Trend Trading Report Part VIII - Trend Following Patterns

In this Part of the Trend Trading Report we'll cover five trend following patterns. A trend following patterns is continuation patterns that represents a form of consolidation that results in a continuation of the trend leading up to the continuation pattern approximately 70% of the time. The five trend following patterns covered in this report are:

1. Symmetrical Triangle
2. Ascending/Descending Triangle
3. Pennant
4. Flag Pattern
5.  Rectangle

I introduced you to these patterns in Part Six of this Report. I'll go into more detail here.

There are three phases to note when it comes to trend following patterns. They are:

1. The candle sticks that form the trend leading to the pattern. They may be trending upward or downward.
2. The pattern formed by the candle sticks
3. The candle sticks that form the trend upon exiting the pattern. 

Symmetrical Triangle

The symmetrical triangle is formed by a descending resistance  trendline and an ascending support trendline. The angle of the resistance line above the horizontal line drawn through the middle of the pattern, is approximately equal to the angle of the support line below the horizontal line. These two lines come together at the point of the triangle. The price action will move up to the resistance line and bounce off the resistance line. The price action will then proceed to move down toward the support line and bounce off the support line. Eventually the price action will breakout to the upside or the downside.

If preceded by a descending trend, the Trader should expect that the price action will break through the support line. If preceded by an ascending trend, the Trader should expect the price action to break upward through the resistance line.

Investing is a game of statistics. Traders should never expect things to go in the predicted direction. Price action can go against the odds forming a new trend direction from the previous trend direction.

Following is an image of a bear symmetrical triangle meaning that the price action was trending down leading up to this pattern and the breakout took place in the same descending direction.

Ascending Triangle

Following is an image of an ascending triangle. You will notice that the lower line, the support line, exhibits higher lows as you would expect with a bullish trend. The upper line is essentially a horizontal line that represents resistance. Within the pattern, the price action will bounce between the lower support line and upper resistance line.

The price action leading to the ascending triangle will generally be an upward trend. The price action exiting (breakout out) from the pattern will generally be an upward trend unless the pattern fails.

The price of the security moves between these trendlines until it eventually breaks out to the upside. This pattern will typically be preceded by an upward trend, which makes it a continuation pattern; however, it can be found during a downtrend.

The price action in the midst of the ascending triangle represents the battle between buyers and sellers with the buyers gaining strength, which is why we see higher lows. Because of the strength of the buyers, the price action eventually breaks to the upside.

The height of the triangle at the entry to the pattern (see the red vertical line on the left) is an estimate of the price move to the upside when price breaks out of the ascending triangle (see the red vertical line on the right).

Descending Triangle

Following is an image of an descending triangle. You will notice that the lower line, the support line, is flat. The upper line, the resistance trendline is sloped downward. This pattern is just the opposite from the ascending triangle. With the descending triangle, the price trend is generally downward where this pattern is formed and the breakout will in most cases be to the downside.. Within the pattern, the price action will bounce between the lower support line and upper resistance line.

The height of the triangle at the entry to the pattern (see the red vertical line on the left) is an estimate of the price move to the downside when price breaks out of the descending triangle (see the red vertical line on the right).

Pennant and Flag Patterns

The next two patterns, the flag and pennant patterns, are also continuation patterns. They're very similar to each other, particularly in their shape. The flag pattern is rectangular and the pennant is in the shape of a triangle.

Both of these patterns generally appear after a spike in the price action, meaning a sizeable movement to the upside or downside. After this spike in price action, there is a sideways price action that forms the pennant or the flag. The pole of the flag or the pennant in the spike in price action leading up to the flag or pennant.

As with the triangular patterns, the price will breakout in the same direction as the spike in price action leading to the flag or pennant pattern.

Generally the size of the spike in price action leading up to the flag or pennant is approximately equal to the size of the price action upon exiting the pattern.

Pennant

Following is an image of a bull pennant that exhibits a strong move upward and it breaks out to the upside.

The pennant looks like a symmetrical triangle formed by an ascending support trendline and a descending resistance trendline. The pennant is generally symmetrical around the horizontal line drawn from the point of the triangle.

Flag

Following is an image of a bull flag that exhibits a strong move upward and it breaks out to the upside. You'll notice how the flag is in the shape of a rectangle formed by two parallel trendline acting like support and resistance until the breakout occurs. Usually the flag will have a slope to it in the opposite direction from the initial spike movement leading to the pattern, as shown in the image below.

Also notice that the size of the movement leading to the flag pattern (see the red dash line on the left) is approximately equal to the size of the breakout move (see the red dash line on the right).

Following is an image of a bear flag.

In both the case of the pennant and the flag, the price movement leading to the flag or pennant should be a strong sizeable move.

Rectangle

A rectangle is formed when the market consolidates in a narrow trading range moving sideways. The rectangle often is formed at the end of a trend as the market takes a breather before moving into another trend. Following is an image of a rectangle pattern.

In some cases, when the breakout takes place, you'll find the price moving back below resistance. Many traders look for price to close above or below the rectangle on two consecutive days before they consider it a breakout.

Summary

All of the chart patterns shown above are trend following patterns. That means that the majority of the time, the trend approaching the pattern is in the same direction as the trend exiting the pattern. Traders that recognize trend-following patterns generally can take advantage of the trend following behavior of the pattern.

End of Part Eight

Part Nine of this report will be released in about one week. The topic is "Trend Reversal Patterns".