This is a review of the 6th chapter of John J. Murphy’s Technical Analysis of the Financial Markets.
Continuation patterns are shorter terms patterns that indicate that a current price action is nothing more than a pause in an existing trend and that the previous trend will resume later.
There are three types of triangles:
- Symmetrical (coil): Formed out of two trendlines where the upper one descending and the lower line ascending.
- Ascending: Formed out of a rising lower line and a flat upper line.
- Descending: Formed out of a flat lower line and a descending upper line
The Broadening Formation (Megaphone Top)
Flags and Pennants
Flags and Pennants represent brief pauses in a one-directional market and they need to be preceded by sharp, straight line moves.
A flag should slope against the trend and volume should dry up during the formation and build again during the breakout. The flag usually forms during the mid-point of the move.
Both patterns are short-term and should be completed within 1-3 weeks with volumes drying up during their formation.
The wedge formation is very similar to a symmetrical triangle, except that it has a prominent slant. A falling wedge is considered bullish whereas a rising wedge is considered bearish.
The Rectangle (Trading Range)
It usually just represents a consolidation area after which the previous trend resumes. A decisive close outside the upper/lower boundary signals a completion.
It describes the movement of a stock when a major advance or decline is divided into two equal and parallel moves. The moves should be fairly orderly and well defined.
The Continuation Head & Shoulders
The price action looks similar to a Rectangular pattern except that the middle trough, in an uptrend, tends to be lower than the other two shoulders. In a downtrend, the middle peak exceeds the other two peaks.
Next: Chapter 7 – Volume & Open Interest