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Continuation Patterns Reversal Patterns
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By: Asish
11 Jun 2021
Learning
13 Most Profitable Continuation Patterns and Reversal Patterns Found in Candlestick Chart.
In technical analysis reversal from bullish trend to bearish trend and vice versa is most of the time is signaled by different price patterns. Price patterns is an identifiable series of price movement which is defined by the use of multiple trend lines and curves. In this article we shall explain 13 most profitable continuation patterns and reversal patterns found in candlestick chart. In this article we shall learn below mentioned topics. Types of price patterns Continuation Patterns Symmetric/ Ascending triangle/Descending Triangle Pennants Flags Wedges Rectangle Cup with handle Round bottom/Cup Reversal Patterns Head and Shoulder Inverted head and shoulder Double Bottom Double top Triple bottom Triple top
Types of price patterns Price pattern can be divided into two types depending upon the continuation of trend or reversal of trend after completion of the pattern. Continuation pattern Reversal pattern Continuation Patterns This is a type of price pattern after completion of which main trend continue. In the uptrend bulls take a breather during formation of this type of pattern and in down trend bears take rest during this time before continue further. Below are some examples of continuation pattern which we shall explain one by one. Symmetric/ Ascending triangle/Descending Triangle Patterns Pennants Flags Wedges Rectangle Cup with handle Round Bottom/cup Symmetric/ Ascending triangle/Descending Triangle Patterns: A Triangle Patterns is formed when price of a stock becomes more and more compressed over time. Here two converging line can be drawn joining the highs and lows. Triangle may be of three types as describe below: Symmetric triangle: Here if we connect highs we get a descending trend line and if we join lows we get an ascending trend line and both the line converges to form a symmetric triangle.
Ascending triangle: This is formed when highs are at same level when joined horizontal line created but line joining the lows become ascending. Normally breakout happens from the upper horizontal line.
Descending Triangle: This type of triangle is created when lows are at the same level and when joined creates horizontal line. Lines joining highs create a descending line. Generally breakout happens from the lower horizontal line.
For all the triangles if breakout happens from the 2/3 area of the triangle then it has been observed that the breakout becomes effective. During formation of the triangle pattern during initial big move volume remains high, then during consolidation volume also reduce and final breakout happens with big move associated with burst in volume. Pennant A pennant is a continuation pattern which is formed after a big move called flagpole. After the up move there is consolidation containing the price with in two converging lines and pennant is formed. After the price breaks out from the pennant it moves again sharply. Trading volume during the flagpole is high and volume during pennant formation dries up and finally during breakout again volume is very high. This is a smaller version of triangle. Here unlike triangle swing high and lows are not clearly visible and it appear as a small triangle during the consolidation period.
Flags: Bullish Flag pattern is a continuation pattern which is formed after an up move called flag pole. Then price consolidate between two parallel lines having downward slope. Once breakout happens upper line is broken with big move with big volume and price again continues to move higher. Here volume dries up during consolidation and again increase during breakout.
Bearish Flag pattern is a continuation pattern which is formed after a down. Then price consolidate between two parallel lines having upward slope. Once breakout happens lower line is broken with big move with big volume and price again continues to move lower. Here volume dries up during consolidation and again increase during breakout.
Wedges: Wedge pattern is formed by two converging trend line in the same direction joining highs and lows of the price pattern. When the trend lines in slanted downward (at the top of an uptrend) it is called falling wedges and when the trend lines is slanted upward (at the end of a down trend) it is called rising wages.
Also Learn the other topics of Demand Supply trading strategy below: Technical Analysis Basics What is Dow Theory Candlestick Charts Bullish Candlestick patterns Bearish candlestick patterns Indecision and continuation candlestick patterns How to use Volume in trading Method of moving average RSI Indicator ATR Indicator Trend line analysis Support resistance Demand Supply zone Chart patterns Trading channels gaps Trading strategy Trade management and stop loss Position size and risk Rectangle: This is pause after up or down trend and price consolidated with in two horizontal support and resistance line. After break out price continue its prior trend.
Cup with handle: Cup with handle is a typical price pattern which is formed after an uptrend and after formation of the pattern the price continues its upward move again. It may form within 7 week to 65 week. It resembles a cup, its first part is U shaped and second part is like handle with slight down move.
