Trader’s Toolkit: Continuation Patterns

As I’ve mentioned many times, our efforts to succeed using technical analysis are predicated on a proper recognition of the patterns that regularly appear on the charts that we study.
The next two installments of the Trader’s Toolkit are dedicated to what’s termed a “continuation” pattern, which is a technical formation that indicates that any pause in the current action is likely to lead to a breakout in line with the existing trend.
Below, we examine the “flag” and “pennant” continuation patterns, as well as a number of “triangle” formations, each of which are indicative of a continuation in the existing trend. In the next issue, we’ll look at several more.
Let’s start with the flag pattern, as seen below on the chart of the Dow Jones Utility Average.

A few key points will aid in the recognition of the pattern.

1. The formation is usually preceded by a sharp move higher (or lower, as the case may be).
2. The flag forms against the prevailing trend – in the above example, lower.
3. The flag itself contains the price action within two parallel lines
4. Volume generally declines while the flag is forming, then spikes directly after.

A buy signal is sounded on the day of the breakout from the pattern, or on any retracement to that level.
Pennant patterns are very similar to flags, and share the same listed characteristics. They look like this:

It’s important that the two lines converge, one from above and one from below, and not from the same direction – the latter of which would constitute a pattern indicative of a rising or falling wedge.
Both flags and pennants form over one to three months, though some may be shorter. After two months’ duration, however, some technicians will disqualify all technical patterns.

Know Your Triangles

Triangle patterns come in three distinct varieties: symmetrical, ascending and descending.
However, there’s some debate regarding whether a symmetrical triangle is any different from a pennant. In the interest of simplicity, we’re going to assume it is and move directly to the ascending and descending patterns.
Have a look here:

This is an ascending triangle. It’s always a bullish formation and is indicative of accumulation.  Resistance (horizontal line at $10) is a sign of the bears running out of ammunition and being increasingly unable to repel the continued advances of the bulls.
A buy signal is triggered at the breakout point, when price finally cracks above resistance, or on any retracement to that level (as occurred at the beginning of February).
Some traders, however, will not buy immediately, preferring to submit the break to a 3% test or a three-day test, after which they’ll be more likely to hop on the trend.
Now look at a chart of a descending triangle, a pattern that’s always bearish and a sign of distribution.

Again, we see a decrease in volume over the course of the pattern, followed by an immediate surge in activity once the support line at 86 is broken. A significant decline then ensued.
Triangles are very reliable technical patterns, and the patient trader who’s also astute at identifying the formation will be able to consistently profit from it.