Cup and Handle (Continuation)
The Cup with Handle is a bullish continuation pattern that marks a consolidation period followed by a breakout.
As its name implies, there are two parts to the pattern: the cup and the handle. The cup forms after an advance and looks like a bowl or rounding bottom. As the cup is completed, a trading range develops on the right hand side and the handle is formed. A subsequent breakout from the handle's trading range signals a continuation of the prior advance.
IMORTANT ASPECTS
1. Trend: To qualify as a continuation pattern, a prior trend should exist. Ideally, the trend should be a few months old and not too mature. The more mature the trend, the less chance that the pattern marks a continuation or the less upside potential.
2. Cup: The cup should be "U" shaped and resemble a bowl or rounding bottom. A "V" shaped bottom would be considered too sharp of a reversal to qualify. The softer "U" shape ensures that the cup is a consolidation pattern with valid support at the bottom of the "U". The perfect pattern would have equal highs on both sides of the cup, but this is not always the case.
3. Cup Depth: Ideally, the depth of the cup should retrace 1/3 or less of the previous advance. However, with volatile markets and over-reactions, the retracement could range from 1/3 to 1/2. In extreme situations, the maximum retracement could be 2/3, which is conforms with Dow Theory.
4. Handle: After the high forms on the right side of the cup, there is a pullback that forms the handle. Sometimes this handle resembles a flag or pennant that slopes downward, other times just a short pullback. The handle represents the final consolidation/pullback before the big breakout and can retrace up to 1/3 of the cup's advance, but usually not more. The smaller the retracement is, the more bullish the formation and significant the breakout. Sometimes it is prudent to wait for a break above the resistance line established by the highs of the cup.
5. Duration: The cup can extend from 1 to 6 months, sometimes longer on weekly charts. The handle can be from 1 week to many weeks and ideally completes within 1-4 weeks.
6. Volume: There should be a substantial increase in volume on the breakout above the handle's resistance.
7. Target: The projected advance after breakout can be estimated by measuring the distance from the right peak of the cup to the bottom of the cup.
As with most chart patterns, it is more important to capture the essence of the pattern than the particulars. The cup is a bowl-shaped consolidation and the handle is a short pullback followed by a breakout with expanding volume. A cup retracement of 62% may not fit the pattern requirements, but a particular stock's pattern may still capture the essence of the Cup with Handle
Symmetrical Triangle (Continuation)
The symmetrical triangle, which can also be referred to as a coil, usually forms during a trend as a continuation pattern. The pattern contains at least two lower highs and two higher lows. When these points are connected, the lines converge as they are extended and the symmetrical triangle takes shape.
While there are instances when symmetrical triangles mark important trend reversals, they more often mark a continuation of the current trend. Regardless of the nature of the pattern, continuation or reversal, the direction of the next major move can only be determined after a valid breakout.
Important aspects of a symmetrical triangle
1. Trend: In order to qualify as a continuation pattern, an established trend should exist. The trend should be at least a few months old and the symmetrical triangle marks a consolidation period before continuing after the breakout.
2. Four (4) Points: At least 2 points are required to form a trend line and 2 trend lines are required to form a symmetrical triangle. Therefore, a minimum of 4 points are required to begin considering a formation as a symmetrical triangle. The second high should be lower than the first and the upper line should slope down. The second low should be higher than the first and the lower line should slope up. Ideally, the pattern will form with 6 points (3 on each side) before a breakout occurs.
3. Volume: As the symmetrical triangle extends and the trading range contracts, volume should start to diminish. This refers to the quiet before the storm, or the tightening consolidation before the breakout.
4. Duration: The symmetrical triangle can extend for a few weeks or many months. If the pattern is less than 3 weeks, it is usually considered a pennant. Typically, the time duration is about 3 months.
5. Breakout Time Frame: The ideal breakout point occurs 1/2 to 3/4 of the way through the pattern's development or time-span. The time-span of the pattern can be measured from the apex (convergence of upper and lower lines) back to the beginning of the lower trend line (base). A break before the 1/2 way point might be premature and a break too close to the apex may be insignificant. After all, as the apex approaches, a breakout must occur sometime.
6. Breakout Direction: The future direction of the breakout can only be determined after the break has occurred. Sound obvious enough, but attempting to guess the direction of the breakout can be dangerous. Even though a continuation pattern is supposed to breakout in the direction of the long-term trend, this is not always the case.
7. Breakout Confirmation: For a break to be considered valid, it should be on a closing basis. Some traders apply a price (3% break) or time (sustained for 3 days) filter to confirm validity. The breakout should occur with an expansion in volume, especially on upside breakouts.
