The 6 Elements of Chart Patterns Every Trader Should Know
Stockscores Foundation for the week ending January 21, 2025
In this week's issue:
In This Week’s Issue:
- Market Outlook – The Two Factors in the Market
- This Week’s Market Minutes video – My Simple (and fast) Way to Analyze Any Stock
- Trader Training – The 6 Elements of Chart Patterns Every Trader Should Know
- Strategy – Stocks in Play
Market Outlook – The Two Factors in the Market
With the change of US Presidency complete, the market can now turn back to the two things investors tend to focus on, earnings and interest rates. It is not necessarily earnings today that matter, but what expectations are for the future. So, when a small company with no earnings announces news that increases the chance for significant future earnings, the stock can move very strong. Of course, when a company announces actual earnings that exceed expectations, the stock can move strong. There are stocks that makes these type of moves every day, even when the market is trending downward.
The expectation that US interest rates will remain higher for longer has weighed on the overall market for the past two months. This does not really show up in the large cap market indexes because they are heavily influenced by the largest companies, which are less interest rate sensitive. The broader market has underperformed the indexes because of the negative interest rate outlook.
Therefore, the best opportunities in the market right now are either trading the strong momentum in large cap stocks with Sentiment Stockscores > 60 or short term trading the small companies that are trading with abnormal price and volume.
This Week’s Market Minutes Video – Is a Stock Market Crash Coming?
Over the past 35 years, I have developed a simple and fast way to analyze any stock. This week, I highlight the essential elements of this approach and then look at a few stocks to show how it is applied. Then, my weekly analysis of the stock, bond, currency and commodity markets and the trade of the week on BTCT.
Click here to watch this week's video on YouTube
https://youtu.be/tmPCsAt7Ogo
Commentary – The 6 Elements of Chart Patterns Every Trader Should Know
Chart patterns are the footprints of money. They reveal the behavior of buyers and sellers, providing clues about what might happen next in the stock market. While there are countless ways to analyze charts, mastering the six key elements of chart patterns—Support, Resistance, Optimism, Pessimism, Price Volatility, and Abnormal Activity—can help you spot trading opportunities and manage risk effectively.
Let’s break down each element and how to use it in your trading.
1. Support: The Floor Beneath the Price
Support is a price level where a stock has consistently found buyers. Think of it as the "floor" that keeps the price from falling further. It occurs when demand overwhelms supply, often because traders perceive the stock as undervalued at that level as it is the lower limit of perceived fundamental value.
When a stock approaches its support level, watch for signs of a bounce. A strong rebound off support can signal a buying opportunity. However, if the price breaks below support, it may indicate further downside as sellers gain control.
Key Tip: Look for multiple touches at the same price level over time to confirm a strong support zone.
2. Resistance: The Ceiling Above the Price
Resistance is the opposite of support—a price level where the stock struggles to move higher. It represents a "ceiling" where selling pressure exceeds buying demand and is the upper limit on what investors perceive is the fundamental value of the company.
When a stock approaches resistance, traders often sell, anticipating a pullback. However, if the stock breaks through resistance with strong volume, it can indicate the start of a new uptrend.
Key Tip: A breakout above resistance is more significant if accompanied by abnormal volume, signaling increased interest in the stock.
3. Optimism: The Fuel for Uptrends
Optimism drives buying, pushing prices higher. In chart patterns, it manifests as a series of rising bottoms. When traders are optimistic, they’re willing to pay higher prices, creating upward momentum.
To capitalize on optimism, identify stocks building rising bottoms below a line of resistance. Focus on those making consistent progress while avoiding overextended stocks that may be due for a pullback.
Key Tip: Use trendlines to visually confirm the direction of optimism. An upward-sloping trendline often indicates sustained buying pressure.
4. Pessimism: The Driver of Downtrends
Pessimism fuels selling, leading to falling tops. This is the opposite of optimism and is a critical element for short sellers or traders looking to avoid losses.
A stock in a pessimistic trend often struggles to break resistance levels and consistently forms lower support levels. Recognizing this pattern early can help you exit losing trades or even profit from the downside.
Key Tip: Watch for signs of a trend reversal, such as a breakout above a downward trendline, to spot when pessimism may be fading.
5. Price Volatility: The Measure of Emotion
Volatility reflects the emotional state of the market. High volatility often signals uncertainty or excitement, while low volatility suggests investors are confident that the price of the stock truly reflects the company’s fundamental value.
In chart patterns, price volatility can help you gauge the risk and reward of a trade. Stocks with shrinking volatility often form consolidation patterns, which can precede explosive moves. Conversely, erratic volatility can signal instability, making it harder to predict price direction.
Key Tip: looks for lines of support and resistance converging toward one another to identify periods of low volatility, which often precede significant breakouts.
6. Abnormal Activity: The Tell-Tale Sign of Opportunity
Abnormal activity is the secret sauce of chart analysis. It refers to price or volume behavior that deviates from the norm. Spikes in volume or sudden price jumps often indicate that something unusual is happening, such as insider buying, news leaks, or institutional interest.
Abnormal activity is often the precursor to significant price moves. When you spot it, dig deeper to understand the catalyst and consider whether it aligns with your trading strategy.
Key Tip: Use the Stockscores Market Scan tool to identify abnormal volume or price changes. These can be powerful indicators of impending breakouts or breakdowns.
Putting It All Together
The six elements of chart patterns—Support, Resistance, Optimism, Pessimism, Price Volatility, and Abnormal Activity—work together to paint a picture of market behavior. By understanding and applying these concepts, you can identify high-probability trades, manage risk effectively, and stay ahead of the market.
Remember, chart patterns are not a crystal ball. They provide probabilities, not certainties. Combine your analysis with sound risk management and a disciplined approach, and you’ll be well on your way to trading success.
By mastering these six elements, you’ll have a solid foundation for navigating the complexities of the stock market.
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This week, I used the Stockscores Market Scan to search for stocks trading with abnormal volume, under $20 and at least 50,000 trades today. I then inspected the charts of those that the Market Scan found to highlight 2 stocks that I think are worth watching.
1. HUSAHUSA is trading with very abnormal volume and is highly liquid, making it a good stock to watch for an intraday chart pattern set up. I am watching the 13 minute chart for a break of the pullback that the stock is in now. If the pullback goes past $2.20, it will need to build a rising bottom before a break higher. Support at $1.70.
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2. VATEVATE came alive today with very strong volume and should be watched for a break from a predictive chart pattern on the 13 minute interval. If the stock falls below short term support at $6.50, avoid until there is an improvement in the chart.
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