Have you ever been intrigued by the way traders seemingly can predict price changes with mysterious arrows, shapes, and patterns? There is nothing random about it: they are using the ages-old know-how of stock market traders. In this guide, the ChangeHero team will demystify their tools, so you will be able to use chart patterns to capitalize on price dynamics, too.
- Like in the stock market, prices in the crypto market do not move randomly: they follow the same principles. As such, the chart patterns that originated in stock market technical analysis, based on crowd psychology, work here, too;
- Some chart patterns show when a trend is about to change or reverse. They include cup and handle, head and shoulders, wedge and diamond patterns;
- The other type of pattern signals a trend continuation. Triangle, channel, rectangle, flag, and pennant patterns belong to this kind.
What is The Difference Between Stock Trading Patterns vs. Crypto Patterns?
There is no huge secret behind crypto chart patterns — they are virtually the same as the ones originating from the stock market. It shouldn’t be too surprising: the price chart structure with candles to indicate the prices is essentially the same here!
A crucial difference between the stock market and crypto markets is that the latter works without closing around the clock. This does not seem to have any influence on the way these markets work, and other than that, the crypto trading experience is generally the same.
It is true that cryptocurrencies have some indicators unique to this type of asset and therefore, trading it. It mostly concerns the on-chain metrics, such as network activity or the number of addresses. When it comes to crypto chart patterns, though, there is no evidence that they are any different from the original stock patterns. And luckily, there are a lot of accessible materials to teach you about those — this guide included.
What Chart Patterns Can Tell You
Generally speaking, crypto chart patterns are divided into several categories depending on what they are useful for. Some patterns are helpful to indicate a trend continuation, while others can signal that a trend is about to change. They are categorized as continuation and trend reversal patterns, respectively.
Likewise, there are trends that act as bullish and bearish signals. Both continuation and reversal patterns can be either bullish or bearish, depending on when they occur. A pattern can double as a bullish signal if it indicates the continuation of an uptrend or a reversal of a downward trend. The same goes for bearish patterns.
There is a category of traders who capitalize on the changes in price — swing traders. They are typically on the lookout for reversal patterns. However, continuation patterns are equally informative to them: if they notice one, they wait it out or correct the course of action.
Should you watch for any signals if you are not a day trader? Most patterns can be applied to different time frames, so even if you trade only occasionally, you can keep an eye on daily or weekly charts.
How to spot the patterns on a chart is another question. Ideally, you should be able to identify the signals as they form, so how do you acquire this skill? Practice is key but you should also know what exactly to look for. Let us list and describe the most common crypto chart patterns with their meaning.
There are multiple crypto chart patterns that point to a potential reversal of a trend: after their formation, the price movement usually changes its direction. By noticing these patterns, you can anticipate when the price of a crypto asset will shoot up or dump.
Cup and Handle
One of the most well-known and effective signs of a trend change is a cup-and-handle pattern. It looks like a U-shape, with the price dipping, slowing down and consolidating, and slowly getting back up. The second part of the cup and handle pattern is a sharp rejection or a brief downtrend that forms the handle.
The pattern usually resolves with a breakout to the upside, so “cup and handle” is a bullish pattern. Traders usually place buy orders after the pattern is confirmed with this breakout from the “handle”. Another helpful indicator that cup-and-handle provides is how long should you go: the usual target is the depth of the “cup”.
Rounded Top and Rounded Bottom
The rounded bottom is a similar crypto chart pattern but it does not have the “handle” part. Instead, the price gradually breaks out above the neckline. This pattern leaves a lot to the trader’s interpretation, so it is not very reliable. Nevertheless, those who use it place their orders after a successful breakout at the same height as the difference between the bottom and the neckline. A rounded top pattern is also sometimes observed, meaning the inverse of this pattern.
Head and Shoulders Pattern
Another well-known and recognizable pattern is “head and shoulders”. It exists in two variations, normal (which is bearish) and inversed (bullish). The head and shoulders chart pattern has three peaks (or bottoms), with the second one being higher (or lower) than the first and the third ones. The support (or resistance) levels the price pulls back to between the peaks is called the neckline.
A common strategy after a head and shoulders pattern has resolved is to place an order at the height of the head to the neckline.
Triple Top/Bottom, Double Top and Double bottom pattern
Double top or double bottom pattern and triple top or bottom are similar to the pattern described above. They occur under similar circumstances when the buyers and sellers are trying to one-up each other. A noticeable difference is that the second or third attempts land at the same support or resistance levels as the previous ones.
The bounces during the formation of this pattern form a neckline, and traders place the first target after seeing it on the chart at the same depth as the neckline and support/resistance.
The next chart pattern takes a bit longer to form. Wedges are in between channels and triangles in shape but unlike them signal a reversal. A rising wedge is formed between a rising resistance level and a steeper support, and a falling wedge is formed by a declining support level and a steeper resistance. Unlike the previously described patterns, for wedges, there is no definite number of touches between the lines. These patterns occur both halfway through and at the point of exhaustion of a trend, or amid a short-term trend change. The resulting breakout can take the price of an asset to at least the level at which the second touch of the wedge took place.
