Patterns are shapes and formations on price charts that occur frequently. Traders and analysts study these price patterns and predict future prices based on past performance. Studying charts, using chart patterns, indicators, support and resistance levels, and psychological levels is called technical analysis. Patterns play an important role in technical analysis. And in this guide, we’ll focus on continuation patterns. Moreover, we will show you how to trade these patterns.
In general, patterns are grouped into two categories: continuation patterns and reversal patterns. Continuation patterns appear in trends and signal that the trends will continue. Reversal patterns appear at top or bottom of trends and signal reversals. In general, patterns offer great risk to reward ratios and they can be coupled with various indicators and trading strategies.
Types of continuation patterns
There are two types of continuation patterns: bullish continuation patterns and bearish continuation patterns. In addition, there are patterns that signal indecision in the markets, which means that prices can go in either bull or bear direction. For instance, the Japanese candlestick pattern called Doji is known to represent indecision. In this guide, we will focus on continuation chart patterns.
Bullish continuation chart patterns appear in uptrends and signal trends to continue. Similarly, bearish continuation patterns appear in downtrends and after completion, predict the price to keep moving downwards.
Continuation chart patterns
Triangle chart patterns, Flags, Pennants and Rectangle patterns are highly popular continuation patterns. Let’s discuss each one of them in detail and learn how to trade them.
Symmetrical triangles can be both bullish and bearish. It all depends on the setup. If price has been in an uptrend prior to the pattern formation, the Symmetrical triangle is bullish. Similarly, when a Symmetrical triangle appears in a downtrend, it signals upcoming bearish moves.
In order to trade the pattern the right way, you should always wait for the trendline breakout. Breakout candle should close outside the triangle and the pattern is ready to be traded. Stop Loss order can be placed right below up over (depends on the trend direction). And Take Profit targets to depend on the strength of the trend. In general, it is considered the minimum Take Profit target is as high as the maximum distance between the pattern’s two trendlines.
Symmetrical triangles appear often on the charts. It’s very easy to be spotted and the risk to reward ratio is amazing. Which is why triangles are very popular among traders.
Ascending triangles appear in uptrends. They have horizontal resistance lines. After the first candle breaks and closes above the resistance, the pattern is ready to be traded. If traders do not wait for the candle to close, the price might reverse and produce a false breakout. Which will lead to losses. Stop Loss can be placed under the broken resistance and the Take Profit target depends on the strength of the trend. Many traders choose as high TP targets as the largest price fluctuation within the triangle.
Descending triangle is a bearish continuation pattern. The patterns are very popular among various asset type traders. In general, triangles appear often throughout various asset markets.
In order to properly trade the pattern, you should always wait for the culmination point when the price breaks the horizontal support level. As the trendline gets broken and the candle closes outside the triangle, you can enter the trade short. Stop Loss can be placed right above the broken trendline.
Bullish and bearish Pennants
Bullish Pennants appear in fast moving markets. They look like triangle patterns but they generally take much less candles to form. It’s easy to notice them on the charts, however, they are not easy to catch as we’ve already mentioned, they take less time to form then triangle continuation patterns. Bearish Pennant is traded similarly to the Bullish one, but in the opposite direction. Trade can be entered after the trendline gets broken and the Take Profit target depends on the strength of the trend.
Bullish and bearish Flags
Bullish and bearish Flags are both continuation chart patterns. The patterns get their name thanks to their flag-like appearance. In addition, they both offer great risk to reward ratios. Similarly to Pennants, they appear in fast moving markets.
Traders can open trading positions long after the bullish Flag’s trendline resistance gets broken. Take Profit target depends on the strength of the uptrend trend, however, many traders anticipate the move to be as large as the size of the flagpole. Bearish Flag is traded in the similar way, but in the opposite direction. Traders can go short once the bearish Flag’s trendline support gets broken.
Bullish and bearish Rectangle continuation patterns
Bullish and bear Rectangle continuation patterns look like Flags but they have parallel horizontal support and resistance trend lines instead.
Traders can join the trends after the trendlines get broken. Stop Loss orders can be placed right below the broken trendline (or over in the bearish Rectangle example).
Shortcomings of trading with continuation chart patterns
Patterns offer a lot of benefits to traders. They make decision making easier. They offer great risk to reward ratios and are an important part of technical analysis. However, there are some shortcomings associated with patterns in general that need to be discussed.
Patterns are purely technical. They don’t take into account what is going on today. Economic and political events can greatly affect prices. And therefore, to counter this, it’s important to keep an eye on the economic calendar when trading.
In addition, chart patterns cannot produce reliable signals on minute time frames. That’s because trading noise increases as the time frame decreases.
Moreover, patterns show the past. Trading is a dynamic process and what has been true yesterday, might not be true tomorrow. For instance, before the wide adoption of the internet and personal computers, trading was conducted using trading floors. Most floor traders have failed to cope with trading using the online platforms and went out of the business altogether. There’s continued effort to create trading algorithms using artificial intelligence. Who knows, maybe one day the chart patterns we know today will become useless in the future. Until that happens, patterns remain an integral part of technical analysis.
The main takeaways
To sum everything up, chart patterns are highly important in technical analysis. There are patterns that help trends continue and they are called continuation patterns. There are patterns that predict reversals and they are called reversal patterns. There are bullish and bearish continuation chart patterns. Some of the most popular continuation patterns are: Symmetrical triangle, Ascending triangle, Descending triangles, Bullish and bearish Pennants, Bullish and bearish Flags and Bullish and bearish Rectangle continuation patterns. In order to trade the patterns the right way, you should always wait for the breakouts. After the first candles close outside the patterns, trades are ready to be entered. Continuation patterns offer great risk to reward ratios, they are easy to spot and very useful in technical analysis. However, there are some shortcomings. The main downside is that patterns do not take into account economic and political events. In addition, patterns tend to fail on small time frames due to increased market noise.
FAQs on continuation patterns in Forex
What are continuation patterns?
You can find candlestick continuation and chart continuation patterns. Patterns that appear in already established trends and predict trends to continue are called continuation patterns. On the other hand, patterns that predict prices to reverse are called reversal patterns.
How can I use continuation patterns?
Continuation patterns and patterns in general should be entered after they are fully formed. Novice traders often complete the patterns in their imagination and open positions too early. Which is a wrong way to trade patterns.
What are shortcomings of continuation patterns?
Continuation patterns and patterns in general are purely technical. This means that political and economic events can cause price fluctuations and damage patterns. In case you are a technical trader, it’s always a good idea to keep an eye on the economic calendar. Moreover, patterns tend to fail to produce reliable signals when they appear on small time frames due to increased market noise.