Continuation patterns

If a trader does not believe in the random walk theory applied to forex markets, according to which currencies move randomly, he must believe that prices follow defined patterns, geometric shapes which emerge from data that provide him a useful tool to understand the price action, as well as formulate predictions about currencies prices. As the name suggests, continuation patterns indicate that a price trend of a currency pair is likely to continue.

These patterns are observable in the middle of a trend and halt the price action of varying durations. When they are observed, it means that the trend is likely to resume after the pattern finishes. A pattern is considered complete when it “breaks out”, potentially continuing on with the previous trend. Contnuation patterns can be detected on different time frames, from a tick to a weekly chart. The most common patterns are: triangles, flags, pennants and rectangles.

Triangles, defined as a converging of the price range, with higher lows and lower highs. The converging price action generates a triangle-like figure. These figures have different duration but have at least two swing highs and two swings lows in price. As price converges, it will eventually reach the apex of the triangle; the closer to the apex price gets, the tighter and tighter price action becomes, thus making a breakout more likely. There are three categories of triangles: symmetrical, which has a downward sloping upper bound and an upward sloping lower bound; ascending, which has a horizontal upper bound and upward sloping lower bound; descending, which has a downward sloping upper bound and horizontal lower bound.

Flags are a pause in the trend, where the price is contained in a narrow range between parallel lines. This pause gives the pattern a flag-like appearance. Flags are generally short in duration, lasting few bars, and do not contain price swings back and forth as a trading range or trend channel would. Flags may be parallel or upward or downward sloping.

Pennants are similar to triangles, but they are smaller, generally made of a restricted number of bars. As a rule of thumb, if a pennant lasts more than twenty bars, it is considered a triangle. The pattern is created as prices converge, covering a relatively small price range mid-trend.

Often traders observe pauses in a trend in which the price action moves sideways, bound between parallel support and resistance lines. These patterns are called rectangles. They can last for short periods of time or many years. This pattern can be observed on many time frames.

Also flags are a pause in the trend, but the price moves in a small band between parallel lines, which take on a flag-like appearance. They generally have a short duration, lasting only several bars and do not contain price swings back and forth as a trading interval or a trend channel would. They can be parallel or inclined upwards or downwards.

Continuation patterns provide some logic to the price action and trading opportunities that may not be exploited using other methods. Unfortunately, they are not always reliable. A pattern may appear in the middle of a trend, but a trend reversal may still occur. It is also likely that, once a pattern is formed, the bounds may be slightly penetrated, but a real breakout does not occur. These ‘false breakout’ could occur many times before the flag is actually broken and a continuation or a reversal occurs. Rectangles, for example, due to their popularity and easy visibility, are often subjected to false breakouts.

Patterns are usually subjective, as what one trader sees is not what another trader sees, or how another trader would draw or define the pattern in real time. This is acceptable, as it provides traders with a unique market view. It always needs time and practice to develop skills in finding patterns, drawing them and formulating a profitable strategy.

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