Advanced Trading

Advanced technical analysis

Continuation patterns

Continuation patterns form where prices consolidate within an overall trend, whether that trend be upwards or downwards. Some of the most well-known continuation patterns include triangles, pennants and flags.

Prices take a breath before the trend is often, but not always, re-established. Identifying these can provide decent trading opportunities as long as each trade is accompanied with sensible and disciplined risk management – that is, carefully selecting a stop for each trade. Triangles and pennants:

These are similar patterns with triangles typically describing a pattern that takes shape over a longer timeframe than a pennant. These can establish themselves within both an uptrend or down trend. Here’s an illustration of a symmetrical triangle in a downtrend and here’s one in an uptrend. You can see price action contract as the market consolidates. This should lead to a build-up leading to a break-out, typically in the direction of the underlying trend. However, that is not always the case so it’s important to make sure you place a stop underneath or above to protect yourself, particularly from pattern breakouts.

Pattern identification is subjective to some extent, particularly when it comes to deciding just how many ‘touches’ of a line can reasonably be said to involved in deciding whether there’s an obvious area of support or resistance.

Reversal patterns

A reversal is when a market changes direction after trading in a trend, whether upwards or downwards. Typical reversal patterns include double and triple tops and bottoms. But perhaps the most famous reversal pattern is the ‘head and shoulders’ which can signal a reversal of direction after an up-trend, and an inverse ‘head and shoulders’ which forms when a down-trend looks as if it is exhausted.

Advanced technical analysis

This shows a head-and-shoulders top. The neckline is formed by drawing a line linking up the lows formed after the first shoulder and the subsequent head. Once the second (right hand) shoulder is formed, the neckline becomes a significant area of support. If the price breaks below here then there’s a strong possibility that prices will continue to decline.

In other words, the head-and-shoulders pattern signals that the price action has reversed and is now heading downwards after previously trending up before forming the pattern. The trade is only opened if price breaks below the neckline. Some traders will immediately enter a position. Others prefer to hold off and wait for support (now resistance) to be tested before selling. This is the more cautious approach.

On one hand it should give a better entry level, but the flip side is that it’s possible to miss the move altogether if prices don’t bounce back. The pattern height is the distance between the neckline and the top of the “head”. Typically traders then anticipate prices falling by a similar amount below the neckline.

If they do then this can be a place to buy back and book profits. A stop can be placed just above the right shoulder, although some traders prefer to put the shop above the head. If successful, we can move the stop down to just above the neckline in the hope of capitalising on an additional move downwards.

Here’s an inverse head and shoulders. Typically, technical traders would look to place a buy order in once the price breaks above the neckline after forming the right shoulder. Traders generally look for a rally which would be the same size as the distance between the “head” and the neckline. But before acting it’s important to get confirmation. Experienced traders look for additional evidence – this may include looking at moving average cross-overs, Bollinger Bands

Advanced technical analysis
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