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Top 3 Continuation Patterns Every Trader Should be Familiar with

By Louis H-P on November 23, 2019

Reading Time: 5 minutes

Price fluctuations are to be expected when trading in the Forex market. Traders with a keen understanding of continuation patterns will have the edge over other traders. It allows you to recognize the best setups before the majority of the traders do. You can then determine how strong a price trend is going to be. But first, what is a continuation pattern, and what are the best patterns to recognize? 

Key Takeaways

Find out how to day trade successfully

Do you know these 3 continuation patterns

Learn how to use them to your advantage


What Are Continuation Patterns?

Continuation patterns indicate a temporary period of consolidation before the trend continues in its original direction. In other words, continuation patterns confirm the continuation of the trend. These patterns typically appear in the form of sideways price movement. When the pattern is complete, the price will break out from the consolidation zone and continue.

A continuation pattern is not a reversal pattern. Some continuation patterns can turn out to be reversal patterns depending on where they appear in the chart. Also, if the pattern turns out to be false and the price continues in the opposite direction, it can be regarded as a reversal pattern.

An experienced trader knows that no pattern is completely reliable and cannot expect it to be profitable all the time. Therefore, they go the extra mile by verifying continuation patterns with indicators and protecting their trades.

For traders who miss the initial breakout points and are looking for the best areas to enter the market, continuation patterns can be the answer. They can point out key levels that make it easy to enter the market. They can also appear in different time frames.

Best 3 Continuation Patterns Every Trader Should be Familiar with

There are different types of continuation patterns that traders can include in their trading strategy, and the best three are:

1. 3 Bar Play Pattern

The 3 bar play pattern is a popular and common pattern on price charts. It is characterized mainly by three consecutive candlesticks that either appear in an uptrend, downtrend, or sideways market. Sometimes, it is possible for 4 or 5 bars to appear in the formation. It can become a reversal pattern depending on where it appears in the chart.

Regardless, it is generally considered a reliable continuation pattern by experienced traders, and it is easy to spot on a chart. In addition, it is mainly used in the stock market to find winning trades. It can be used to build a trading strategy for short-term price trends.

Identifying the Pattern

See below to learn how you can identify and trade the three bar play pattern.

  • The first candlestick has a long body, well above that of an average candlestick.
  • The opening price of the second candlestick should be the same or close to the closing price of the first. The second bar in the formation should not exceed 50% retracement of the first.
  • The third candlestick, or the trigger bar, has its opening price at the same level as the closing price of the second bar. The closing price of the trigger bar should be slightly above that of the second bar. This occurs in both bullish and bearish variations of the candlestick but with a few differences. In the bullish pattern, the first candlestick to appear is bullish, followed by a short bearish bar and a bullish trigger bar. In a bearish pattern, there is a long bearish bar followed by a bullish candlestick and a third bearish candlestick.

After identifying the pattern, use a momentum indicator like a moving average to confirm the signal. Enter the market when the third bar rises above the middle candlestick. A rising 3-bar play indicates a clear buying point, while a bearish pattern signals a selling point. Set up a stop-loss at the highest or lowest point of the first bar.

2. Pennant Pattern

Pennants are continuation patterns that appear in both uptrends and downtrends. It offers early signals of impending significant price actions and can be found in different time frames.

The pattern is made up of several candlesticks and looks like a small symmetrical triangle. In terms of structure, the pennant pattern resembles the flag pattern and can last one to three weeks.

When looking for a pennant, you should identify the following:

  • A flagpole: A pennant begins with a flagpole which is an initial strong move in either a falling or rising trend. The flagpole is the main difference between a triangle and a pennant, as such a strong move may not appear before the formation of the triangle pattern.
  • A symmetrical triangle: The pennant itself is a small triangle that forms as the market consolidates. There will be two breakout points, one will be at the end of the flagpole, and the other will appear right after the consolidation period.

Unlike bullish flags, where the support and resistance lines run parallel, the support and resistance lines in a pennant converge as the breakout occurs.

One tip for identifying bullish pennants is to look at the change in volume. The volume of the asset will fall as the price consolidates and rises just before the market breaks out. The same applies to a bearish pennant.

Trading the Pennant

Looking for continuation patterns can be exciting

Pennants tend to form before an extended breakout, and there are two methods you can use to find the ideal position to open a trade. The first strategy is to wait for price action to break the trendline and continue moving in the intended direction.

The price will break the resistance line for bullish pennants or break the support line for bearish pennants. The second method is to wait for the market to revert briefly before the breakout is established.

After confirmation of the breakout, traders can look to enter the market after a sharp change in price. A stop-loss level can be set at the lowest point of the pattern because a breakdown from these levels means that the trend is reversing.

This also offers the most amount of protection to traders while giving enough room for the price to fluctuate. In addition, pennants are used in conjunction with indicators like the RSI indicator to watch if the breakout has the potential to move higher.

Identifying a pennant pattern can be tricky at first, and it is best to build your knowledge by practicing on demo accounts.

3. Flag Continuation Pattern

Flag patterns occur when there is a pause in the trend, and the price becomes confined to a small price range between the support and resistance lines. Flags usually appear for a short time and do not have the price swings a trading range or trend channel would have. Flags may appear upward, downward, or parallel sloping depending on the predominant trend.

The flag pattern is made up of three components:

  • The flag pole: This is the initial move, whether high or low, that starts the flag pattern. It is irrelevant what angle the move takes because it does not affect the validity of the flag.
  • The flag: The flag itself is the most important part of the formation. This is the point where the market consolidates after a strong move, and the duration of this period also doesn’t affect the validity of the pattern. However, keep in mind that longer consolidation periods might lead to aggressive breakouts.
  • The Continuation: For this part, the market has stopped consolidating, and it is moving in its original direction.

Bullish Flag

The bullish flag resembles a downward-sloping rectangle, and it is associated with explosive price moves. For a pattern to be a bullish flag, it must have a Fibonacci retracement of less than 38% of the existing trend. During the period of consolidation, the volume falls only to rise on breakout.

Entry into the market can be done at the bottom of the flag or once there is a breakout. Ideally, the breakout price should be high, with the length of the candlestick potentially equal to the flagpole.

Bearish Flag

The bearish flag is identified by an upward-sloping consolidation, and like the bullish flag, it is also associated with explosive price movements. In addition, the Fibonacci retracement should be less than 38% for it to be a valid flag.

For trading purposes, an ideal position to enter the market is at the top of the flag or when the price breaks out from the support line.

Conclusion

Remember that the market doesn’t always move as you expect it to, and you should have a risk management strategy in place before opening any positions.

Although these are the best continuation patterns for traders, it is advisable to have knowledge of others and see how they can be incorporated into your trading strategy.

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Louis H-P

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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Louis H-P

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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