Technical analysis is a broad term we use when we’re examining market data to try and predict future price trends. An important part of any trader's technical strategy is the use of technical indicators.
These pattern types are easily spotted by traders but sometimes they can struggle to decide whether the signal they’re seeing is valid or not. Therefore, it can be beneficial to use additional tools to filter them.
But before you dive into the world of continuation and reversal patterns, it's important to be well-acquainted with some relevant trading knowledge, such as how to read candlestick patterns and what is the difference between bullish and bearish markets.
Keep reading to learn how to predict price trend continuation using common reversal and continuation patterns.
A chart pattern (or price pattern) is an identifiable movement in the price on a chart that uses a series of curves or trendlines. These patterns may repeat and occur naturally due to price action, and when they can be identified by market analysts and traders, they can provide an edge to trading strategies and help them beat the market.
Like the majority of price patterns, there are four key elements that are needed to form the pattern:
Chart patterns are an important part of technical analysis that every avid trader should understand so as to improve how they view and operate in the market.
Continuation patterns are price patterns that show a temporary interruption of an existing trend. For example, the price of an asset might consolidate after a strong rally, as some bulls decide to take profits and others want to see if their buying interest will prevail.
Most traders will wait for a breakout above/below the line of resistance/support as a confirmation that the trend is resuming, and enter a position in the same direction.
When setting stop loss and take profit orders, many traders place the stop slightly above or below the chart formation, while the take profit order depends on the pip range within that pattern.
For example: If the pip value of the consolidation within the rectangle is 30 pips, a trader who wants to keep a risk-reward ratio of at least 1:1 might target 30 pips as a take profit target.
The most common continuation patterns are:
Tip: Continuation patterns can be identifiable as both bullish and bearish signals.
Rectangle patterns are formed when the price is hitting horizontal support and resistance levels, several times. The price is therefore constricted, bouncing between the horizontal levels and creating the shape of a rectangle. The price will eventually break out and the trend will follow that direction, either an upward or downward movement.
Bullish rectangle and bearish rectangle patterns
Triangle patterns are a commonly used continuation pattern by technical analysts. There are three variations of triangle patterns and they are all important to learn because they can help identify the continuation of a bullish or bearish market. They are symmetrical triangles, ascending triangles, and descending triangles.
The triangle begins forming with its widest point, and as the market keeps moving sideways the range of trading narrows, completing the full formation of the triangle at its apex. This chart pattern is often described as a horizontal trading pattern and is similar to wedges and pennants, where bullish or bearish movement can signal a continuation or reversal of the previous trend direction.
Ascending triangle: The ascending triangle typically breaks out in the same direction as the trend was going just prior to where the triangle formed.
Descending triangle: The descending triangle shows traders that the demand for an asset is weakening as the price breaks below the low support levels, with downward momentum likely to continue.
Symmetrical triangle: The symmetrical triangle continuation pattern shows a consolidation period before the price sees a breakout or breakdown, starting a new bullish or bearish trend.
Bullish and bearish symmetrical, ascending and descending triangle patterns
Pennant patterns form the shape of a flag or triangle on the chart and occur when price movements are becoming tighter and tighter between the support and resistance levels as time moves on. This pattern is generally considered a pennant when there are at least five touches of support and resistance. Similar to rectangle patterns, the pennant continuation pattern can be formed from bullish or bearish price movements.
Bullish and bearish pennant
A wedge price pattern is shown on a chart by converging trend lines, where the two lines are marked to connect the respective highs and lows of a price series. The wedge is a signal that the current trend is going to pause. A rising wedge is found in a downward trend and is a bearish pattern with lines sloping up. A falling wedge is found in an upward trend and is a bullish chart pattern with lines sloping down.
Rising and falling wedge pattern
The cup and handle pattern can be formed in small time frame charts or large time frames, such as daily to monthly. The cup and handle pattern is a bullish continuation pattern and gets its name from the shape it forms on the chart. This can occur where an upward trend has paused and become stable, followed by an upswing of a similar size to the prior decline.
The cup portion of the pattern is shaped like the letter "U" with both sides of the cup having equal sides. The handle portion is then formed on the right side of the cup with the chart moving sideways or drifting downwards which may lead to a breakout of the instrument to a height larger than the beginning of the cup.
Inverted and normal cup and handle pattern
Reversal patterns might signal that either the bulls or bears have lost control and that there might be a change of trend imminent. The current trend will see a pause and then the price will move in a new direction from the other side (bull or bear).
