Technical analysts look for certain types of patterns that generally indicate that a market will reverse or continue moving in a certain direction.
Markets never move in one direction forever, so technical analysts are looking for indications that the market trend is changing, by either reversing or continuing a move.
When the market is between trends, traders look for clues from price as to how price will continue to move once a trend is re-established, either reversing or continuing with the initial trend.
To look for a continuation of a move, traders will find patterns like triangles, rectangles, pennants and flags. Each one of these patterns can be identified on charts of the timeframe of your choice.
You can identify a triangle from bars on a chart by drawing two lines from the price bars that look like the shape of a triangle. When price forms a triangle, it moves from a wide trading range to a narrower trading range. It is this pause and narrowing of the size of price bars that forms the point of the triangle pattern on the chart.
Generally, price does not stay still for very long, so as it forms the point of the triangle, traders will use this pattern to anticipate that price will break out from the triangle once it forms.
Technical analysts believe that the shape of the triangle can indicate the direction of the subsequent breakout. Ascending triangles are bullish, symmetrical triangles can move in either direction, and descending triangles are bearish.
Symmetrical triangles are formed when the price range narrows and makes lower highs and higher lows until it reaches a point. Since the triangle is symmetrical, the theory is price can break out of the triangle in either direction, in the same direction it entered or reversing on exit.
Ascending triangles, are formed when consistent highs and higher lows are made. The ascending triangle is generally a bullish signal with price tending to break out upwards when the pattern is complete.
Descending triangles are the opposite of ascending triangles. They are formed with consistent lows and lower highs. This is generally a bearish signal and price will tend to break out lower when the pattern is complete.
When the market is consolidating, rectangles are formed as price moves in a narrow range with consistent highs and lows. Price will tend to exit the consolidation in the same direction that it entered. Rectangles are just another name for the typical, channel-like formation that traders associate with the term consolidation.
Consolidation means price is unable to break out of a defined range since neither buyers or sellers can move price beyond a certain price. This pattern can last for a long time, and there is no real rule for the maximum length of this pattern.
Flags are formed when price retraces for a short time in a tight parallel range. This formation is called a flag because the consolidation looks like a flag. Flags are used to show a period of retracement in price. When price breaks out of the tight consolidation, it will generally move higher, resuming its original trend. These patterns are usually seen mid-trend and not at tops or bottoms.
Pennants are small triangle formations and work in the same way. Since these are smaller retracements that do not take as long to form, they are typically seen mid-trend.
Traders will use these patterns when stocks retrace or consolidate to indicate if the breakout will be a continuation of the original trend. The patterns will not always signal continuation but traders can use the patterns with other evidence they have collected to help indicate where price might move next.
Peter Knight Advisor