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Simple Guide to Continuation Patterns

Introduction

Continuation patterns are a crucial concept in technical analysis. These patterns surface on price charts when the market pauses before continuing its established trend. They are also termed consolidation or congestion patterns.

Let’s understand various types of continuation patterns.

Different types of Continuation Patterns

1. Triangles

A triangle pattern is when the price moves within a narrow range. They indicate that the market is indecisive and that buyers and sellers are in a tug-of-war.

This pattern can be of three types: symmetrical, ascending, and descending.

Symmetrical triangles have two converging trend lines that slope in opposite directions.
Ascending triangles have a horizontal upper trend line and a rising lower trend line.
Descending triangles have a horizontal lower trend line and a falling upper trend line.

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The trading implications of triangles are similar for all types. The breakout direction is usually the same as the previous trend. That means if the market was in an uptrend before the triangle, it would likely break out to the upside, and vice versa. The target price is calculated by measuring the triangle's height at its widest point and projecting it from the breakout point. The stop-loss level is placed below the lower trend line for an upside breakout and above the upper trend line for a downside breakout.

2. Flags

Flags are formed when the price moves in a narrow range after a sharp move in the direction of the previous trend. They indicate that the market is resting or correcting before resuming its momentum.

They are subclassified into bullish and bearish. Bullish flags have a downward-sloping range after an upward move. Bearish flags have an upward-sloping range after a downward move.

The trading implications of flags are similar for both types. Typically, the breakout direction aligns with the preceding trend. For instance, if the market showed an upward trend before the flag formation, the breakout is likely to occur upward, and conversely, if it was in a downtrend.

The target price is calculated by measuring the length of the pole (the sharp move before the flag) and projecting it from the breakout point. The stop-loss level is placed below the lower boundary of the flag for an upside breakout and above the upper border for a downside breakout.

3. Pennants

Pennant formation is when the price moves within a symmetrical triangle after a sharp move in the direction of the previous trend. They indicate that the market is consolidating and that buyers and sellers are balanced.

Pennants are similar to triangles but smaller and shorter in duration. They usually last a few days or weeks, while triangles can last for months or years.

The trading implications of pennants are similar to those of triangles. The breakout direction is usually the same as the previous trend, meaning that if the market was in an uptrend before the pennant, it would likely break out to the upside and vice versa. The target price is computed by gauging the length of the pole (the sharp move before the pennant) and projecting it from the breakout point. The stop-loss level is set below the lower trend line for an upside breakout and above the upper trend line for a downside breakout.

4. Rectangles

Rectangles are continuation patterns that form when the price moves within a horizontal range, creating a rectangular shape on the chart. They indicate that the market is in a state of equilibrium and that buyers and sellers are equally matched.

Rectangles have two parallel upper and lower boundaries that act as support and resistance levels. They also have a volume pattern that shows a decrease in trading activity as the pattern develops and an increase in volume as the pattern breaks out.

The trading implications for both types of rectangles are comparable. The breakout direction typically mirrors the preceding trend; if the market was in an uptrend before the rectangle, it is likely to break out upwards, and conversely, if it was in a downtrend, the breakout is expected to be on the downside.

The target price is determined by gauging the width of the rectangle and extending it from the breakout point. In the case of an upward breakout, position the stop-loss level beneath the lower boundary of the rectangle, and for a downward breakout, place it above the upper boundary.

Conclusion

Continuation patterns aid in technical analysis. It predicts future price movement, identifies trade entry/exit points, and establishes risk-reward ratios.

However, continuation patterns are not foolproof. They can sometimes fail or produce false breakouts. Therefore, you should always use confirmation signals, such as volume, indicators, or candlestick patterns, to validate.