8. Return to Apex: After the breakout (up or down), the apex can turn into future support or resistance. The price sometimes returns to the apex or a support/resistance level around the breakout before resuming in the direction of the breakout.
9. Price Target: There are two methods to estimate the extent of the move after the breakout. First, the widest distance of the symmetrical triangle can be measured and applied to the breakout point. Second, a trend line can be drawn parallel to the pattern's trend line that slopes (up or down) in the direction of the break. The extension of this line will mark a potential breakout target.
Ascending Triangle (Continuation)
The ascending triangle is a bullish formation that usually forms during an uptrend as a continuation pattern. There are instances when ascending triangles form as reversal patterns at the end of a downtrend, but they are typically continuation patterns. Regardless of where they form, ascending triangles are bullish patterns that indicate accumulation.
Because of its shape, the pattern can also be referred to as a right-angle triangle. Two or more equal highs form a horizontal line at the top. Two or more rising bottoms form an ascending trend line that converges on the horizontal line as it rises. If both lines were extended right, the ascending trend line could act as the hypotenuse of a right triangle. If a perpendicular line were drawn extending down from the left end of the horizontal line, a right triangle would form.
IMPORTANT ASPECTS OF THE ASCENDING TRIANGLE
1. Trend: In order to qualify as a continuation pattern, an established trend should exist. However, because the ascending triangle is a bullish pattern, the length and duration of the current trend is not as important as the robustness of the formation, which is paramount.
2. Top Horizontal Line: At least 2 reaction highs are required to form the top horizontal line. The highs do not have to be exact, but they should be within reasonable proximity of each other. There should be some distance between the highs, and a reaction low between them.
3. Lower Ascending Trend Line: At least two reaction lows are required to form the lower ascending trend line. These reaction lows should be successively higher, and there should be some distance between the lows. If a more recent reaction low is equal to or less than the previous reaction low, then the ascending triangle is not valid.
4. Duration: The length of the pattern can range from a few weeks to many months with the average pattern lasting from 1-3 months.
5. Volume: As the pattern develops, volume usually contracts. When the upside breakout occurs, there should be an expansion of volume to confirm the breakout. While volume confirmation is preferred, it is not always necessary.
6. Return to Breakout: A basic tenet of technical analysis is that resistance turns into support and vice versa. When the horizontal resistance line of the ascending triangle is broken, it turns into support. Sometimes there will be a return to this support level before the move begins in earnest.
7. Target: Once the breakout has occurred, the price projection is found by measuring the widest distance of the pattern and applying it to the resistance breakout.
Descending Triangle (Continuation)
The descending triangle is a bearish formation that usually forms during a downtrend as a continuation pattern. There are instances when descending triangles form as reversal patterns at the end of an uptrend, but they are typically continuation patterns. Regardless of where they form, descending triangles are bearish patterns that indicate distribution.
Because of its shape, the pattern can also be referred to as a right-angle triangle. Two or more comparable lows form a horizontal line at the bottom. Two or more declining peaks form a descending trend line above that converges with the horizontal line as it descends. If both lines were extended right, the descending trend line could act as the hypotenuse of a right triangle. If a perpendicular line were drawn extending up from the left end of the horizontal line, a right triangle would form.
IMPORTANT ASPECTS
1. Trend: In order to qualify as a continuation pattern, an established trend should exist. However, because the descending triangle is definitely a bearish pattern, the length and duration of the current trend is not as important. The robustness of the formation is paramount.
2. Lower Horizontal Line: At least 2 reaction lows are required to form the lower horizontal line. The lows do not have to be exact, but should be within reasonable proximity of each other. There should be some distance separating the lows and a reaction high between them.
3. Upper Descending Trend Line: At least two reaction highs are required to form the upper descending trend line. These reaction highs should be successively lower and there should be some distance between the highs. If a more recent reaction high is equal to or greater than the previous reaction high, then the descending triangle is not valid.
4. Duration: The length of the pattern can range from a few weeks to many months, with the average pattern lasting from 1-3 months.
5. Volume: As the pattern develops, volume usually contracts. When the downside break occurs, there would ideally be an expansion of volume for confirmation. While volume confirmation is preferred, it is not always necessary.
6. Return to Breakout: A basic tenet of technical analysis is that broken support turns into resistance and visa versa. When the horizontal support line of the descending triangle is broken, it turns into resistance. Sometimes there will be a return to this newfound resistance level before the down move begins in earnest.
7. Target: Once the breakout has occurred, the price projection is found by measuring the widest distance of the pattern and subtracting it from the resistance breakout.
