Beginners Guide to Finding Great Forex Trades (Part 3)

08/12/2009 12:01 am EST

Focus: FOREX

S. Wade Hansen

Co-Founder, Profiting with Forex (PFX) and Learning Markets

Road trips are some of our favorite vacations. You jump in the car, head out on the open highway and soak in all of the scenery that you miss when you fly somewhere. Of course, every once in a while you have to interrupt your cruising to take a pit stop—to put some gas in your car and buy some snacks.

Pit stops are part of the adventure. And let’s face it, driving would get pretty old after a while if you didn’t stop and take a break every now and then. At the same time, nobody wants to spend their entire vacation at the rest stop. So once you’ve had a chance to stretch your legs and fill up the gas tank, you jump back into the car and head back out on the open road.

Currency pairs take exciting road trips all of the time. They cruise along for a while, passing support and resistance levels and other significant price points along the way, but every once in a while, they need to take a pit stop too. After big price moves, the traders who are pushing these currency pairs higher and lower have to stop to catch their breath. Don’t get too comfortable though; because the pit stop isn’t going to last forever.

If the currency pair really is in the middle of a road trip, a continuation pattern will form while the currency pair consolidates in its pit stop. Continuation patterns tell you that the currency pair is going to resume its previous trend after it breaks out of the continuation pattern.
  
Identifying Continuation Patterns

Continuation patterns, like all price patterns, are made of the following four pieces:

  • Old trend: the trend that the currency pair is in as it starts to form the price pattern
  • Consolidation zone: a constrained area defined by set support and resistance levels
  • Breakout point: the point at which the currency pair breaks out of the consolidation zone
  • New trend: a resumption of the old trend that the currency pair enters as it comes out of the consolidation zone

Continuation Pattern Attributes

Click to Enlarge

Continuation patterns form in a few different shapes, but for the most part, they look quite similar. The only real difference you will see is in the shape of the consolidation zone. The consolidation zones of some continuation patterns have support and resistance levels that converge as the pattern forms, while others have support and resistance levels that remain parallel. Every other aspect of the price pattern is identical.

Uptrends

The following are the most common continuation patterns you will see during an uptrend:

Pennants: These form during an uptrend as the up-trending support level and the down-trending resistance level that encompass the consolidation zone converge.

Flags: Flags form during an uptrend as the horizontal or down-trending support level and the horizontal or down-trending resistance level that encompass the consolidation zone remain parallel.

Wedges: During an uptrend, as the down-trending support level and the down-trending resistance level that encompass the consolidation zone converge, you see a wedge.

Ascending Triangles: Ascending triangles form during an uptrend as the up-trending support level and the horizontal resistance level that encompass the consolidation zone converge.

To see examples of the price patterns we’ve been discussing and how to use them in your trading, watch the video below.

Downtrends

The following are the most common continuation patterns you will see during a downtrend:

Pennant: They form during a downtrend as the up-trending support level and the down-trending resistance level that encompass the consolidation zone converge.

Flags: Flags form during a downtrend as the horizontal or up-trending support level and the horizontal or up-trending resistance level that encompass the consolidation zone remain parallel.

Wedges: Watch for wedges during a downtrend as the up-trending support level and the up-trending resistance level that encompass the consolidation zone converge.

Descending Triangles: Descending triangles form during a downtrend as the horizontal support level and the down-trending resistance level that encompass the consolidation zone converge.

See Continuation Patterns in Practice

Learning to identify price patterns enables you to get a glimpse into the future price movement of the currency pair. Whereas technical indicators, like moving averages and the commodity channel index (CCI), lag the current market price, price patterns project into the future. Once you have identified a breakout point, you can get a pretty good idea of where the price is going to go in the near future, and you can take advantage of that potential movement.

Make sure to watch the video below, and then stay tuned for more tomorrow in Part 4.




Read Part 1 | Read Part 2 | Read Part 4 | Read Part 5

By S. Wade Hansen of LearningMarkets.com

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