August and then it pulled back to a new low of $1.06. The stock then rallies three times without breaking the resistance level of $1.68, and it pulls back twice without dipping below $1.06.
IGC finally breaks its resistance level on the fourth run. The stock then gapped up the next day before pulling back again. This chart looks more like a quadruple bottom rather than a triple bottom pattern.
#5 Big Drop Pattern
Last but not least, the "Big Drop Pattern". It is a secret pattern that I invented myself. After studying hundreds of stock charts and existing patterns, I came up with this pattern that has been working exceptionally well for me.
The Big Drop Pattern is more like a trading system than a pattern. Following are the criteria for it.
1. Stocks from $0.8 - $5 - Find penny stocks that are trading in the range of $0.8 - $5.
2. Stock Rallies Big Time Recently - The stock must rally big recently with huge volume. At the bare minimum, the stock should be up over 30% on a single day, or 80% on multiple days based on close price. The bigger the rise the better. The trading volume should be over eight million, and it should be way above the average volume for the stock.
3. Falling at Least 40% From Recent Closing Price - If measured by closing price, the stock should be falling at least 40% or 65% from intraday high. More importantly, the volume should be light during the pullback period compared to the day that it spiked. The pullback period may last anywhere from a few days to a few weeks.
Let's take a look at a real chart example, EVK.
EVK is within our price criteria of $0.8 to $5.
On October 22, the stock spiked with a huge volume of over 149 million which is way above the average trading volume for the stock. The stock made an intraday high of $6.76 which is almost a 587% jump from the previous day's closing price of $1.15.
EVK then falls almost 74% from the recent high in 3 weeks.
Hence the stock qualifies for our Big Drop Pattern and we should add it to our watchlist.
There are two other signals that give us a bullish signal for the stock.
EVK stops declining and it's price consolidates
EVK stays above the support level at $1.65 that was established on Oct 19 before the big rise.
I entered a trade around $2.02 for EVK on December 1st and profited handsomely when the stock rose big time on December 3rd.
I'm showing you the screenshot not to brag, but just to prove that the system works if you can execute it with strict discipline.
Don't expect a 200% gain overnight to be the norm, it's not. There are many times the pattern fails, and I had to cut losses and move on to the next trade.
To learn more about the Big Drop Pattern and how I use it to trade penny stocks, read my step by step penny stocks trading guide.
I only trade penny stocks and tested the Big Drop Pattern for stocks that are listed on the NASDAQ, NYSE, and AMEX. I don't know how well or if the pattern works at all for the OTCBB market.
There are many other useful patterns that you should learn such as descending triangle, head and shoulders, cup and handle, symmetrical triangle, bull flag pattern, and other classic patterns.
You can search them online or read the book Technical Analysis of the Financial Markets for an in-depth study and explanation of all the popular chart patterns and technical indicators.
Personally, tweaking and combining multiple chart patterns gets me the best result.
By using existing chart patterns as a baseline, you can build patterns that work the best for yourself. You can modify or expand the Big Drop Pattern so that it works well for you too.
Stock chart patterns give traders an edge in the stock market. However, a wise trader knows that patterns are not bulletproof. From time to time, patterns fail. If it does not, everyone would have become a penny stock millionaire by following the classic stock chart patterns.
What differentiates a winning trader from a losing one is the actions taken when a pattern fails.
The winning trader cuts his losses short and moves on to the next trade quickly, whereas a losing trader hangs on to his losing position and allows a small loss to turn into a monster loss.
No matter how good a pattern looks, do not fall in love with it. Unfortunately, falling in love with a stock or a trade is one of the top trading mistakes beginners often make.
Chart reading is a necessary skill that every trader should have. However, charting read is not a science, it merely gives you an edge in the market.
In order to trade successfully in penny stocks, a trader must learn to be disciplined and control his or her emotions. Combining chart patterns and trading psychology is the only key to trading success.
Get a free penny stocks guide with a secret chart pattern that I use to make 200% on a single trade. Get access to our intraday penny stock screener for free.
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