MARKET TACTICS - CONTINUATION PATTERNS

MARKET TACTICS

Breakouts from tight Boxes, tight Flags and tight Pennants are exceptionally reliable signs of future trends. They not only indicate the direction prices will move, but they also usually precede fast and wide movements. For this reason, some traders act only on such signals.

Not quite so reliable, but still among the more reliable of chart indicators, are loosely built Boxes, Flags and Pennants, and all Wedges and Diamonds. They can help to confirm other signs of a major trend development, and they of course are useful in locating levels of support and resistance and good buying or selling points.

CAUTION

It is always possible that an apparent Continuation Pattern may slip suddenly and without notice into a Reversal Formation. The chart follower must accept this risk as part of the odds, and remain alert and ready at all times to turn with the trend.

This chart of General Time is a kaleidoscope of formations described in preceding chapters. Between September and December, a Line formation or Long Base prepared the way for a vigorous bull move. Triangles, Flags. Pennants and Gaps heralded the advance. A sharp uptrend line was penetrated on Feb. 5, but the advance resumed along the underside of the trendline extended. In Chapter 2. this was described as an Internal Trendline. Of interest are the Pennant (end of January) and the Flag (end of April) which were not completed. In both cases, new highs were made later, but the breakdown of the Flag did warn of an impending top. The Key Reversal Day was on high volume and marked the beginning of a decline that lasted five months and carried prices back to 60.

The first formation outlined left is a rather large rising Wedge. As explained in the preceding chapter, the tilt distinguishes the Wedge from a Triangle. Further, a rising Wedge has bearish implications, which is confirmed by a downside breakout. The Inverted Flag shows that flags form just as well upside down and are fairly reliable signs that a decline will continue, at least for the time being. Immediately after the Flag was completed, prices traced out a well-cut diamond, which here proved to mark a reversal in the major trend, an uncommon role for what is usually a continuation pattern but a tricky one.

The Diamond outlined in April, May, and June is of a type often mistaken by inexperienced chartists for a Head & Shoulders pattern. However, the difference can be easily distinguished by the experienced chart reader. In the first place, the decline from the head carries below the low of the supposed left shoulder. It can be added that in most Diamond formations, it would be difficult to recognize shoulders. In this chapter, a behavior pattern was described that fits the illustration above. As stated on page 126, "Often, prices will break down through an apparent Diamond top and later turn to rally to sharply higher ground". Here the Diamond proved to be a continuation pattern, even though the initial breakout made it look like a reversal.

A series of Boxes featured the chart of General Instrument in early 1961. The third one evolved into a major top, which set the stage for a decline that wiped out about 55 percent of value in less than five months. As explained in the preceding chapter, Box formations are usually continuation patterns and only infrequently signal major turns. The long-range chart picture can be helpful in finding these exceptions. At 50-55, General Instruments was selling at all-time highs after a four-year advance. Such heights should make anyone a bit queasy. Second, (not shown here), a Measured Move objective was achieved at 55. And third, a major trendline was broken on the completion of the pattern. The decline that ensued proved to be an excellent illustration of an internal trendline and a downside Measured Move formation. Note how prices, after breaking the initial downtrend in July, then adhered to the top side of the trendline, and how to swing A to B almost exactly equals C to D.