The most reliable price data is transaction data and that gives the clearest insight into traders’ beliefs. Surveys, positioning information and broker comments are all highly prone to delay and distortion. In turn, a price chart is nothing more than a record of transactions and a technical pattern on a chart is nothing more than a very condensed representation of supply and demand at certain price levels over a certain time frame with volume included as well. This means pattern recognition on charts is mostly about figuring out who’s in at what price and how confident they are.

This information is especially relevant for individuals who are already using technical frameworks to trade and want to improve their understanding of specific patterns and the useful information that the internal structure of a formation provides about the balance of pressure at particular price levels.

What price structure actually tells you about pressure

The value in every pattern is found in the asymmetry of the failed attempts to move price in the opposite direction to the current trend. Therefore, in uptrends, the highest points of the pullbacks are higher than the previous high, while the tops of the rallies are stuck at a price level and are being absorbed by a rising bid at lower and lower prices. The demand is increasing in scale while the supply is not. Thus, ascending triangles and falling wedges are descriptions of shrinking seller resolve and must be read that way.

Volume on the other hand highlights for us when both parties to a trade have given up on trying to move price. In cases of consolidations, volume which decreases as we travel through the body of the consolidation and then explodes on the boundary in either direction indicates that neither side is actively contesting the other and that it is whoever turns up last that will decide things for the entrenched positions.

Reading the failure, not just the pattern

Failed patterns often tell you more about what has happened than completed ones. For example, a breakout that is back within the body of the pattern within a few hours often means that the people who bought at the high were small and are now long and trapped. The resulting supply of this trapped position will act as overhead resistance on subsequent attempts to break out in the same direction as the failed pattern.

Continuation formations and the question of pause versus exhaustion

Flags, pennants and rectangles are all shapes that represent a trend taking a breath and therefore are useful for judging the strength of a trend. When analyzing shapes for continuations it is crucial to remember the vast majority will form within the architecture of a future top rather than continue for much longer. Duration and depth are by far the best two parameters for determining a continuation pattern from a potential top and therefore the best reversals.

The position of a continuation formation within a trend is also important. A third or fourth continuation pattern within a long running trend has much lower odds than the same pattern at the start of the trend. Each successive pause in the price has likely already brought in the marginally aware buyer. Before leaning on any of these pauses, it is worth reviewing how the standard bullish patterns are constructed so that a late stage flag is not mistaken for an early one.

Reversal formations as evidence of distribution

Reversal patterns can also be viewed as a means to track transfers between different sets of investors. Double tops are formed by two attempts to clear a price level by aggregate demand that fails. A head and shoulders top has a final attempt to clear a price level, followed by a subsequent attempt to advance that fails at a lower price level than the prior high, thus signifying the marginal buyer has been replaced by the marginal seller.

The right shoulder of a Head and Shoulders formation is very important. It should be lower in price than the head and also have less volume. The difference in price and volume between the head and the right shoulder will give you an idea of how much conviction remains with the buyers. A near symmetrical right shoulder is a much weaker signal than a very weak right shoulder with very low volume.

Timeframe coherence

A reversal in a 4 hour chart is usually a liquidity event (i.e. Not part of a change in trend in higher time frames such as weekly charts). In assessing a formation look to see what is the implied move from the formation. If that move is outside of the intact structure of the upper timeframe then treat it as a tactical opportunity to take a tactical position with a tactical target.

Grading confirmation before committing capital

A spectrum, not a simple binary for confirmation. A grading scheme forces you to size based on the degree of confirmation rather than the degree of conviction you have in the pattern.

Where pattern reading breaks down

Charts contain many patterns so we have to filter them with a few rules to avoid spotting them after the fact.

• Define the formation’s boundaries and invalidation level in writing before entry, so the trade cannot be quietly redefined after it moves against you.
• Require a liquidity check. Thin instruments produce convincing shapes that cannot be exited at the assumed price.
• Account for scheduled catalysts. Earnings, central bank decisions, and index rebalances override structural reads.
• Track your own hit rate by formation type and market regime rather than trusting published statistics.

When used correctly, formations provide a structured means to ask and answer three of the most important questions relating to an active investment, Who currently owns an asset and at what price? How comfortable are they? The direction of the next move is not provided by the pattern and therefore must be obtained from other independent information.