Another reversal pattern worthy of mention is diamond: it can be tricky to spot in the making, so it is not as popular. A bearish diamond at the market top is believed to occur more frequently than a bullish diamond at the bottom. This pattern is different from the rest because it is not confirmed once it is fully formed. Only when the price reaches the diamond height after the breakout, do traders place their orders.
Chart patterns that don’t signal a trend change can be helpful as well. They help traders determine whether to keep holding or take profits.
Rectangle chart pattern
When you see the price bouncing between the same support and resistance levels for a while, you are looking at a rectangle pattern. It is a neutral pattern, since the stalemate between buyers and sellers, in which no side has a clear advantage, can be resolved either way. The only thing you can expect for certain is that a breakout after this consolidation will be powerful.
If the support and resistance levels are rising or descending in parallel to each other, it is a pattern typical for consolidation phases as well — a rising or descending channel. Unlike rectangles, these patterns demonstrate the influence of a larger trend but channels are also neutral and show indecision on both sides. Channels are easier to pinpoint because to be considered valid, the price has to touch each trend line at least three times. Like with rectangles, the stalemate can be resolved either way, but there is a slightly higher probability that a breakout will be in the opposite direction to the trend direction.
A chart pattern that looks like a channel is a flag: it is also formed by two parallel trend lines. Flags can be bullish or bearish and have two important distinctions from channels. Firstly, a flag is a short-term pattern, forming for a few weeks at most. Secondly, it has to have a “pole” part: a large move up or down that precedes the short-term volatility.
Flags often interrupt impulse moves but resolve in continuation. A common strategy is to take the height of the pole and place an order at the breakout plus the pole size. Flags can also form series, and the second flag will usually be sharper than the first.
When the price moves similarly but the trend lines between which the price is bouncing are converging, this pattern is called a pennant. Unlike a wedge or a triangle, it is also preceded by a strong move forming a pole. The strategy is the same as with flags.
Triangle chart patterns
And speaking of triangles, these patterns are formed by two converging trend lines but unlike wedges, either the support or resistance is static. There is also a neutral variation of the triangle pattern, which is symmetrical and shows no trend bias — wedges follow an upward or downward trend.
As the buyers or sellers gain more confidence in the range, they are increasingly likely to push through the support or resistance level. A possible range where the breakout can take the price is measured by applying the height of the widest part of the triangle to the breakout level. For a triangle to be considered valid, the price has to touch each of the trend lines more than twice.
Some economists and traders believe there are patterns based on the rhythm with which the price moves. This is the principle behind wave, ABCD, and butterfly patterns. By noticing these trends, we can anticipate where the price will end up next.
For example, the ABCD pattern consists of two equal leg-ups (the movement from A to B and C to D). A butterfly pattern aims to predict the best price to enter during a trend change: it starts with a swing, a reversal, followed by another reversal, and is expected to conclude with a breakout of a similar magnitude to the first move. If we know the first three or four points, we should easily extrapolate the final one and place an order.
Wave principles, such as Elliott waves, also follow the same logic: a price increase is always followed by a decrease, and the only difference is in the intensity of these moves. These patterns are self-repetitive on any time scale. However, there are as many criticisms of these theories as there are endorsements.
How Reliable are Chart Patterns?
Opinions differ on how really helpful are chart patterns, especially in crypto. On the one hand, there have been scientific and academic attempts to shape the practice. On the other hand, they are sometimes dismissed as pareidolia (seeing patterns where there are none) or “astrology for boys”.
Without any doubt, using chart patterns is common among traders. Perhaps, after years of looking for the patterns and expecting a certain behavior to follow, it has become a self-fulfilling prophecy to an extent.
Nevertheless, there have been empirical-based attempts to measure just how effective these patterns really are. One of the most effective chart patterns turned out to be inverse head and shoulders with an 82% validity rate. Pennants and rectangles pointed to trend continuation in 52% of the cases, making them some of the least reliable indicators.
There is always a chance that the price action will be influenced by external factors: news, updates, FUD and FOMO alike. Indicators and chart patterns work in conjunction with each other but ultimately are not ironclad rules that dictate how price moves.
Crypto chart patterns more often than not help determine where the price will move next and how far it will go. Once you learn to notice these common crypto trading patterns yourself, the crypto market will seem less hectic and more manageable.
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Frequently Asked Questions
What are chart patterns in crypto?
In crypto, just like in the stock market, chart patterns are commonly observed regularities and trends that manifest in certain ways on the price charts. They are theorized to demonstrate the mass psychology of traders in a market and be the basis for forecasting the continuation of the price trajectory.
What are the basic patterns in crypto?
There is a multitude of crypto chart patterns, pointing either at a trend continuation or a reversal. They include but are not limited to channels, wedges, triangles, flags, pennants, tops, and bottoms.
Do patterns work for crypto?
Despite the crypto market generally being more volatile than the stock market or currency exchange, and despite being open 24/7, it follows the same principles and structures as traditional markets. As such, patterns that originate from the stock market work here as well.