Chart Patterns Part 3: Continuation Patterns

In previous posts we have discussed a few key reversal patterns and now we need to cover patterns that form in between reversals; we need to identify patterns that occur during trends. There are many patterns that occur while a trend is in place, they are often referred to as continuation patterns. Just as with the reversal patterns, we are only going to focus on the most common continuation patterns.

Continuation patterns, by their very names, tend to resolve in the current direction of the pattern or prior trend. The primary continuation patterns I like to focus on are Flags, Cup/Handles, and consolidation ranges.

Flags

Flag patterns come in two varieties Bull Flags and Bear Flags. A flag pattern symbolizes a swift, sharp move in one direction followed by a pausing period where short-term traders take profits and reposition after the quick rally.

 Bull Flag

You can see the sharp increase in price (flag pole) that almost moved straight up for several bars right at the end of 2012, followed by a tight downward consolidation (flag). Flag patterns are also accompanied by a large spike in trading volume during the flag pole stage, then preceded by a low volume consolidation. This sort of volume spike rally and subsequent sideways trading without heavy selling shows strong conviction behind the previous up move. The pattern triggers once price breaks above the upper consolidation line and continues the upward momentum. Measuring a flag pattern is as simple as taking the length of the mast (flag pole) and adding that to the breakout area. That gives you your projected price target from the flag pattern.

Bear Flag

Here is a possible Bear flag in process; this is one of our watch list stocks HAIN. To me it looks like HAIN is forming a bear flag. Keep in mind that until the support trendline of the flag area breaks, nothing is confirmed. However, this is setting up like a textbook bear flag patten: high volume selloff, followed by a low volume rally into over head resistance (if you remember back to previous posts the $57 level is key here in HAIN). Also price is nearing a test of its down-sloping 20 DMA (blue line). If the 50 DMA (red line) fails, that would be the pattern confirmation and a definite sell signal.

 Cup/Handle

Cup/Handle patterns can also be called rounded bottoms. A Cup/Handle formation gets its name because the formation very much resembles a cup with a handle. This is a bullish pattern setup and can be found often in rallying stocks.

This is one of my favorite setups at the current moment, Abbott Labs (ABT). The Cup/Handle pattern represents a pause in a previous rally, followed by a bullish move to retest the prior high. After the retest, price will then pull back, but not back to the previous lows; price forms a higher low. The pattern is triggered once the price breaks out back above the recent high. Something that you may notice with Cup/Handles is that the right part of the cup and then handle, resembles the bull flag we just discussed. That's the thing about reading patterns and price action, many of these patterns form within other patterns and simply reenforce the bias of the larger pattern in play. So to see a cup/handle forming with the right side of the cup being a bull flag symbolizes a strong conviction behind the future upward movement of the stock. Cup/Handles are measured similarly to other patterns we have discussed; take the highs of the rim of the cup, minus the low that forms the bottom of the cup and project that difference above the breakout from the rim highs.


Rectangles/Consolidation Ranges

Consolidation ranges and rectangles are very common forms of price taking a pause from its recent ascent/descent. Similar to what we have looked at with flag patterns, consolidations tend to let a strong move cool off a bit and allow traders to reposition for another leg higher or lower. The most important thing to remember with consolidations and rectangles is that nothing is resolved until a new high or a new low is made. Also, being continuation patterns, ranges tend to resolve in the direction of the larger trend in play.

Enbridge is a great example of a range consolidation. After moving strongly higher over the past few years, price took about a 9 month pause in the uptrend and chopped sideways. ENB recently broke out of this rectangle formation and has continued higher over the past 6 months. When measuring a range breakout you simply take the difference between the highs of the range and the lows of the range. You then add that range height to the breakout area and that projects your expected move.

Here is another example of a rectangle/range trade. This shows a downward breakout from rectangle patterns preceded by a longer-term down trend. 


To wrap up our lessons on patterns, I would like to say that these patterns don't always play out to fruition. Sometimes patterns fail and as always you need to be ready and aware of any curve balls the market might through your way. Remember if it was easy then everyone would be a millionaire. But being able to successfully identify these reoccurring and consistent formations can give you some valuable information about the future price movements of the assets you choose to invest in.

I strongly advise you to do further reading and research into these pattern formations which you can find on investopedia, stockcharts.com in their chart school section, or in your google browser. There are always nuances and different perspectives on trading psychology that can be shared from others as well. I have found through my experiences in the markets that these formations play out to success at a very high frequency and give you yet another way to navigate the waters ahead.