Few points regarding Cup with handle: Trend: There should be prior trend before formation of the pattern. Prior trend should be of few months old and less mature. If it is mature enough then there is low chance of the pattern to be successful and continue the trend. Cup: Cup should be of U shaped. V shaped curve should be avoided because it has low chance to be successful. Cup depth: Cup depth should be of 1/3 or less of the previous trend. Sometimes it is more than 1/3 and cup depth of more than 2/3 should be avoided. Handle: Handle is the last consolidation before the break out. It is normally within 1/3 range of cup depth. Lesser the handle length more bullish the pattern is considered. If the handle is more than ½ of the cup length then there is high chance that the pattern will be failed. Handle can be a pennant, flag or small down move. When the upper line of the handle is broken then it is considered that the pattern is completed. Duration: Cup may be formed with in 1 to 6 month, sometime takes even more time. Handle can be of 1 week, may range from 1-4 week. Volume: Volume should increase during rising portion of the cup and should be lower during handle and breakout should happen with high volume. Target: Target should be considered as the breakout level (higher end of the cup) + length of the cup. Stop loss: Stop loss may be placed below the handle of the cup and can be trailed as price move up using trailing stop loss
Round bottom/Cup Round bottom or cup is a continuation pattern which is formed during up trend. It is a temporary pause in the trend. During this phase some traders book profit who entered in the lower level and new traders take positions. This pattern signifies accumulation before continuation of the trend. This pattern is same in all aspect with cup with handle except that it doesn’t have handle. Price give breakout once it reaches the prior high and complete formation of the round bottom without forming handle.
Few points regarding Cup/round bottom: Trend: There should be prior trend before formation of the pattern. Prior trend should be of few months old and less mature. If it is mature enough then there is low chance of the pattern to be successful and continue the trend. Cup: Cup should be of U shaped. V shaped curve should be avoided because it has low chance to be successful. Cup depth: Cup depth should be of 1/3 or less of the previous trend. Sometimes it is more than 1/3 and cup depth of more than 2/3 should be avoided. Duration: Cup may be formed with in 1 to 6 months, sometime takes even more time. Volume: Volume should increase during rising portion of the cup and breakout should happen with high volume. Target: Target should be considered as the breakout level (higher end of the cup) + length of the cup. Stop loss: Stop loss may be placed below the breakout level and can be trailed as price move up using trailing stop loss techniques. Reversal Patterns We shall explain below mentioned six reversal patterns: Head and Shoulder Inverted head and shoulder Double Bottom Double top Triple bottom Triple top Head and Shoulder Pattern Head and shoulder pattern is a trend reversal pattern which is formed at the end of an uptrend. It consists of three successive peaks. The middle one is called head being the highest one and other two outside high is called shoulder and is about equal height. The line joining the swing lows of each peak is called neck line.
Head and shoulder pattern consists of left shoulder, head, right shoulder, neck line. Other things to consider in this pattern in trading volume, break out, price target and retesting of neck line. Previous trend: Previous trend should be up and this reversal pattern form at the end of an uptrend. Left shoulder: Left shoulder is part of the uptrend. First it makes a new high and price fall to create the shoulder. Head: Head start from the low of the left shoulder and then creates new high (It marks the top of the current trend) and then fall again. It breaks the uptrend line and creates a low point. Joining the low pint of left shoulder and head we get neck line. Right shoulder: Price again advances from the low of head to form the right shoulder. Left and right shoulder is symmetrical most of the cases but there may be exceptions as well. The decline from right shoulder can break the neck line. Neckline: Neckline can be drawn joining the two low points, one point is where left shoulder complete and head starts and another point is where head complete and right shoulder starts. Depending up on position of these two points the neck line can be slanted upward, horizontal or slanted downward. The slope of the neck line determines the bearishness of the pattern. If slope is downward the pattern is more bearish. Volume: Volume gives an important indication in formation of the pattern. Usually during the left shoulder volume is higher than the head. It gives the first signal that new high is not supported by high volume. Again volume rises when price fall from the peak of the head and reduces during the advancement of right shoulder. Finally during the falling side of the right shoulder the pattern breaks the neck line with high volume. Retesting of Neck line: After the breakout from the neckline sometimes price retrace back again to the neck line to retest the level. Now the neckline becomes resistance and gives a second chance to sell. Price target: Generally the down side price target is set measuring the height of the peak of the head and subtracting it from the neck line. This is the rough method to set target. Rather we can use trailing stop loss or we can use other techniques to set target (like Fibonacci levels and higher timeframe support etc.). Stop loss: Here stop loss can be set above neck line and we have to take help of ATR and other stop loss techniques to set the stop loss. Inverted head and shoulder pattern: Inverted head and shoulder pattern is formed at the bottom of the down trend. It is just opposite of the head and shoulder pattern. It consists of three successive lows. Middle one is the lowest and called head and other two low is called shoulder and are symmetrical. Line joining the swing highs of the lows is called neck line. Below is an example of inverted head and shoulder in the chart.
