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The Traders Wheel
8/15/98 by Alan Farley

 Continuation Patterns

After rapid price movement, markets need time to absorb instability generated by that trend’s momentum. They pause to catch their breath while both volume and price rate of change drop sharply. During this consolidation period, the new price level undergoes continuous testing for support and resistance. To the pattern reader, this range phenomenon reveals itself through the familiar shapes of Flags, Pennants and Rectangles.

Relatively simple mechanics underlie the formation of these continuation patterns. The orderly return to a market’s mean state sets the foundation for a new thrust in the same direction. An instructive example of this process is found in the current secular bull market. The popular strategy of buying on the dips reflects the core psychology seen with these patterns.

In a series of sharp trend moves, congestion tends to alternate between simple and complex in both time and size. Trade defensively when the prior pattern was both short and simple. Go on the offense after observing an extended battle in the last range.

When examining continuation patterns, the technician must pay close attention to proportionality. This visual element will validate or nullify all other predictive observations: constricted ranges should be proportional in both time and size to the trends that precede them. When they take on dimensions larger than expected from visual examination, odds increase that the observed range actually relates to the next trend larger in scale than the one being viewed. This can trigger devastating trend relativity errors, in which positions are executed based on patterns longer or shorter than the time frame being traded.

All patterns must be evaluated within the context of this trend relativity. The existence of any range depends upon the time frame being considered. For example, a market may print a strong bull move on the weekly chart, a bear on the daily and a tight continuation pattern on the 5-min bar, all at the same time. A range drawn through one time frame does not necessarily signal swing conditions in the other periods that market trades through.

Look for the familiar countertrend parallelogram imbedded between sets of strong trend thrusts. These continuation ranges should complete in no longer than 15-20 bars. If they don’t, watch for a violation of the parallel on the next swing.
Pennants narrow to a countertrend apex point and a new trend leg erupts. Completion times are similar to flags. Expanding bars against the trend near the apex signal possible reversal.
Horizontal support and resistance allow profitable swing trading as the pattern develops. Expect a breakout just as the 3rd hit appears to fail.

 

 
Alan Farley is a full-time trader and author residing in Denver, CO. He publishes The Hard Right Edge premier web site for trader education, technical analysis and trader resources featuring both Morning Trader and Traders Workshop. The site provides traders with comprehensive resources including original tactics and strategies on multi-trend technical analysis and short-term trading .

  Alan also authors on-line training technical analysis in association with independent sites. His most recent publications include the Mastering The Trade on-line workshop, Momentum: Riding The Tiger, and Time of Day. In addition to writing, he is an outstanding speaker and lecturer on short term trading strategies.

 He has been featured in Barrons, Smart Money magazine, Tech Week, MoneyCentral and TheStreet.com.

 

 

 
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Last modified: April 02, 2001

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