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 gets narrower until it does not. The direction of the break that follows is far less predictable than the pattern names suggest.

Triangles

Ascending triangle: horizontal resistance above rising lows — (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 again and again, while the lows keep rising. The reading: supply sits at the upper edge and is absorbed step by step, while buyers accept higher and higher prices.

Descending triangle: horizontal support beneath falling highs — 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, because the stop orders that built up there trigger extra selling.

Symmetrical triangle: falling highs meet rising lows — (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 move toward each other. It is the most honest of the three, because it suggests no direction at all: it says that something is contracting, nothing more.

One observation that matters in practice: breakouts in the last third of a triangle hold more often than breakouts close to the apex. If the price runs all the way into the apex, the formation usually dissolves instead of completing.

Flags and pennants

Bull flag: a steep rally, a downward-sloping consolidation, then a new breakout — (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 that slopes slightly against it. It is the pattern with the clearest argument behind it: profit-taking meets continued demand, and the move is not given back.

Bear flag: a steep drop, an upward-sloping consolidation, continuation lower — 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 version looks like a base but is not one. The difference is how far it goes: a bounce that recovers less than a third of the previous move is a pause; one that recovers half or more is no longer a flag.

Pennant: pole, a short symmetrical contraction, breakout in the trend direction — (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 usually lasts only a few periods. If the contraction drags on, you are looking at a triangle – and its link to the trend is much weaker.

Wedges

Rising wedge: two upward-sloping converging boundaries with a downside break — (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 than the last. The break is mostly to the downside.

Falling wedge: two downward-sloping converging boundaries with an upside break — (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 around. What makes both readable is not the direction of the lines but the shrinking amplitude – the same quantity a volatility indicator measures.

Rectangle

A horizontal range with several tests on both edges. The practical advantage: a failed breakout is obvious right away, because the price simply drops back inside. Of all the formations, the rectangle gives you the cleanest points of refutation.

Cup and handle

A rounded base followed by a short pullback just below the old high. The handle is where the last sellers get out. If it is deeper than roughly a third of the cup, the formation is void, because the recovery has been undone.

All of 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 choices is a degree of freedom, and degrees of freedom are the raw material of overfitted results. If you want to test a pattern seriously, you first have to define it tightly enough that a program can find it without judgment. That is where most pattern statistics fall apart, long before probabilities come into play.

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