Rounding Bottom (Reversal)
The rounding bottom is a long-term reversal pattern that is best suited for weekly charts. It is also referred to as a saucer bottom, and represents a long consolidation period that turns from a bearish bias to a bullish bias
IMORTANT ASPECTS
1. Prior Trend: In order to be a reversal pattern, there must be a prior trend to reverse. Ideally, the low of a rounding bottom will mark a new low or reaction low. In practice, there are occasions when the low is recorded many months earlier and the security trades flat before forming the pattern. When the rounding bottom does finally form, its low may not be the lowest low of the last few months.
2. Decline: The first portion of the rounding bottom is the decline that leads to the low of the pattern. This decline can take on different forms: some are quite jagged with a number of reaction highs and lows, while others trade lower in a more linear fashion.
3. Low: The low of the rounding bottom can resemble a "V' bottom, but should not be too sharp and should take a few weeks to form. Because prices are in a long-term decline, the possibility of a selling climax exists that could create a lower spike.
4. Advance: The advance off of the lows forms the right half of the pattern and should take about the same amount of time as the prior decline. If the advance is too sharp, then the validity of a rounding bottom may be in question.
5. Breakout: Bullish confirmation comes when the pattern breaks above the reaction high that marked the beginning of the decline at the start of the pattern. As with most resistance breakouts, this level can become support. However, rounding bottoms represent long-term reversal and this new support level may not be that significant.
6. Volume: In an ideal pattern, volume levels will track the shape of the rounding bottom: high at the beginning of the decline, low at the end of the decline and rising during the advance. Volume levels are not too important on the decline, but there should be an increase in volume on the advance and preferably on the breakout.
Double Top (Reversal)
The double top is a major reversal pattern that forms after an extended uptrend. As its name implies, the pattern is made up of two consecutive peaks that are roughly equal, with a moderate trough in-between.
Although there can be variations, the classic double top marks at least an intermediate change, if not long-term change, in trend from bullish to bearish. Many potential double tops can form along the way up, but until key support is broken, a reversal cannot be confirmed.
IMOPRTANT FEATURES.
1. Prior Trend: With any reversal pattern, there must be an existing trend to reverse. In the case of the double top, a significant uptrend of several months should be in place.
2. First Peak: The first peak should mark the highest point of the current trend. As such, the first peak is fairly normal and the uptrend is not in jeopardy (or in question) at this time.
3. Trough: After the first peak, a decline takes place that typically ranges from 10 to 20%. Volume on the decline from the first peak is usually inconsequential. The lows are sometimes rounded or drawn out a bit, which can be a sign of tepid demand.
4. Second Peak: The advance off the lows usually occurs with low volume and meets resistance from the previous high. Even after meeting resistance, only the possibility of a double top exists. The pattern still needs to be confirmed. The time period between peaks can vary from a few weeks to many months, with the norm being 1-3 months. While exact peaks are preferable, there is some leeway. Usually a peak within 3% of the previous high is adequate.
5. Decline from Peak: The subsequent decline from the second peak should witness an expansion in volume and/or an accelerated descent, may be marked with a gap or two. Such a decline shows that the forces of demand are weaker than supply and a support test is imminent.
6. Support Break: Even after trading down to support, the double top and trend reversal are still not complete. Breaking support from the lowest point between the peaks completes the double top. This too should occur with an increase in volume and/or an accelerated descent.
7. Support Turned Resistance: Broken support becomes potential resistance and there is sometimes a test of this newfound resistance level with a reaction rally. Such a test can offer a second chance to exit a position or initiate a short.
8. Price Target: The distance from support break to peak can be subtracted from the support break for a price target. This would infer that the bigger the formation is, the larger the potential decline.
Double Bottom (Reversal)
The double bottom is a major reversal pattern that forms after an extended downtrend. As its name implies, the pattern is made up of two consecutive troughs that are roughly equal, with a moderate peak in-between.
Although there can be variations, the classic double bottom usually marks an intermediate or long-term change in trend. Many potential double bottoms can form along the way down, but until key resistance is broken, a reversal cannot be confirmed
IMPORTANT ASPECTS
1. Prior Trend: With any reversal pattern, there must be an existing trend to reverse. In the case of the double bottom, a significant downtrend of several months should be in place.
2. First Trough: The first trough should mark the lowest point of the current trend. As such, the first trough is fairly normal in appearance and the downtrend remains firmly in place.
3. Peak: After the first trough, an advance takes place that typically ranges from 10 to 20%. Volume on the advance from the first trough is usually inconsequential, but an increase could signal early accumulation. The high of the peak is sometimes rounded or drawn out a bit from the hesitation to go back down. This hesitation indicates that demand is increasing, but still not strong enough for a breakout.
