Classic patterns are of great importance in technical analysis, specifically in trend research. Appearing as vast formations at the end of a trend, they might signify that this trend is going to be continued or reversed. However, unlike the candlestick patterns, classic patterns are rarely exclusively reversal or continuation: most of them can act as both, but statistically tend to continue or reverse the trend.
Another difference is that candlestick patterns appear as immediate local configurations of several candles (generally, one to five) of specific shape and location while classic patterns take their time to form completely, a couple of weeks to several months in general. Configurations of individual candles do not matter in this kind of patterns: it's all about shapes and lines and angles they make together.
A classic pattern is identified when for a specified time period there are several lines whose attributes satisfy certain conditions. These conditions are defined based on the pattern type, but all consist of some combination of trendlines, support, and resistance:
- A trendline is a line that runs through tops and bottoms and has a definite slope, up or down.
- Tops (peaks) and bottoms (troughs) are local price reversal points.
- Peaks appear when a bearish reversal occurs and bottoms appear with bullish reversals.
- Support and resistance lines are straight lines that run through bottoms and peaks, respectively.
When the system detects a special configuration of trendlines, support, and resistance showing the necessary number of reversals, you will be notified that a pattern has occurred.
While being within a classic pattern, often seen as a sideways trend, the price accumulates power to break through one of the lines. It can then move upward or downward, thus making the pattern to be reversal or continuation. The point where the price comes out of the pattern is called breakout point. Patterns that have resulted in a breakout are called completed; those still inside the lines are called emerging. For completed breakouts, the system can calculate the "predicted" range. This is the range the price is statistically likely to move in.
Breakout points are of great interest to chartists as they may indicate further price move. While in most cases patterns may be broken out of in either direction, they statistically tend to "choose" one. When the breakout happens, the price is likely to follow the direction of the breakout so the preceding trend is reversed or continued.
Having breached the line, the price may retreat back into the pattern; this is called pattern failure. In order to avoid a lot of failures, use the 5% rule: a breakout may be considered "stable" when the breakout price has risen/fallen by at least 5%. This will not take care of all the false breakouts but may filter out most of them.