Will an existing price trend continue in a stock?

There is a popular expression in trading circles, "The trend is your friend." If you are a trader, or an investor, you would definitely want to know if the prevailing trend in a particular stock or the index will remain as it is for a certain period of time, or if it will change direction. Continuation patterns come in handy here. Continuation patterns are a form of chart pattern, the other being reversal pattern. These patterns signal the direction in which the price of a security or stock is likely to move when the pattern is completed.

Types of Trends

There are three basic types of trends -- up, down and sideways. These trends are identified by trend-lines or price action. The one that displays higher highs and higher lows is said to be on an uptrend. When the price action is stalled or moves in a band, it is a sideways trend. When the price forms lower lows and lower highs, it is in a downtrend. These trends are broadly considered primary trends. There could be secondary trends in the form of a correction within the primary trend.

For instance, if the main or primary trend is upwards for the stock, there could be a secondary trend in the form of a sideways movement or a downturn. Continuation patterns occur mainly in the secondary trends. These patterns show an inclination for the primary trend (either up or down) to continue after formation of a continuation pattern. For instance, a stock is in an uptrend and undergoes a continuation pattern in the form of an ascending triangle, after an upward break-out of this pattern, the stock should continue to trend upwards.

That said, some patterns may result in trend reversal due to reasons such as the pattern being as big as the primary trend, or the stock being highly volatile. The stock may move in such a way that is symbolic of increased instability and lack of conviction in the direction of the primary trend. Therefore, the trading technique to be adopted when sighting continuation patterns is to wait for the pattern break-out in the direction of the primary trend before initiating a trade. Also, if the stock price trends upward and forms a continuation pattern, then trends up and again forms a continuation pattern, this could be less convincing and is less reliable depending on the strength of the second continuation pattern.

Continuation Patterns

The most popular or common continuation patterns are triangles, rectangles, flags and pennants. Other patterns such as wedge and head and shoulders, when they occur in the middle of a trend, can act as a continuation pattern.

Uptrend patterns

Ascending Triangle: An ascending triangle is a trend continuation pattern that is formed in an uptrend. The pattern is formed in a narrow band between high and low prices which visually form a triangle. Upper boundary is the horizontal line or resistance and ascending trend-line is the support.

An ascending triangle pattern was formed on the daily chart of Shoppers Stop and it reached the target of ₹260 in a short time

The price break-out of the horizontal line or resistance of the pattern indicates confirmation of the pattern. Traders can buy the stock above the resistance line. For example, on the daily chart of Shoppers Stop, the stock has formed an ascending triangle with the horizontal line at ₹220. With good volumes, it broke out of the resistance in March and continued the prevailing uptrend. The range of triangles is used to determine the target on the upside and it reached the target of ₹260 in a short span of time.

IOC witnessed an ascending triangle that failed in March this year. The resistance at ₹104 had limited the rally

There is possibility of the pattern becoming a failure in some scenario if there is high volatility. For example, on the daily chart of Indian Oil Corp (IOC), the resistance is at ₹104. After testing the resistance in February and early March this year, the stock price failed to break above the pattern due to increase in volatility. Subsequently, it started to decline, breaching the ascending trend-line or the support, in mid-March. The stock has retraced the entire pattern and has reached the price target of ₹90.

Falling Wedge: This pattern starts with a wide formation from the top to the first bottom and contracts, or compresses, as the stock price moves lower and the trading movement narrows. The pattern has a clear downward slope but the slope will be against the primary uptrend. Irrespective of the type (reversal or continuation), falling wedges are viewed as bullish patterns.

A flag pattern and an inverse head and shoulders continuation pattern is visible on the daily chart of TCS

Inverse head and shoulders: The inverse head and shoulders pattern is more commonly found in reversal patterns. On the daily chart of TCS, the inverse head and shoulders continuation pattern is visible, with sloping neckline at ₹3,100. A breakthrough of this pattern can resume the uptrend, taking it higher to ₹3,440 levels over medium term.

Downtrend patterns

On the daily chart of Bajaj Healthcare, there is a descending triangle pattern downward breakthrough

 

Descending Triangle: Descending triangle is a continuation pattern that is formed in a downtrend, indicating continuation of the primary downtrend. It is the opposite of the ascending triangle pattern. This pattern is evident on the chart of Bajaj Healthcare in March. After testing the support level at ₹460 in late March, the stock breached this level on April 1 by declining 5.4 per cent. With this fall, the pattern is completed and downtrend is confirmed. The stock can reach the target of ₹420 levels over the short term.

Rising Wedge: This continuation pattern starts with a wide formation from the top to the first bottom and contracts as the stock price moves higher and the trading movement narrows. The pattern has a clear upward slope that is against the prevailing downtrend. The confirmation of the pattern occurs when the price convincingly declines below the support line. After a downward breakthrough of the support, the price continues to trend downwards.

Patterns in uptrends and downtrends

A clear symmetric triangle pattern was apparent on the daily chart of Raymond in January and February

 

Symmetric triangle: This continuation pattern is formed both in an uptrend and a downtrend. It has descending swing highs and ascending swing lows. That is, the highs are connected and form a descending trend-line and lows are connected for ascending trend-line, both trend lines should converge towards each other. If the triangle is formed in a downtrend, the price breaks below the support line, signifying a sell. On the other hand, if the triangle is formed in an uptrend, the price breaks above the resistance line, indicating a buy. The stock of Raymond had formed a symmetric triangle pattern between late December 2020 and late February 2021. It broke out on the upside, continuing the previous uptrend and reached the target of ₹400 in March.

The stock of Granules had formed a bearish rectangle pattern on the daily chart recently and likely to extend the downtrend

Rectangles: Like symmetric triangle, the rectangle patterns are formed in an uptrend and a downtrend. This pattern is the depicted by support and resistance levels which connect recent lows and highs of the price. When the rectangle pattern is formed in a downtrend, it has bearish implication. The downtrend will continue upon a decisive fall below the support line, which will indicate a sell. For example, on the daily chart of Granules India, a bearish rectangle pattern is formed as price is in a downtrend in the band between ₹320 and ₹360. The resistance at ₹360 limited the upside in March and it breached the lower boundary recently. This indicates the price is likely to decline to ₹280 in medium term.

Flags: Flag is a minor and near-term trend continuation pattern that indicates that the previous direction will continue after the pattern formation. This pattern is formed after a sharp rally which is known as flag post, with a minimum of two trading sessions to a maximum of a week. This pattern involves two trend-lines: support and resistance levels, forming in a narrow band. Graphically, it forms a parallelogram or a flag (refer chart of TCS). An upward breach of the pattern will extend the rally and the length of the flag post is measured as the pattern price target.

ACC has formed a pennant pattern at around ₹1,900 on the daily chart and is likely to extend the uptrend

Pennants: Pennant is very similar to the flag pattern; the difference is that instead of a minor parallelogram it forms a minor triangle. See the daily chart of ACC, after a sharp rally in mid-March, the stock met resistance at ₹1,900. Thereafter it moved sideways in a narrow band, forming a pennant pattern.

(All charts illustrated here are sourced from TradingView.com)