4. Second Trough: The decline off the reaction high usually occurs with low volume and meets support from the previous low. Support from the previous low should be expected. Even after establishing support, only the possibility of a double bottom exists, it still needs to be confirmed. The time period between troughs can vary from a few weeks to many months, with the norm being 1-3 months. While exact troughs are preferable, there is some room to maneuver and usually a trough within 3% of the previous is considered valid.
5. Advance from Trough: Volume is more important for the double bottom than the double top. There should clear evidence that volume and buying pressure are accelerating during the advance off of the second trough. An accelerated ascent, perhaps marked with a gap or two, also indicates a potential change in sentiment.
6. Resistance Break: Even after trading up to resistance, the double top and trend reversal are still not complete. Breaking resistance from the highest point between the troughs completes the double bottom. This too should occur with an increase in volume and/or an accelerated ascent.
7. Resistance Turned Support: Broken resistance becomes potential support and there is sometimes a test of this newfound support level with the first correction. Such a test can offer a second chance to close a short position or initiate a long.
8. Price Target: The distance from the resistance breakout to trough lows can be added on top of the resistance break to estimate a target. This would imply that the bigger the formation is, the larger the potential advance.
It is important to remember that the double bottom is an intermediate to long-term reversal pattern that will not form in a few days. Even though formation in a few weeks is possible, it is preferable to have at least 4 weeks between lows. Bottoms usually take longer than tops to form and patience can often be a virtue. Give the pattern time to develop and look for the proper clues. The advance off of the first trough should be 10-20%. The second trough should form a low within 3% of the previous low and volume on the ensuing advance should increase. Volume indicators such as Chaikin Money Flow, OBV and Accumulation/Distribution can be used to look for signs of buying pressure. Just as with the double top, it is paramount to wait for the resistance breakout. The formation is not complete until the previous reaction high is taken out.
Flag, Pennant (Continuation)
Flags and Pennants are short-term continuation patterns that mark a small consolidation before the previous move resumes. These patterns are usually preceded by a sharp advance or decline with heavy volume, and mark a mid-point of the move.
IMPORTANT ASPECTS
1. Sharp Move: To be considered a continuation pattern, there should be evidence of a prior trend. Flags and pennants require evidence of a sharp advance or decline on heavy volume. These moves usually occur on heavy volume and can contain gaps. This move usually represents the first leg of a significant advance or decline and the flag/pennant is merely a pause. (UNLIKE SYMMETRICAL TRIANGLE-PROPER, WHERE SHARP MOVE MAY OR MAY NOT EXIST BEFORE FORMATION OF THE PATTERN)
2. Flagpole: The flagpole is the distance from the first resistance or support break to the high or low of the flag/pennant. The sharp advance (or decline) that forms the flagpole should break a trend line or resistance/support level. A line extending up from this break to the high of the flag/pennant forms the flagpole.
3. Flag: A flag is a small rectangle pattern that slopes against the previous trend. If the previous move was up, then the flag would slope down. If the move was down, then the flag would slope up. Because flags are usually too short in duration to actually have reaction highs and lows, the price action just needs to be contained within two parallel trend lines.
4. Pennant: A pennant is a small symmetrical triangle that begins wide and converges as the pattern matures (like a cone). The slope is usually neutral. Sometimes there will not be specific reaction highs and lows from which to draw the trend lines and the price action should just be contained within the converging trend lines.
5. Duration: Flags and pennants are short-term patterns that can last from 1 to 12 weeks. There is some debate on the time frame and some consider 8 weeks to be pushing the limits for a reliable pattern. Ideally, these patterns will form between 1 and 4 weeks. Once a flag becomes more than 12 weeks old, it would be classified as a rectangle. A pennant more than 12 weeks old would turn into a symmetrical triangle. The reliability of patterns that fall between 8 and 12 weeks is debatable.
6. Break: For a bullish flag or pennant, a break above resistance signals that the previous advance has resumed. For a bearish flag or pennant, a break below support signals that the previous decline has resumed.
7. Volume: Volume should be heavy during the advance or decline that forms the flagpole. Heavy volume provides legitimacy for the sudden and sharp move that creates the flagpole. An expansion of volume on the resistance (support) break lends credence to the validity of the formation and the likelihood of continuation.
8. Targets: The length of the flagpole can be applied to the resistance break or support break of the flag/pennant to estimate the advance or decline.
Even though flags and pennants are common formations, identification guidelines should not be taken lightly. It is important that flags and pennants are preceded by a sharp advance or decline. Without a sharp move, the reliability of the formation becomes questionable and trading could carry added risk. Look for volume confirmation on the initial move, consolidation and resumption to augment the robustness of pattern identification.
