Chart Patterns - Continuation and Reversal Patterns

Education /
19 Jul 2019

Price patterns are popular amongst traders who use technical analysis in their trading, and can generally be divided into reversal and continuation patterns.

They are more easily spotted in hindsight, and traders sometimes struggle to decide whether the signal is valid or not. Therefore, it might be beneficial to use additional tools to filter them.

Continuation Patterns

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 there buying interest will prevail.

Popular continuation patterns are wedges, rectangles and pennants. 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 take profit target).

Below is an illustration of the three popular continuation patterns. For the full version, please click on the picture.

Continuation Patterns
Continuation Patterns

Reversal Patterns

Reversal patterns might signal that either the bulls or bears have lost control, and that there might be a change of trend imminent. Three popular reversal patterns are wedges (please note that wedges can be both continuation and reversal patterns, depending on the trend), head and shoulders and double top/bottom.

Double tops and double bottoms consist of two failed attempts where the price attempted to break above a key resistance level or below a key support level. This may signal that the trend has lost momentum and that selling pressure (after an uptrend) or buying pressure (after a downtrend) is increasing.

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 and the one after the head formation. This line is important, as a break below triggers the signal. The inverted H&S pattern is the bullish equivalent and can be seen in the image below.

Below is an illustration of the three popular continuation patterns. For the full version, please click on the picture.

Reversal Patterns
Reversal Patterns

How To Use Those Patterns In Your Trading

When you open a chart and try to locate chart patterns that occurred in the past, it is quite an easy task once you memorized them. 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 timeframe charts. It might therefore help to use additional tools – such as indicators (RSI, MACD) and candlestick patterns.

The 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. Readers should seek their own advice. Reproduction or redistribution of this information is not permitted.

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