A distribution pattern is a reversal that occurs at market tops, where the instrument that is being traded becomes more eagerly sold than bought.
An accumulation pattern is the opposite – a reversal that occurs at market bottoms – with the instrument being traded more actively bought than sold.
The most common reversal patterns are:
Tip: Wedge chart patterns can be both continuation and reversal patterns, depending on whether there is a bullish or bearish trend.
Head and Shoulders consist of three parts: a peak to the left (shoulder), a higher peak (the head), and another peak to the right (shoulder). The "neckline" is drawn by connecting the two bottoms - the one prior to and the one after the head formation. This line is important, as a break below triggers the signal. The bullish reversal pattern and bearish reversal pattern can be seen in the image below.
The inverse head and shoulders – or 'head and shoulders bottom' – is a reversal chart pattern similar to the head and shoulders, except it is inverted.
The pattern contains three successive lows with the middle low (the head) being deeper than the two outside lows (the shoulders), which are shallower. When this pattern is complete it is usually a signal for a bullish trend reversal.
Inverse and normal head and shoulders pattern
Double tops and double bottoms represent two failed attempts by the price to break beyond either a key resistance level or below a key support level. This may be an indicator that momentum has been lost in this trend, increasing selling pressure after an uptrend moving into overbought territory or increased buying pressure after dipping too deeply during downtrends.
There is a similar reversal pattern known as triple tops and triple bottoms. This movement is even more powerful since the price did not break out three times instead of just two, signifying a stronger support or resistance level.
Double top and double bottom pattern
A triple top consists of three peaks that nearly hit the same price level and signals the asset may no longer be trending upwards, with lower prices expected to be on the way. The triple top can occur on all time frames but it must follow an uptrend for the pattern to be considered. This chart reversal pattern looks like the letter 'M' on a candlestick chart.
The triple bottom is the opposite of the triple top, where the chart pattern looks like the letter 'W' and will occur after a downtrend, with the three bottoms hitting around the same price level before it breaks through resistance levels.
Triple top and triple bottom pattern
The sushi roll reversal pattern was conceived by Mark Fisher over lunch with other traders where the topic of conversation was trade set-ups, with Fisher thinking of the possibility of combining narrow and wide price ranges.
Fisher first started with an 'inside pattern' which included 10 consecutive prices that were within a narrow and tight price range. The second series followed which was labeled the 'outside pattern', and included five price bars that engulfed the first series of price bars.
The pattern can help traders detect potential market reversals using a combination of inside and outside trading and is applicable to any time frame. One of the benefits of using this pattern is that it signals a potential price reversal much sooner than a chart pattern e.g. double bottom or head & shoulders.
While this chart reversal pattern does provide some great insight into the potential top and bottom for the asset you are monitoring, it is best to use it in conjunction with other technical indicators and candlestick patterns.
The Quasimodo pattern – sometimes referred to as the 'over and under pattern' – is quite new to the trend reversal patterns group of technical analysis.
The Quasimodo Pattern can seem quite complex but it is actually rather easy to spot. Once you see it, this trading pattern will usually provide a trader with confluent information about the market and increase confidence in trades when they occur near either support or resistance levels on charts. This means that if you are waiting for divergence set-ups before exiting your trade but notice a Quasimodo pattern at the same time, it might be worth taking advantage of both opportunities by increasing your position size and adjusting stop losses accordingly.
The reversal pattern can be seen after a significant obvious trend when a series of lower highs, lower lows, higher highs, or higher lows is interrupted. This pattern can repeat itself constantly so it's best to identify and react quickly, as many traders consider this chart pattern one of the most reliable and powerful patterns to trade.
Bearish and bullish Quasimodo pattern
When you open a chart and try to locate chart patterns that occurred in the past, it’s a fairly easy task once you have them memorised. However, it is more difficult to identify them in real time and act on the signals that they may provide, especially when trading on lower time frame charts. It might therefore help to use additional tools, such as technical indicators (RSI, MACD) and candlestick patterns.
It is not advisable to rely solely on price patterns for your technical analysis. Combining this information with more identifiers, like technical indicators and trading tools, can be a more effective way of improving your trading strategy and positions in the market.
Ready to trade your edge?
This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.
Learn everything you need to know about proprietary trading, prop traders, prop trading firms, and how the world of prop trading works in general.
Understand why money management is important to trading and critical in order for traders to preserve their capital.
Learn how to create a trading plan, the benefits of having a trading plan, and how it could help you improve your trading performance.