Continuation patterns indicate that the price action described by the pattern is merely a pause in the prevailing trend and that upon breaking out of the pattern the price trend will continue in the same direction. We will look at the following patterns that imply trend reversals: Flags, Rectangles, Triangles, and Wedges. The latter two are presented on the next page.
Of course, patterns do not result in a continuation of the prevailing trend all the time and analytical skill is needed to gauge whether they will come to fruition.
Flags are a type of short-term pause in the dynamic and progressive movement of a market trend. Flags are usually marked by a sharp, almost horizontal entry into the pattern. Flags are bound by parallel lines of support and resistance. The pattern is commonly followed by a sharp break back into the prevailing trend.
Flags have a tendency to form slanted in the direction opposite to the major market trend they inhabit.
On the right, is a flag that interrupts an uptrend. It is short lived, and there is a substantial breakout when price moves above the line of resistance.
Also on the right, is a flag pattern during a downtrend, that plays out in a long timeframe. The consolidation phase lasts two months but does not turn into a new trend. The line of support is broken, ending the flag pattern and continuing the downtrend.
A Rectangle is a period of consolidation within an existing trend where the price moves sideways, fluctuating between two horizontal lines before finally resuming its previous trended course. Such a pattern is not very significant to the trend’s future course – a rectangle seldom accelerates the prevailing trend beyond its previous slope. Though not characteristic in determining any anomalous effects in the presiding trend, a rectangle pattern presents an opportunity to trade within, as one can open alternating positions as the price repeatedly bounces from support to resistance and back.
A theoretical sketch of a rectangle in a downtrend and an uptrend is shown on the right.
A real world example is presented below. An uptrend that was started in September enters a period of consolidation in October. Price forms a rectangle pattern before the uptrend continues. You can see a flag pattern emerge a couple of months later as well.
Last Modified: 2009/10/27 20:43:08