Inverted head and shoulder consist of left shoulder, head, right shoulder, neck line. Other important aspect of this pattern is volume, previous trend, breakout, retesting of trend line, target and stop loss. We shall discuss these one by one. Prior trend: Inverted head and shoulder is a reversal pattern and already a down trend should be established before formation of this pattern. Left shoulder: Left shoulder is a part of the prevailing down trend and during formation it creates a new low and then price retrace back to form the shoulder. Head: Once the left shoulder is completed price again fall to create new low and then retrace back with high volume to complete the head. Right Shoulder: Once the head is completed price again fall to create one higher low that is called right shoulder. Both the shoulders are symmetrical in most of the cases, but it may be slightly different also like higher, lower, narrower, wider. Neck line: Neck line is drawn joining the junction point of left shoulder and head and head and right shoulder. It is not necessary that neckline will always be horizontal. It may be sloped upward or downward. If it is sloped upward then more bullish the pattern is. Breakout: After completion of right shoulder price should break the neckline with high volume and large move to complete the pattern. Volume: Volume has more importance in inverted head and shoulder pattern rather than head and shoulder pattern. Below mentioned points should be verified to validate the pattern: Volume during second half of the pattern is more important than the first half. Generally during the first half of the left shoulder volume is high and there is intense selling pressure. Also, during falling part of the head volume may be high. After completion of the peak of the head during rising part volume must be very high and increasing. During falling part of the right shoulder volume should be decreasing. Finally, during rising part of the right shoulder volume should increase significantly and breakout should happen with massive move associated with very high volume. Retesting of the Neck line: Once neck line is broken it converted to support line. Some times price fall again after breakout to retest the neck line. This gives another opportunity to go long. Target: Length from neck line to peak of the head is measured. Then it is added to the neckline value at breakout point to get a rough target. We can use trailing stop loss, projections, higher timeframe resistance and other methods to get target also. Stop loss: Stop loss should be above neck line. We should use out stop loss technique to determine stop loss which has been discussed in separate article. Double Bottom Reversal Patterns: Double bottom is a reversal pattern which is formed after a down trend. During a down trend many potential double bottoms can form but to confirm trend reversal break out from the pattern must happen. As the name suggest this pattern consist of two lows and one intermediate high in between. Now we look into every detail of this pattern.
Previous trend: There should be down trend established before formation of a double bottom. The down trend should be prevailed for several months. First low: The first low of the pattern should mark the lowest point of the down trend. Actually, it is the part of the existing down trend. Peak: After formation of the first low retracement of 10 to 20 percent happens and creates an intermediate high. Usually, volume of this advancement is not much significance but if price rise with high volume, then this an early sign of accumulation. This high is some time rounded and price is hesitant at the top because here buying pressure is not enough to break the resistance and selling pressure still exists. Second low: Second low is created after formation of intermediate high. In this phase price fall with lower volume and retest the previous low. These low levels should be at the same level but variation up to 3% is acceptable. Previous low should give support to the price. At this phase also we cannot say the trend is reversed, we have to wait for the breakout to happen. Time difference between two lows should be 1-3 months. Advance from the low: Price advance from the second low to the intermediate high. This move should be associated with high volume. Some time it is associated with gap up moves which represents buying pressure. Breakout: Even after the move up to the previous intermediate high we cannot say trend has been reversed. The resistance has to be taken out with massive up move along with large volume. Price should trade comfortable above the resistance. Retesting of Resistance line: After breakout sometimes price fall back to the resistance line to retest. It gives second chance to cover sort or initiate long. Target: We have to measure the length between intermediate high and the lows. We can add this length to the breakout level to get target. So bigger the size of the pattern higher the target. Stoploss: Stoploss should be kept below resistance line and stoploss technique which has been explained in separate article may be used here. Double top Double top is a reversal chart pattern which is formed after an uptrend. Here two high is created at the same level with an intermediate low in between. The pattern is assumed to be complete once the intermediate low is broken with significant volume along with large candle. A double top consists of first high, intermediate low, second high, a fall from the second high to intermediate low, breakout. Some other aspect of the double top is prior trend, volume, retesting of the breakout level, target, stop loss. Each of these items will be discussed in detail here.
