Introduction to Reversal Patterns and Continuation Patterns IX-XII

Chart Patterns IX: Symmetrical Triangles

The symmetrical triangle has two equal sides sloping towards each other at the same angle. It favors neither a downside nor an upside breakout. As a result, traders should look for it to signal a continuation of the move in the original direction; or, in other words, the move of the overall trend.
In the chart below, USD/CHF formed a large symmetrical triangle over a six-month period before breaking above resistance to the upside. It was difficult to know which direction the price would breakout. Traders can pay attention to the original trend and trade along the direction of the overall trend.

The trade signal provided by a symmetrical triangle should come as no surprise, since it is a rising support line and a descending resistance line converging as the chart moves to the right. Eventually one of these technical levels must be broken, at which point the trader operates just as if the line were a simple trend line. Breakouts from a triangle that has become narrow can be decisive, because buying or selling interest has accumulated while the price has consolidated.

Chart Patterns X: Flags and Pennants

Flags and pennants are very short consolidation periods that appear within a fast moving trend. Both are preceded by a sharp move that is nearly a vertical line, and both show consolidation against the direction of the trend. The flag is a pattern formed by two parallel lines sloping against the trend, while the pennant is a pattern of two converging lines that appear very similar to the triangle or the wedge formation.
The downtrend of EUR/USD started since Mar2005. There was a plunge at the end of May, and then it started the consolidating period, which was represented by the flag pattern. Notice the flag sloped against the dominant trend on the chart. At the beginning of September, the trend resumed after the price fell below the flag.

As with the previous patterns we have discussed, the breakout signal on a flag or a pennant almost always occurs in the direction of the original move, and when the market breaks out it usually moves decisively to continue the trend. Of course, since the pennant formation is in the shape of a triangle, it does fall into the category of triangles that has been previously discussed. What distinguishes the pennant, though, is the speed with which the market moves both before and after the pattern is created.

Chart Patterns XI: Wedges

The formation of wedges can signal breakouts in upward or downward trending markets. They are similar to triangles in terms of their application. The Wedge formation is a variation on the ascending or descending triangle in which both the angled sides of the triangle are sloping against the dominant trend in the market. The wedge formation is used in the same manner as the triangle formations discussed in the previous articles. It shows consolidation of the market in either an up or down trend, and once the support or resistance provided by the wedge is broken, it most often signals a continuation of the trend in its original direction.
The chart below showed a downward-sloping bullish wedge of USD/JPY at the end of year 2003. Notice that there was a plummet before the wedge formation, confirming the strong downtrend. The price then fell further down with narrower range, which formed the wedge. At the beginning of February 2004, the price broke above the wedge edge and surged to a peak around 112.00.

Below is a chart of a rising wedge. The price of EUR/USD consolidated from March 2004 to October 2004. It finally surged above 1.2550 in October 2004, where it broke through the upper wedge edge and continued to rise further. Generally speaking, traders can notice the dominant trend and the break out usually favors the dominant trend direction. Nonetheless, wedges are signs of price consolidation, they do not exactly indicate which direction the price is going to break through.

Chart Patterns XII: Rectangles

The rectangle formation is often a very simple one to recognize. It is essentially a market that is trading in a range between two horizontal lines. The rectangle formation represents consolidation of the move that preceded it, creating a foundation for a continuation of a further move in the same direction.
The chart below showed the consolidation period of EUR/USD from May 2004 to October 2004. EUR/USD had been going on an up-trend since the beginning of 2002. In February 2004, EUR/USD started a retracement and followed by the consolidation period in the chart, forming a rectangle. EUR/USD traded between 1.1970 and 1.2460 for five months. The price eventually broke above 1.2460 in mid-October and continued the up-trend, reaching EUR/USD historical high at 1.3660 at the end of year 2004. The rectangular consolidation period created a foundation for the continuation of a further move in the up-trend.

The rectangle formation can be used in either an up trend or a down trend, and although it normally signals continuation of a market move in the direction of the original trend, the important signal is upon the breakout from the rectangle. Reversals are possible in a rectangle pattern if the breakout occurs back towards the origin of the trend that preceded the pattern.