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Task №3 part 2. Graphic pattern analysis: triangles, flags, and pennants

Continuation patterns

In technical analysis, the patterns that point to a short-term correction before the major trend resumes are called continuation patterns. Traders can prevent opening losing deals if they identify these patterns correctly. Main continuation patterns are the triangle, flag, and pennant. Each pattern is determined by two lines: support and resistance. The first line goes through local lows, and the other covers only local highs. The more highs or lows there are on a line, the clearer a pattern will stand out on a chart.

Triangle

First, let’s discuss the triangle as it is the most popular pattern indicating trend continuation. It is formed by convergence of support and resistance lines. Triangles can be symmetrical, ascending, and descending.

Price highs and lows in the symmetrical triangle pattern have almost the same slopes but in the opposite direction. So, the lines cross each other at one point. This pattern is neutral as neither bulls nor bears dominate in the market and the activity is low. Supply and demand are rather limited in this period. A symmetrical triangle points to a continuation of the trend that was in the market before the price entered the pattern’s range. In this case, the direction in which the line is broken is more important than the pattern’s type. This triangle is often described as a zone where prices consolidate after a serious slump or surge.

Symmetrical triangle


The triangle has become the last consolidation pattern before a peak formation


An ascending triangle is represented by a horizontal resistance line and an ascending line formed by linked lows. This triangle type means that bulls cannot breach a certain price level (resistance), and still they are gradually raising prices, which becomes clear when analyzing the chart. Lows constantly become higher. Traditionally, the upper price line is broken. The ascending triangle is usually formed during an uptrend and has a rather clear direction towards a possible price breach. So, prices leave the pattern in the same direction they entered it. However, there could be some unexpected situations. If a bullish trend fails to overcome a bearish one, price fluctuations could be completely unpredictable.

Ascending triangle


The ascending triangle has formed shortly before the termination of the short-term trend


A descending triangle is the exact opposite of the ascending one. It is formed by an almost horizontal support line and a resistance line built on descending highs. Only bears can break through the formed price level, though still pushing prices lower until support is breached.



The descending triangle signaled a near termination of the two-week bearish trend


Let’s have a closer look at the charts. A triangle formation means a pause in the current trend that continues afterwards. For example, the previous trend was mowing upwards, and the rise is most likely to resume following the triangle price consolidation. In case of a downtrend, a symmetrical triangle indicates a further drop in prices once the pattern shows signs of fading. Each triangle pattern requires four points. Two points are needed to draw trend lines. So, to draw two converging trend lines, each of them has to run through at least two points. A triangle starts at point 1, where trend consolidation takes place. Prices fall to point 2 and then rise again to point 3. Take notice that point 3 is below point 1. Draw the upper trend line only after prices drop from point 3.

Point 4 is above point 2. Draw the lower ascending line after prices start moving upwards from point 4 amid active market. At this moment, analysts start to doubt the existence of a symmetrical triangle. Now we have four base points (1, 2, 3, and 4) and two converging trend lines.

When the close price goes through one of trend lines, it is considered a sign of a pattern’s closure. Sometimes, a breach is followed by a price reversal back to the trend line. The line becomes a support (resistance) level if the trend is upward (downward). Besides, after a break, the top becomes an important support or resistance area. Breach criteria can vary. The minimum proof of a breakout is a close price logged beyond trend lines, not an intraday breach.

Trading rules for different triangles are identical. Refrain from high activity on small fluctuations within a triangle unless the pattern is large. With the pattern fading away, there are less price fluctuations. Profits become smaller; slippage and commissions keep on destroying your account as usual. In this case, the best decision is to buy (sell) at an upward (downward) breakout of the triangle alongside the major trend. Place stop orders above (below) the breached trend line.

Just like in reversal patterns, there is a way to determine price reference points that the market will reach after the triangle pattern is formed.

It is very simple. You need to measure the pattern’s height in the widest part and put it up or down (depending on the main trend). The acquired level will be a price reference point.

Flag and pennant

The flag and pennant patterns appear on price charts quite often.

The flag is considered the most reliable pattern in technical analysis. It is a continuation pattern serving as a consolidation period after sharp changes. A flag appears when market participants need a sort of a break after bears fix their profits, followed by bulls or vice versa. Of course, they cannot cash in profits simultaneously; that is why a short opposite trend appears. A flag is usually directed in the same way as the trend that dominated when the pattern appeared. A breakout in one direction or another is a sign of uptrend or downtrend continuation. However, if the breach direction is opposite to the major trend, you should be ready for a trend reversal.

Bullish flag


The pennant is a short consolidation within the current trend. This pattern’s key feature is that it is formed in the presence of very strong market movements. A pennant is a short-term pattern with the direction opposite to the major trend. In this case, there is no correction. The flag’s parallel lines converge in the pennant pattern; therefore, it is sometimes mistaken for a triangle. However, unlike the triangle pattern, a pennant forms quickly and has the opposite direction to the major trend, which is not that important. You should pay close attention to the direction of a breakout as it indicates either a trend continuation or its reversal.

Bullish pennant


The rectangle is formed when the price is moving between two parallel lines (support and resistance). Highs and lows are located horizontally. A rectangle is a pattern indicating a longer price consolidation after a very strong major trend. As a rule, prices exit the rectangle pattern in the same direction they entered it.

Bearish rectangle


To identify continuation patterns, you can use weekly, monthly, and even intraday charts. The following is true for all the mentioned patterns: the more traders discover a pattern, the more chances there are for market shifts. However, remember that different forex time frames imply different patterns.

Questions for revision
  1. What types of triangles do you know?
  2. What confirms the invalidation of a triangle pattern?
  3. What's the difference between a flag and a pennant?
  4. Suppose that the price moved by 80 points upward before a flag started to form. The pattern has been invalidated with the breakout of 1.2540. Find price reference points towards which the rise will continue.
  5. Locate the above-mentioned continuation patterns on charts in a trading platform.
  6. Name trading rules for the situation when there is a triangle on a chart.

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