Prior trend: Double top is a bearish reversal pattern. So, there should be an uptrend established which may be reversed. First high: First high is a new high with is formed as the part of the prevailed uptrend. It marks the top of the uptrend if the pattern is successful. Volume during this move is not much important, generally buying pressure is there as this is a part of the uptrend. Intermediate low: After first high intermediate low is formed as the price fall. Some time the intermediate low is round in formation and price is hesitant to go down as there is still buying pressure in this phase. Intermediate low should be at list 10 below the top to make the pattern valid. Second high: Price again rise to the previous high to form the second top. This move is associated with low volume which signifies buying pressure is reducing and this is a signal of trend reversal. Some time this high is little bit up on down than the previous high. I should be around 3 percent range of previous high. Two high should be separated by minimum one month. Fall from the high to intermediate low: This fall is associated with high volume which signifies selling pressure. Till this phase the pattern is not complete until breakout happens. Breakout: Breakout should happen with large volume and big candle to break the support at the intermediate low. Price should stay below the support level comfortably to confirm the break out. Retesting of Support level: Once the support is broken it becomes resistance. Price may retrace back to this level again to retest. This gives a second chance to sort. Target: Rough target may be set by measuring the length between top and intermediate low and subtracting it from the breakout level. Other methods like higher time frame resistance, Fibonacci projections and other techniques may also be uses to set target. Stop loss: Stoploss should be set above breakout level and other stop loss techniques should be used. Triple Bottom: Triple bottom is a bullish reversal pattern which is formed after a down trend. During formation it may resembles like a rectangle, double bottom in the early phase. We should remember that this pattern is neutral until breakout happens.
Triple bottom consists of three lows, two inter mediate high. Other aspect of triple bottom is resistance line, break out, volume, target. We shall explain these below. Prior trend: This is a bullish reversal patter, so, its prior trend should be down Three low: These are three consecutive low which is formed almost at the same level and almost between equal intervals. High volume during formation of the lows may be signifying accumulation. Intermediate high: This is two intermediate highs between the lows. Through this high resistance line is drawn. Break out: Upward price movement from the third low should be associated with increasing volume and finally price should break above the resistance line with large volume. To be confirm price should trade above this resistance for few days. Retesting of resistance: Once the resistance is broken it converted to support and price may retest this level. This gives the second chance to trade. Target: Rough target may be set by adding the length of the pattern to the resistance line. Other target setting methods may be applied here. More time taken to develop the pattern more bullish it becomes. Stop loss: Stop loss should be below resistance line, Other stoploss management techniques may be applied here. Triple top: Triple bottom is a reversal pattern which is formed after an uptrend. It looks like a double top and rectangle in the early phase of its formation. It may be noted that it is a neutral pattern until breakout happens.
Triple top consists of three highs, two inter mediate low. Other aspect of triple bottom is support line, break out, volume, target. We shall explain these below. Prior trend: This is a bearish reversal patter, so, its prior trend should be up. Three high: These are three consecutive high which is formed almost at the same level and almost between equal intervals. High volume during formation of the highs may be signifying distribution. Intermediate low: This is two intermediate lows between the highs. Through this lows support line is drawn. Break out: Downward price movement from the third high should be associated with increasing volume and finally price should break below the support line with large volume. To be confirm price should trade below this support for few days. Retesting of support: Once the support is broken it converted to resistance and price may retest this level. This gives the second chance to trade. Target: Rough target may be set by subtracting the length of the pattern to the support line. Other target setting methods may be applied here. More time taken to develop the pattern more bullish it becomes. Stop loss: Stop loss should be above support line, Other stoploss management techniques may be applied here.
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