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4. D
iscovering Multiple
Period Chart Patterns
H A N TE C R E SE A R C H WE BINARS - Technical Ana lysis Series
Chart Patterns
Continuation patterns
Therefore there is no need to get bogged down with what you call your top pattern. As long as the
basic principles of building the pattern are there, a top is a top. The basics of technical analysis can be
formed in Dow Theory, which states that uptrends are defined as a series of higher highs and higher lows
(downtrends are defined as a series of lower lows and lower highs).
Therefore, as long as you have a high in the price with a subsequent reaction low; followed by renewed
upside which fails at or just below the previous high (breaking the sequence of higher highs), and a move
back below the previous reaction low (breaking the sequence of higher lows), the top pattern will be
complete.
Ultimately, the number of times that the highs and lows are tested before the pattern completes is of
minor detail (although it can add to the conviction on the break). The most important fact we need to be
concerned with is the fact that a reversal pattern has completed and there is a change of trend underway.
Fig 2. A head & shoulders top on the STOXX 600 hourly chart
Also note how in Fig 3, in the second hour following the completed breakout,
there is a pullback correction back to the neckline support which gives a second chance to buy.
Technical analysis theory suggests that a target can be derived from the completed head and shoulders pattern.
For the top patterns, measuring the move from the tip of the head to the neckline and then projecting this
measurement downwards gives us an implied downside target.
N.B. Imperfect
pattern targets
Patterns are imperfect where the reaction from the neckline in the second move may not be
quite as large as the first move, leaving a pattern that is not uniform in shape.
You can either derive a conservative target (from the smaller peak/trough)
or measure the full implied target (higher conviction).
4
The implied target of the rounding bottom pattern comes from the measurement from the key low
up to the neckline resistance and then projected upwards. The rounding top is the opposite.
Continuation patterns are technical consolidation patterns that ultimately breakout in the direction
of the prevailing trend prior to the consolidation.
Triangles
Triangles are some of the most well-known
consolidation patterns used in technical analysis.
The two main types of triangles, which vary in
construct and implication, are the ascending
triangle and descending triangle.
The Ascending Triangle develops as a
consolidation in the price during a bullish trend.
In an ascending triangle, the upper trendline
is flat, while the bottom trendline is upward
sloping. The ascending triangle is generally
thought of as a bullish pattern in which chartists
look for an upside breakout. The price knocks
up against the resistance, whilst continuing to
leave a series of higher lows. The eventual break
through the resistance can often be seen with
a burst through a supply vacuum and a sharp
rise in price. The implied target derived from
the pattern uses the upslope of the triangle,
projected higher from the resistance point.
N.B.
The Third Triangle
There is a third triangle pattern, the
symmetrical triangle, which is a pattern
where the two trendlines converge
toward each other. However this is
a neutral pattern with no symmetry
between the trendlines and no indication
of which direction the breakout will
subsequently come.
Although the breakout will often be in
the direction of the prevailing trend,
with the price action providing little clue
to the breakout during the formation, it
cannot therefore be considered as a true
continuation pattern.
The Descending Triangle is the opposite of an ascending triangle and develops as a consolidation
pattern during a bearish trend. In a descending triangle, the lower trendline is flat and the upper
trendline is descending. This is generally seen as a bearish pattern where chartists look for a
downside break. The price this time has been trending lower but then encounters support which is
tested on a consistent basis. During this test of support a series of lower highs is left. The eventual
break through the support will often be characterised by a demand vacuum, where a series of stoplosses are triggered leading to a sharp decline in price. The implied target derived from the pattern
uses the downslope of the triangle, projected lower from the point of support.
Flags
A flag is a short-term continuation pattern, formed over just a few periods. Flags can be both bullish
(in an uptrend) and bearish (within a downtrend). Flags are formed on the consolidation which can
follow a sharp price movement. With a Bull Flag the consolidation can often be characterised by a
gradual drift lower which culminates in another sharp move to the upside in the same direction as
the prevailing trend.
A Bear Flag is the
opposite, with a sharp
decline followed by a
consolidation pattern
(which can often contain
a slight upside drift.
The pattern is then
completed after another
sharp price movement in
the same direction as the
move that started the
trend.
Fig 9. A Bull Flag on the S&P 500 hourly chart
Wedges
A wedge pattern is similar to a flag pattern but the period of consolidation can last a lot longer. As
with flag patterns what tends to happen is that you will get a Falling Wedge in an uptrend, which is a
bullish pattern, and a Rising Wedge in a downtrend which is a bearish pattern. The similar principles
apply as for flag patterns.
Unfortunately, just to make things a little bit more complicated, you can also get falling wedges in
a downtrend (which are usually considered to be a bearish continuation pattern) and also get rising
wedges in an uptrend (which is usually considered to be a bullish continuation pattern).
Range Breakouts
A Range Breakout is another trend continuation pattern. It is a consolidation phase that follows
a strong move. The consolidation is characterised by a series of highs and lows within a range that
eventually break in the direction of the prevailing trend. It is then subsequently possible to trade
in the direction of the breakout. Note how in the example of Euro/Dollar below, how there was a
pullback towards the breakout, before the trend eventually continued higher.
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