Hello friends and welcome to this podcast by Angel One.
Today we are talking about continuation patterns, which are basically patterns you can spot on candlestick charts to see if the current trend will persist for the underlying security.
But before we learn how to do that, let us look to see why Richa decided not to exit her long position after inferring a continuation of an existing uptrend of an asset’s price.
Richa started investing in her early twenties and could grow her savings at a respectable annual rate for five years. A couple months back, Richa purchased stocks of a company along an uptrend. Fast forward to now, and the prices have just been swinging high and low. She tracks her investments on a mobile app everyday, and after noticing these swings without an apparent pattern, she decided to look at it in greater detail.
While looking at the candlestick chart, she spotted that the price is actually converging to a point. She quickly recognised that it is a symmetrical triangle pattern. Since the preceding trend was an uptrend, Richa decided not to sell right now.
Before we can know what happened to her investment, let’s look at how Richa inferred this.
Basically, candlestick patterns can be reversal or continuation patterns. Which means that they will either tell you if an existing trend will continue or if it is going to reverse. So you already know what continuation patterns are. There can be various types of continuation patterns - let’s look at a few of them and understand how they can help you in navigating the market.
The first type is triangles: Basically triangles show price fluctuation converging at a point - this process can be called consolidation. What happens, is that successively lower peaks and successively higher troughs result in the price converging at a certain point. For a triangle pattern, there should be at least two peaks and two troughs.
Depending on the shape of the triangle, this pattern can be classified into three types - symmetrical triangle pattern, ascending triangle pattern, and descending triangle pattern. In the ascending triangle, the upper trendline is flat while in the descending one, the lower trendline is flat. And finally, the symmetrical triangle pattern is formed by upper and lower trend lines converging to the same point at almost an equal angle.
And this is it - now you can understand how Richa decided to stick with her position rather than selling out. Basically, after she spotted the symmetrical triangle forming, she waited to see the movement after the convergence. Once it had moved up by the difference between the first high and low swings, she took a breath of relief as the continuation had been confirmed.
Cool, right? You too can deploy these patterns to make the right decisions when trading in the market. Let’s look at another pattern that can help you confirm a continuation.
This one is called the flag pattern. In the flag pattern, when you connect the peaks with one line and troughs with another, what you get are parallel lines. If you spot a flag along an uptrend, the parallel lines will be sloped downward. If there is a breakout beyond this point, the market might enter for this security with higher enthusiasm.
Similarly, if you spot the flag pattern along a downtrend, the parallel trend lines will point upwards.
Now let’s look at another continuation pattern, which is also called the pennant. This pattern is very similar to the triangle pattern, except that it is much smaller in size. So while in a triangle pattern you will notice converging highs and lows, in a pennant, this consolidation will be in a much tighter range. You will usually notice the pennant after steep increase or decrease in an underlying asset’s prices. This pattern simply tells you that the market is taking some time before the next breakout.
However, before reading these patterns as signs of certainty, you must understand one thing - candlestick patterns must be used with the relevant technical analysis indicators to take decisive actions.
Now, let’s look at one last continuation pattern, called the rectangle. In a rectangle pattern, the price of the security swings high and low around the same levels. As a result, when you connect all the successive peaks and all the successive troughs with two trendlines, what you get are two almost parallel and almost horizontal lines. This is what the rectangular pattern looks like.
As you might already know, when the price exits the pattern, it can be subject to a breakout. Sometimes, the price might penetrate the resistance to some degree, and then reverse. This is called a false breakout. Because the rectangle pattern is easily spotted and commonly used, it is often misinterpreted and traders can end up misreading the initial penetration as a breakout.
This is exactly why making use of technical analysis indicators in conjunction with candlestick patterns is a good idea. Oh, and we almost forgot to tell you - Richa didn’t take the decision solely on the basis of the symmetrical triangle that she spotted. She was doing rigorous technical analysis, which confirmed the signal of the triangle pattern.
So the lesson learnt here apart from these cool patterns is that honest and objective analysis is the key to creating wealth in the long term.
So friends, this is all we had from today’s podcast.
To learn more about such intricate concepts that make the world of stocks go around, check out our podcasts, or visit our website www.angelone.in.