Continuation patterns indicate that the current price trend in a security or an index is likely to persist. It occurs in the middle of a trend and signals a continuation after the end of the ongoing pattern. Traders work with triangles, flags, pennants, and rectangles, which are popular examples of a continuation pattern.
Types of Continuation Patterns
Traders know a pattern has completed when the pattern has formed and then “breaks out” of that pattern, continuing on with the earlier trend. Continuation patterns can be observed on every time frame, be it a tick chart or a daily or weekly chart.
Triangles can be defined as a convergence of the price range, with higher lows and lower highs. The converging price action creates a triangle formation. The three basic types of triangles are symmetrical, ascending and descending. The triangle continuation pattern varies in their duration but they always have at least two swing highs in price and two swings lows in price.
- Symmetrical: A downward sloping upper bound and an upward sloping lower bound in price makes for a symmetrical triangle formation.
- Ascending: A horizontal upper bound and upward sloping lower bound formation is called an ascending triangle.
- Descending: A downward sloping upper bound and horizontal lower bound is called a descending triangle.
Flags appear when there is a pause in the trend where the price becomes restricted in a small price range between parallel lines. The flag-like appearance comes from the pause in the middle of a trend. Also, flags are short in duration and may be parallel, upward or downward sloping.
Pennants are similar to a triangle but smaller in shape. They are formed only by several bars. A pennant is considered to be a triangle if it has more than 20 price bars. However, this must not be considered a thumb rule. The pattern is formed as prices converge, covering a relatively small price range mid-trend.
Traders often witness a pause where the price moves sideways, bound between parallel support and resistance lines. Rectangles or trading ranges can last for short periods or several years. This pattern appears on a regular basis and can sometimes be seen intra-day or in a long-term time frame.
Working With Continuation Patterns
By being aware of the common patterns, a trader can benefit in trade. Continuation patterns tend to provide a certain level of logic to the price move which often leads to trading opportunities that may not be seen using other methods.
However, the pattern is not always reliable. This is why a combination of patterns should be used before making trading decisions. The continuation pattern may appear during a trend but a reversal may still occur.
It is also possible that, once traders have figured out the pattern on the charts, the bounds may be slightly penetrated, but a full breakout does not occur. This is called a false breakout. It may occur multiple times before the pattern is actually broken and a continuation or a reversal occurs. Rectangles, owing to their easy visibility and popularity, are highly susceptible to false breakouts.
Patterns can also be subjective. One trader’s perspective could differ from another, in terms of defining or drawing a pattern in real time. This might seem tricky but it helps traders develop a unique perspective on the markets.
Besides, finding a pattern is mostly about skills that you develop over the years by knowing and looking out for patterns.
Continuation patterns such as flags, pennants, rectangles and flags provide logic to what the markets can potentially do. These patterns usually emerge in between a trend and indicate a continuation. But for the trend to continue, the pattern must break out in the correct direction. However, while the continuation patterns do help traders in making trading decisions, they are not always reliable. Few problems include a reversal in a trend instead of a continuation, and occurrence of multiple false breakouts when the pattern is beginning to be established.