Level 2 Patterns & indicators · Part 4/9

Continuation Chart Patterns

Most of the time markets are not moving, they are waiting. Continuation formations describe that waiting – and the moment it ends.

They all rest on the same process: compression turns into expansion. The range narrows until it does not. The direction of the ensuing break is considerably less predictable than the pattern names suggest.

Triangles

(1) Highs stop at the same price repeatedly — supply sits there. (2) Lows keep rising: buyers accept ever higher prices. Supply gets absorbed, the range narrows, (3) the breakout releases the tension. The direction is not guaranteed — the pattern tells you where something happens, not what.

In an ascending triangle the highs stop at the same price repeatedly while the lows rise. Interpretation: supply sits at the upper edge and gets absorbed step by step, while buyers accept ever higher prices.

The counterpart: (1) lows end at the same price, (2) highs fall — sellers accept less and less. (3) When support breaks, the move is often fast, because the stop orders clustered there trigger additional selling.

The descending triangle is the mirror image. When the horizontal support breaks, a fast move often follows – the stop orders clustered there trigger additional selling.

(1) Falling highs, (2) rising lows: the range narrows from both sides and volatility contracts. Such compressions nearly always end in expansion — (3) — but the direction is open. Anticipating it trades a guess; waiting for the break costs you entry price.

In a symmetrical triangle both boundaries converge. It is the most honest of the three because it suggests no direction: it says something is contracting, nothing more.

One practically relevant observation: breakouts in the final third of a triangle hold more often than those close to the apex. If price runs all the way into the apex, the formation usually dissolves rather than completing.

Flags and pennants

(1) The pole — a fast, steep advance. (2) The flag: a slightly downward-sloping consolidation in a tight band, usually on falling volume. Profit-taking meets demand without breaking the trend. (3) The break above the upper boundary. If the pole is fully retraced instead, it was not a flag but a reversal.

A flag consists of a steep move – the pole – and a narrow consolidation sloping slightly against it. It is the pattern with the clearest substantive argument: profit-taking meets continued demand without the move being given back.

The mirror of the bull flag: (1) a steep sell-off, (2) an upward-sloping, narrow recovery — it looks like a base but is too shallow and too weak, (3) continuation lower. The difference between a flag and a bottom shows in the extent and volume of the bounce, not in its shape.

The downside variant looks like a base and is not one. The difference is extent: a bounce recovering less than a third of the prior move is a pause; one recovering half or more is no longer a flag.

(1) Pole, (2) a short, symmetrically converging pennant — unlike a flag it has no slope but narrows from both sides. (3) Breakout in the trend direction. Pennants typically last only a few periods; if the contraction drags on it becomes a triangle with far less trend context.

The pennant is the symmetrical version of a flag: no slope, but contraction from both sides. It typically lasts only a few periods. If the contraction drags on, it is a triangle – with a much weaker link to the trend.

Wedges

(1) Both boundaries rise, but the lower one more steeply than the upper — the move runs out of room. (2) Each new upward wave is shorter than the last. (3) The break is usually downward. A rising wedge is the rare case where rising prices signal weakness — the slope lives on momentum, not direction.

The rising wedge is the special case where rising prices signal weakness: both boundaries rise, the lower one more steeply, and each new wave is shorter. The break is predominantly downward.

(1) Both boundaries fall, the upper one more steeply — downward pressure is fading. (2) Each new down wave covers less ground. (3) The break is usually upward. As with the rising wedge, what matters is the shrinking amplitude, not the direction of the lines.

The falling wedge works the other way round. What makes both readable is not the direction of the lines but the shrinking amplitude – the same quantity a volatility indicator measures.

Rectangle

(1) Upper and (2) lower boundaries are each tested several times without breaking — supply and demand face off at fixed prices. (3) The breakout. The height of the range serves as a rough measure for the ensuing move; more usefully, a failed breakout is obvious here — price simply drops back inside.

A horizontal range with several tests on both edges. The practical advantage: a failed breakout is immediately obvious, because price simply drops back inside. Of all the formations, the rectangle provides the cleanest refutation levels.

Cup and handle

(1) The cup — a rounded base that slowly recovers the prior decline. (2) The handle: a short, shallow pullback just below the old high where the last sellers exit. (3) Break above the rim. A handle deeper than roughly a third of the cup height voids the pattern, because it undoes the recovery.

A rounded base followed by a short pullback just below the old high. The handle is where the last sellers exit. If it is deeper than roughly a third of the cup height it voids the formation – the recovery has been undone.

The shared warning

All these formations have fuzzy definitions. How shallow may a flag slope? How many touches does a triangle need? Where exactly does the boundary sit?

Every one of those freedoms is a degree of freedom – and degrees of freedom are the raw material of overfitted results. Anyone seriously testing a pattern must first define it tightly enough that a program can find it without judgement. That is where most pattern statistics fall apart, long before probabilities enter the picture.

From shapes to numbers: moving averages as the first indicator.