Technical Analysis

Continuation patterns are technical indicators that appear as sideways price movements on charts. These patterns differ from reversal patterns, which suggest a shift in trend. Instead, continuation patterns signal a temporary consolidation phase following a significant price move.

Imagine a strong price surge. Continuation patterns often emerge as buyers take a breather to regroup before resuming their buying spree. Similarly, after a steep price decline, sellers might pause to lock in profits by closing existing short positions before continuing to sell. These pauses lead to price consolidation, which can take specific visual forms on charts known as continuation patterns.

The validity of a continuation pattern is confirmed when prices break out of the consolidation zone and resume the prevailing trend.

Let's explore some of the most frequent continuation patterns traders encounter:

• Triangles, wedges: These signal potential trend continuation over a mid-term timeframe.

• Flags, pennants: These are known for their shorter duration and suggest trend continuation in the near term.

• Rectangles: Rectangles represent consolidation phases and can indicate a continuation in either direction, requiring a breakout for confirmation.

Triangles

There are three main types of triangles:

• Symmetrical Triangles: These triangles are considered neutral and don't inherently predict a bullish or bearish breakout. They take shape when support and resistance levels converge, forming a symmetrical triangle. The price action tests both the support and resistance lines multiple times, potentially leading to a breakout in either direction.

• Ascending Triangles: These are bullish continuation patterns. As the name suggests, ascending triangles are formed by a horizontal resistance line and a rising support line. The price repeatedly tests the resistance level, but fails to break below the rising support, indicating buyers may be accumulating. A breakout above the resistance line suggests a continuation of the uptrend.

• Descending Triangles: These are considered bearish continuation patterns. Descending triangles are characterized by a horizontal support line and a declining resistance line. The price repeatedly tests the support level, but fails to break above the declining resistance, suggesting sellers may be gaining strength. A breakout below the support line signals a potential continuation of the downtrend.

Key Points about Triangles:

• Triangle patterns typically require at least four to six price touches on the support and resistance lines to form a clear triangle shape.

• The more times the price tests the support or resistance lines within the triangle (without breaking through), the more reliable the potential breakout is considered to be.

• The formation period of triangles can vary, but they generally last around one to three months.

Targeting Triangle Breakouts:

When trading triangles, a common strategy focuses on capitalizing on potential breakouts. This involves waiting for the triangle pattern to reach completion, which is typically signaled by a clear price close either above the resistance line (bullish breakout) or below the support line (bearish breakout).

Once a confirmed breakout occurs, traders can then analyze the triangle's dimensions to gauge potential price movements.

Estimating Price Targets After a Breakout:

Traders often use a common technique to estimate potential price targets following a triangle breakout. This method involves measuring the height of the triangle. The height is the vertical distance between the triangle's resistance and support lines.

Here's a general approach:

1. Measure the Height: Identify the highest point (resistance) and the lowest point (support) of the triangle on the chart. Then, calculate the vertical distance between them. This distance represents the triangle's height.

   
   

2. Projecting the Target: For a bullish breakout (price closing above resistance), add the triangle's height to the breakout price. This projects a possible price target in the direction of the uptrend. Conversely, for a bearish breakout (price closing below support), subtract the height from the breakout price to estimate a target in the direction of the downtrend.

Symmetrical Triangles:

Symmetrical triangles are characterized by price consolidation where the price action creates a triangle shape. This pattern forms when:

• Converging Trendlines: Two trendlines emerge, one connecting a series of lower highs and the other connecting a series of higher lows. As the price moves back and forth, these trendlines gradually converge towards a common point.

Breakout Direction:

Unlike ascending or descending triangles, symmetrical triangles are considered neutral because they don't inherently predict a bullish or bearish breakout. The breakout direction depends on the prevailing trend before the triangle formation:

• Continuation of Prior Trend: If an uptrend preceded the triangle, a breakout above the resistance line suggests continuation of the uptrend. Conversely, if a downtrend came before the triangle, a breakout below the support line signals a continuation of the downtrend.

Ascending Triangles: A Bullish Signal

Ascending triangles are chart patterns recognized for their bullish continuation potential. They take shape when:

• Flat Resistance: A horizontal line forms along the highs, indicating a resistance level that the price has repeatedly struggled to surpass.

• Rising Support: A diagonal trendline connects the lows, showcasing increasing buyer demand. As the price dips, buyers become more active, creating higher lows.

Why Bullish?

The ascending triangle suggests a buildup of buying pressure. While the price struggles to break above resistance, the rising support line demonstrates buyers are defending the price at increasingly higher levels. This can be interpreted as a sign that buyers are accumulating the asset in anticipation of a breakout.

Confirmation and Target

A confirmed breakout occurs when the price closes decisively above the resistance line. This signifies a potential continuation of the uptrend. Traders often use the triangle's height to estimate a price target by adding the height to the breakout price. The height is the vertical distance between the resistance and support lines.

Descending Triangle

The descending triangle is basically a mirror image of the ascending triangle. In this case, the upper trend line has a downward slope while the lower line is just horizontal. This occurs because the sellers are more aggressive than buyers. Therefore, it is a bearish continuation pattern which is completed when prices breakout to the downside.

