Pattern formations or chart formations are resting areas in a trending market, where the prices consolidate to form figurative chart patterns.
This is the place where majority of trading mind is thinking, to decide whether to buy more or sell more. This big collective mind's oscillations results in price oscillations and in chart patterns.
Taking trading decisions based on different types of chart patterns, statistically gives more consistent and profitable trades.
The world is chaotic. So is the market. The world is systematic. So is the market.
No two human beings, no two animals, no two plants or flowers are alike. But all the systems, which run in and around each species, each situation, bear similarities and have patterns.
Though no two days, two seasons or two years are alike, every day and night cycles, seasonal cycles, yearly cycles are systematic and accurate.
Though no two individuals are alike, all the cycles, for example growth cycles, learning cycles, respiratory cycles, heart beat cycles, etc; are systematic and repetitive.
The whole world is regularly irregular or irregularly regular.
If not for the accurate, systematic and repetitions, it would have been impossible to land on moon and visit distant planet and land unmanned vehicles on the distant planets to the accuracy of a millimeter.
In the unpredictable chaotic market, we get areas of predictable, repetitive formations, which we call chart patterns.
Once a chart pattern is forming, its future boils down to a predictable few directions or possibilities.
Imagine you are going in a vehicle in a big city. You reach a junction of several roads. Now you slow down momentarily. Here you have many choices. You can enter any one road or you can even make a U turn and go back in the same road as you came.
But let us say you choose to go in a particular road. Once you enter an avenue then you have very limited choice. You have to go forward until you meet a cross road or another junction, where you meet with more options.
With this analogy, you can understand the market better. The pattern formations are like junctions, where there is indecision. So the momentum slows down. Once there is breakout from the patterns, it is like you enter an avenue, you accelerate. You have only one direction to move. You slow down again only near the next cross road or at the next junction. On a chart the prices slows down around the support and resistance.
Can you see any patterns in this chart? What mind does not know, eyes will not see. Once you learn about pattern formations you start seeing chart patterns.
Breakout from a pattern formation on a stock chart is like entering an avenue where the possibility of market movement reduces to a level, which we can handle or manage. We can trade them profitably.
These patterns may be continuation patterns. In a trending market, the stock prices rests for a while, before they continue their journey.
Or they may be reversal patterns. The trend, when exhausted, slows down, forms a pattern before they change their direction.
So these patterns alerts us as to the direction of the market. They provide us early signal either to book profit or make a new entry.
It is said that patterns are created by amateurs for professionals to trade at the right time.