Excelling in stock market moves

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Having a good knowledge about continuation chart patterns allows investors to speculate positively about trends

For a novice, stock price alterations are haphazard movements up and down without any rhyme or reason. However, a trained eye can see patterns in these random moves. Chart patterns are geometric shapes found in price data that can help a trader understand price action as well as make predictions about where the price is likely to go. Patterns can show both continuation as well as reversal trends. Continuation patterns,when they occur, indicate that a price trend is likely to continue and are a pause in the price action of varying durations as they generally occur mid-trend. A pattern is considered complete when it has formed and then ‘breaks out’, potentially continuing with the former trend. Continuation patterns can be seen both in bullish and bearish markets.

Continuation patterns like all price patterns are made of the following four pieces: Old trend: The trend that the stock price 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 stock price breaks out of the consolidation zone. 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 most part, they look quite similar. The only real difference one 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. Common continuation patterns include triangles, flags, pennants and rectangles.

Flags and pennants are formed during a small period of consolidation or pause, after a defined uptrend or downtrend. After a sharp move, market takes a breather and moves sideways. A flag looks like a parallelogram, a bullish flag normally sloping downwards and bearish flag sloping upwards. These patterns are usually accompanied with heavy volume and mark a midpoint of a trend. A pennant is also formed during the period of consolidation (sideways movement) — the support and resistance lines converge each other (like a symmetrical triangle). Break of the flag and pennant indicate the continuation of the trend. Flags and pennants are short-term patterns that can last from one to 12 weeks. Ideally, these patterns will form between one and four weeks.

Triangles are of three types: Symmetrical, ascending and descending. Ascending triangle in a bullish trend indicates further bullishness and is considered continuation pattern. In an ascending triangle, the support line is sloping upward and resistance line remains a horizontal line. Descending triangle in a bearish trend can also be considered as a continuation pattern, indicating bearish trend to continue after a small pause. In this kind of triangle resistance, the line is sloping downwards while the support line remains as a horizontal line. A rectangle is a continuation pattern that forms as a trading range during a pause in the trend. The pattern is easily identifiable by two comparable highs and two lows. The highs and lows can be connected to form two parallel lines that make up the top and bottom of a rectangle. Rectangles are sometimes referred to as trading ranges, consolidation zones or congestion areas. Rectangles can extend for a few weeks or many months. If the pattern is less than three weeks, it is usually considered a flag and also a continuation pattern. Ideally, rectangles will develop over a three-month period. Generally, longer the pattern, more significant will be the breakout. A three-month pattern may be expected to fulfill its breakout projection. However, a six-month pattern might be expected to exceed its breakout target.

After a look at the types of continuation price patterns, let us understand what causes them. In an up trend, the momentum moves down due to periodic profit booking. A good lot of traders think that it is enough or that they have reached their target. So they want to sell their position. The supply increases reducing the momentum of price rise or the price might even drop. Buy smart money finds it an opportunity to add more to their position. So the price slows to drop or it may even rise. Similarly, in a down trend, a lot of traders, who are short, want to book some profit. Those, who think that the stock is available for a bargain, start buying. But smart money finds it easy to sell when there is increased demand. When supply becomes more than the demand, the price falls further. And the trend continues. This tug of war between buyers and sellers  moves the prices up and down, causing continuation chart patterns in stock charts before they continue in the direction of the original trend. Having good knowledge about continuation chart patterns allows investors to speculate positively about the further course of the trend. It allows them to add more to their existing position and helps investors to hold on for a longer period without worrying about temporary setbacks in stock prices.

(The writer is Assistant Professor, Amity University)

2019-05-21 11:53:00

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