It is essential for you to know that the price closes below the flat lower line in order for the pattern to be completed and to be called an ascending triangle. We can see this in the chart below. Prices then resume the downtrend.

Descending Triangles: Signaling a Downtrend

Descending triangles are technical indicators known for their bearish continuation potential. They mirror the ascending triangle but with a reversed orientation, suggesting a weakening uptrend or a continuation of a downtrend.

Key Features:

• Downtrending Resistance: A descending trendline connects the lower highs, reflecting sellers exerting increasing pressure and pushing prices down.

• Flat Support: A horizontal line forms along the lows, indicating a support level that the price has found temporary stalls at.

Why Bearish?

Descending triangles suggest a gradual decline in buying power. As sellers become more aggressive, they drive the price down while buyers become less active in defending the support level. The price action forms a pattern where the highs keep falling, and the lows struggle to rise significantly.

Confirmation and Target

A confirmed breakout occurs when the price closes decisively below the support line. This signifies a potential continuation of the downtrend. Traders often use the triangle's height to estimate a price target by subtracting the height from the breakout price. The height is again the vertical distance between the resistance and support lines.

Wedges

Wedges are another type of continuation pattern that resemble triangles but with a key distinction. Like triangles, wedges form when two trendlines converge, indicating a consolidation phase.

Slanted vs. Horizontal:

• Triangles: Triangles typically have a more horizontal orientation, with both trendlines (support and resistance) appearing relatively flat.

• Wedges: Wedges, however, exhibit a noticeable slant against the prevailing trend. This slant differentiates wedges from triangles.

Bullish vs. Bearish Wedges:

• Falling Wedge (Bullish): In an uptrend, a wedge that slopes downward is considered a bullish continuation pattern. This falling wedge suggests that despite the price dipping lower, the lows are formed at progressively higher levels, indicating buyers may be accumulating. A breakout above the wedge's resistance line signals a potential continuation of the uptrend.

• Rising Wedge (Bearish): Conversely, in a downtrend, a wedge that slopes upward is considered a bearish continuation pattern. This rising wedge suggests a temporary pause in the downtrend, but sellers remain in control. A breakout below the wedge's support line signals a potential continuation of the downtrend.

Pennants and Flags

Pennants and flags are categorized as continuation patterns, similar to triangles and wedges. However, they are known for their shorter duration compared to their counterparts. These patterns typically take less than a month to form, making them valuable tools for identifying potential short-term trading opportunities.

Pennant

A pennant is usually preceded by a strong move in prices, almost in a straight line, to resemble a flag pole or mast. Bullish pennants are continuation patterns known for their brief formation period and their appearance following a strong upward price movement.

Here's a breakdown of their characteristics:

• Flagpole: The pattern is often preceded by a sharp price increase, resembling a vertical flagpole on a chart.

• Consolidation: After this initial surge, a period of consolidation sets in, marked by a price movement contained within a triangular pattern. This consolidation phase is often referred to as the "pennant" itself, typically forming around the middle of the entire price move.

• Breakout and Target: If a breakout occurs, it's usually above the pennant's resistance line. This breakout signifies a potential continuation of the uptrend. The height of the flagpole (the initial price move) can sometimes be used as a rough estimate for the length of the subsequent price movement after the breakout.

Looking at the chart below, we can see that after a quick rally, there is a pause and then a blast higher.

Flags

Flags are another type of continuation pattern recognized for their short formation period. Similar to channels, they are characterized by two parallel trendlines that act as support and resistance zones for the price.

Key Characteristics:

• Trend-Dependent Slope: The slope of the flag's trendlines can vary depending on the prevailing trend:

  • Upward Trend: If an uptrend precedes the flag, the flag will typically have a downward slope (negative slope).

  • Downtrend: If a downtrend precedes the flag, the flag will typically have an upward slope (positive slope).

  • Sideways Trend: In some cases, the flag may have a horizontal orientation (zero slope), resembling a rectangle.

• Consolidation Phase: Regardless of the slope, flags represent a period of price consolidation following a significant price move. The price action becomes confined within the parallel trendlines of the flag.

• Breakout Direction: If a breakout occurs, it's usually in the direction of the prior trend. This signifies a potential continuation of the prevailing trend before the flag formation.

Rectangles

Rectangles are another type of continuation pattern characterized by a trading range formed by two horizontal parallel lines (support and resistance). This price action indicates a period of consolidation following a significant price movement.

Key Points:

• Trend Pause: Rectangles suggest the market is taking a breather from the prevailing trend.

• Breakout Direction: A breakout from the rectangle, either above the resistance or below the support, signals a potential continuation of the trend that preceded the rectangle formation. There's no inherent bullish or bearish bias in rectangles themselves.

• Prior Trend as Clue: Traders often look to the trend before the rectangle to gauge the possible breakout direction. For instance, an uptrend preceding the rectangle suggests a potential upside breakout, while a downtrend might indicate a downside breakout.