Answering the Question: Will the Trend Continue?

11/27/2008 12:01 am EST

Focus: STRATEGIES

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 and put some gas in your car and buy some snacks for you. 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.

Stocks take exciting road trips all 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. After big price moves, the traders who are pushing these stocks 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 a stock really is in the middle of a road trip, a continuation pattern will form while the stock price consolidates in its pit stop. Continuation patterns, as you will see in the video on Continuation Price Patterns, tell you that the stock is going to resume its previous trend after it breaks out of the continuation pattern.

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

  1. Old trend - the trend that the stock price is in as it starts to form the price pattern
  2. Consolidation zone - a constrained area defined by set support and resistance levels
  3. Breakout point - the point at which the stock price breaks out of the consolidation zone
  4. New trend - a resumption of the old trend that the stock price enters as it comes out of the consolidation zone

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.

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

- Pennants
- Bullish flags
- Bullish wedges
- Ascending triangles

Pennants form during an uptrend as the uptrending support level and the downtrending resistance level that encompass the consolidation zone converge.

Bullish flags form during an uptrend as the horizontal or downtrending support level and the horizontal or downtrending resistance level that encompass the consolidation zone remain parallel.

Bullish wedges form during an uptrend as the downtrending support level and the downtrending resistance level that encompass the consolidation zone converge.

Ascending triangles form during an uptrend as the uptrending support level and the horizontal resistance level that encompass the consolidation zone converge.

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

- Pennants
- Bearish flags
- Bearish wedges
- Descending triangles

Pennants form during a downtrend as the uptrending support level and the downtrending resistance level that encompass the consolidation zone converge.

Bearish flags form during a downtrend as the horizontal or uptrending support level and the horizontal or uptrending resistance level that encompass the consolidation zone remain parallel.

Bearish wedges form during a downtrend as the uptrending support level and the uptrending resistance level that encompass the consolidation zone converge.

Descending triangles form during a downtrend as the horizontal support level and the downtrending resistance level that encompass the consolidation zone converge.

Click to watch the video on Continuation Price Patterns.

By Wade Hansen of LearningMarkets.com

Related Articles on STRATEGIES