Chart patterns: head and shoulders, flags, triangles

Clouds in the sky sometimes take the shape of a dragon or a coffee cup. If you want to, you will see anything in them. Charts are similar: whoever looks for a pattern will find one, often where there is none. This lesson is about telling a real pattern from a cloud that only resembles a dragon.

What you will learn

• how continuation patterns differ from reversal patterns,
• what head and shoulders, flags and triangles look like and what they say about buyers and sellers,
• when a pattern is confirmed (breakout and volume),
• how to estimate an approximate target from the size of the pattern and why it is not a promise.

A pattern is a story, not a picture

A chart pattern is a repeatable arrangement of highs and lows that forms when buyers and sellers balance each other for a while. It does not work because it has a nice name. It works (when it does) because it describes a shift in forces: someone is tiring, someone else is taking the initiative.

We divide patterns into two families. Reversal patterns signal that the current trend may be ending, like the head and shoulders. Continuation patterns are a pause in the trend, after which the move often resumes in the previous direction, like flags and many triangles.

The key word: often. No pattern gives certainty; it only gives an edge in probability, and only once it is confirmed.

Head and shoulders

This is the classic reversal pattern of an uptrend. It consists of three peaks:

• left shoulder: a peak in the uptrend, followed by a pullback,
• head: a higher peak, after which price falls again roughly to the level of the previous low,
• right shoulder: a peak lower than the head, usually close to the left shoulder.

The line connecting the two lows between the peaks is the neckline. Recall lesson 1: in an uptrend each peak is higher than the previous one. The right shoulder breaks that rule, because buyers failed to exceed the head. That is the first warning. Confirmation comes only when price closes below the neckline.

There is also an inverse head and shoulders: the mirror image at the bottom of a downtrend, signalling a possible end of the decline.

Flags and pennants

A flag is a short, orderly pause after a sharp move. It looks like a flag on a pole:

• pole: a fast, steep move (e.g. upwards),
• flag: a small channel sloping slightly against the pole, or flat.

When the pause narrows into a small triangle instead of a channel, we call it a pennant. The idea is the same: the market catches its breath after a sprint, and sellers cannot take back much of the gain. A flag is more credible when volume falls during the pause and rises clearly on the breakout in the direction of the pole (lesson 4).

Triangles

A triangle forms when price swings gradually narrow. There are three varieties:

• ascending triangle: flat resistance on top and rising lows. Buyers are getting more and more impatient.
• descending triangle: flat support at the bottom and falling highs. Sellers are gaining the upper hand.
• symmetrical triangle: highs fall and lows rise. Nobody has the edge, so only the breakout decides the direction.

The narrowing of swings is the same mechanism as the Bollinger Band squeeze from lesson 11: volatility falls, and after a period of calm a move often follows. A triangle says more than the bands, because its shape hints at which side is weakening, but in the end the breakout sets the direction, not the geometry.

Confirmation: breakout and volume

A pattern under construction is only a hypothesis. It becomes a signal only when price closes beyond the key line (the neckline, the edge of the flag, the side of the triangle), rather than just piercing it briefly during the session. The second condition is volume on the breakout clearly higher than while the pattern was forming. That is a sign that real money stands behind the move, not random orders.

After a breakout price often returns to the broken line to test it from the other side. This is the so-called throwback (or pullback). As you remember from lesson 2, broken resistance likes to become support and vice versa.

Measured move: a target from the height of the pattern

The classic method of setting a target is simple:

• head and shoulders: measure the distance from the top of the head to the neckline and project it down from the breakout point,
• flag: project the length of the pole from the breakout point of the flag,
• triangle: project the height of the widest part of the triangle from the breakout point.

Treat it as an approximate range, not a target the market "must" reach. Price can stop earlier at important support or resistance, or go much further. The measured move is useful mainly for judging whether the potential move is worth the risk at all.

Chart example: Intel (INTC), weekly chart

The weekly chart filters out the noise of daily swings, which makes patterns easier to read, and each candle is a whole week of fighting between buyers and sellers. On such a chart it is easier to tell genuine consolidation from a few days of commotion.

The turn of 2023 and 2024 is good practice material. After a strong rally, price stalled around 50 dollars, and the following peaks in the first half of 2024 were already lower. Buyers stopped taking out previous highs, which is exactly the warning a right shoulder gives. The verdict came only when price fell below the earlier lows and volume rose clearly. In the summer of 2024 the decline accelerated with a sharp gap after quarterly results, but gaps are the topic of the next lesson.

Open the weekly INTC chart for the last five years and add volume. Look for periods when the swings narrowed, and for places where a lower peak appeared after a series of rising peaks. Draw the lines that in your view form a pattern and check: was there a close beyond the line? Did volume rise on the breakout? How far did price travel compared with the height of the pattern?

How it fails

• Seeing patterns everywhere. The brain loves patterns. If you have to "stretch" the lines for a long time, the pattern probably is not there.
• False breakouts. Price pierces the line, attracts buyers and returns inside the pattern. That is why you wait for the close and volume.
• A pattern without context. A head and shoulders in a sideways market has nothing to reverse. A reversal pattern needs a prior trend.
• The target as a certainty. The measured move is an estimate. Quarterly results or sudden news can invalidate it in a single day.
• Hindsight. On a finished chart patterns look obvious. In real time you do not know whether the right shoulder has already formed.

Check yourself

1. How does a continuation pattern differ from a reversal pattern?
2. What is the neckline in a head and shoulders pattern and when is the pattern confirmed?
3. How does volume behave in a credible flag?
4. How do you estimate the approximate range of a move from a triangle?

Next lesson

Lesson 13. Price gaps and quarterly results (coming soon): you will see what happens when the market opens far from yesterday's close, and why earnings day can wipe out the prettiest pattern in a few minutes. Does every gap have to be "filled"?

Educational material, not investment advice.