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Continuation Patterns - Part 3

This article is reproduced with the permission of Investopedia.com. Back to Trading 101 Index

The term "continuation pattern" may be unfamiliar to some, but perhaps triangles, both ascending and descending, flags, pennants, rectangles and wedges are recognizable to most. All these constitute the study of continuation patterns, and in this four-part series we will break them down into bite-size morsels, allowing you to see them clearly and act upon them in your decision-making process.

Let's begin with an introduction and a brief look to at triangles. In Feb 2002 we saw somewhat of a horizontal pattern developing in the Dow Jones Industrial Average starting mid-November of 2001, as the index traded between 9,625 on the low side and 10,200 on the high side. Arguments could arise that the low side was slightly higher and perhaps it was, but at the time, many traders err on the side of conservatism rather than project a higher, riskier line in the sand.

Chart Created with Tradestation

Many texts will tell you that a continuation pattern has a distinct difference with a reversal pattern (one in which the trend changes) in that the former is often very short in the time that it takes to setup, or more simply, its duration.

This is very true and should make the continuation pattern much easier to see and act upon - especially if you are new to technical analysis. What the new chartist needs always to remember is that a continuation pattern is never set in stone. It may end up being a reversal pattern, and we wouldn't recognize this until a lengthy period of time. All patterns that may initially appear to be continuation patterns may end up being reversal patterns and vice versa. This has always been the major caveat to triangles, flags and pennants, and even HS patterns.

Continuation patterns, triangles in particular, are not very reliable. Here's what Stuart Evens has to say:

Look at most any book on the subject of technical analysis, and you’ll come across triangles. These formations are usually one of the first chart patterns that novice technicians study, and it deserves some examination. Triangles are classified as reversal patterns in some reference works, while they are described as continuation patterns in others. Robert Edwards and John Magee, in their "Technical Analysis Of Stock Trends", have a chapter titled "Important Reversal Patterns - The Triangles".

John Murphy, on the other hand, in his "Technical Analysis Of The Futures Markets", has triangles as a subheading under the chapter titled "Continuation Patterns".

Both works, however, instruct the reader about triangles behaving as both reversal and continuation patterns. What is common to both discussions, and in fact most discussions on triangles, is that once triangles are properly identified, subsequent price action tends to react in predictable ways. What technicians have found over the years is that after prices break out of the triangle pattern, it is highly probable that prices will continue moving in that direction. Knowing this gives us the opportunity to trade in that direction, and to profit if we are correct.

Throughout this series we study all three categories of triangles - symmetrical, ascending and descending - how are they formed and drawn, and how to recognize them in light of their tendencies to break out of formations and give the investor strong signals, either on the buy or sell side. As always, volume plays a major role in continuation Patterns, and we spend some time in the study of increasing and decreasing volumes inside symmetrical triangles.

In part 2 and part 3 we continue our discussion of triangles, and in part 4, we look at flags and pennants.

Next chapter: Part 2

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