Basics part 2: Bar patterns

Technical analysis is all about understanding the shifting balance of supply and demand for a given stock or exchange traded fund (ETF) in the market. Over many years, traders have come to rely on technical analysis as a tool to help identify trends, possible reversals of trends, support and resistance levels, as well as provide an indication of possible target prices. There are a variety of technical patterns and indicators in common use today. In this article, we'll highlight three types of price bar patterns that should be understood by technical traders.

Bar patterns are commonly used in technical analysis due to their easy identification directly from price charts. Their name derives from the fact that they are seen when using a particular style of charting, specifically price bars.

A key reversal bar indicates a possible reversal of the current trend to a new trend in the reverse direction. Both bullish and bearish key reversal bars exist. One- and two-bar patterns, such as the key reversal bar, reflect changes in investor sentiment that have a short-term influence on future prices — typically no more than 10 to 20 bars. For traders looking for clear entry and exit points, these patterns are useful. The key reversal bar is characterized by a bar with a wide trading range and opening strongly in the direction of the preceding trend. Changing investor sentiment causes a price reversal and the stock closes near or above the previous day’s close.

Whether bullish or bearish, the two bar reversal pattern is a sign of trend exhaustion. This pattern occurs at the end of a well-defined trend: downward for the bullish two bar reversal and upward for its bearish counterpart. The two bars forming the pattern reflect a wide trading range and have their opening and closing prices near the extremes of the day. The key aspect of this pattern is to have a second bar, which completely reverses the gains or losses made in the preceding bar. Similar to the key reversal bar, this pattern reflects a change in investor sentiment, which leads to a reversal of the preceding trend.

Gaps are very common bar patterns that occur when a stock’s daily price range forms a gap with the price range from the preceding day. When gaps form at the end of a defined trend, it can be seen as a sign of exhaustion and precedes a reversal in the price trend. For example, a gap up at the end of a long downtrend can be seen as a sign of a reversal to the upside.