Chapter 3: Price Action Fundamentals (Audio)

In this chapter, we’re going to learn how to understand and use chart patterns in your trading. Chart patterns are shapes that price forms on a chart. They can help you predict what the market might do next.

There are two main types of chart patterns: continuation patterns and reversal patterns.

A continuation pattern means the market will likely keep moving in the same direction. A reversal pattern means the trend might be coming to an end and could go the other way.

Let’s start with continuation patterns.

One of the most common continuation patterns is the flag. A flag forms after a strong move in one direction, called the flagpole. Then, price moves sideways or slightly in the opposite direction, forming the flag. This pause is temporary. When price breaks out of the flag, it often continues in the same direction as before.

Another pattern is the pennant. It’s similar to a flag, but instead of moving sideways, the price starts to form a small triangle. This shows that the market is taking a short break before making its next big move. Just like the flag, once price breaks out of the pennant, it often continues in the same direction.

Rectangles are another type of continuation pattern. A rectangle forms when price moves between the same high and low over a period of time. Buyers and sellers are in balance, and the market is waiting. When price finally breaks out of the rectangle, it usually keeps going in that direction.

Now let’s talk about reversal patterns.

One of the most famous reversal patterns is the double top. This happens when price reaches a high point, falls back, and then tries to go up again — but fails to break the previous high. It creates an ‘M’ shape. When price breaks the low between the two highs, it’s often a signal that the market will go down.

The opposite is the double bottom. Price hits a low, bounces, tries to go lower again — but fails. This creates a ‘W’ shape. If price breaks the high between the two lows, it’s often a signal the market might go up.

Another important pattern is the head and shoulders. This one looks like three peaks: the middle peak is the highest, and the two on the sides are lower. When price breaks below the line that connects the two low points — called the neckline — it can signal a reversal from uptrend to downtrend.

The opposite of this is the inverse head and shoulders. It looks like a valley with a deeper dip in the middle. When price breaks above the neckline, it may mean the trend is changing from down to up.

These patterns work because they reflect how traders behave. After a strong move, the market often takes a pause. Traders are deciding whether to continue in the same direction or reverse. Chart patterns help us read these decisions before they happen.

But patterns don’t always work perfectly. That’s why we use confirmation.

Confirmation means we wait for price to break a key level — like a neckline or a trendline — before we enter a trade. This helps us avoid false signals.

It’s also important to combine chart patterns with other tools — like support and resistance, volume, or multiple timeframes. When these all line up, your trade has a stronger chance of success.

Finally, always remember to manage your risk. Even the best patterns can fail. So use stop-loss orders and never risk more than you can afford to lose.

Learning chart patterns takes time. But the more you study them, the more confident you’ll feel in your trading.