There are a number of continuation patterns in the stock market. In this article, I will discuss a few of them, how to find them, and how to trade them.
A continuation pattern means the expectation is the price will continue moving higher once the pattern forms within an overall uptrend.
I only trade these patterns in strong stocks. In other words, stocks in uptrends that are showing strong momentum. See How to Scan for Cup and Handle and Continuation Patterns for the type of stocks I look for.
Types of Continuation Patterns and How to Trade Them
There are many “continuation patterns” in technical analysis. Some are well known, and others not so much. Don’t confuse the general term with the very specific types of continuation patterns discussed here. When I refer to continuation patterns, I am talking about one of these, since I don’t trade any other “continuation patterns” other than the ones discussed here.
I don’t hold swing trade through earnings, nor do I take trade right before earnings unless I suspect I can get out before earnings.
Cup and Handle Continuation Pattern
The cup and handle is a form of continuation pattern since the stock price was moving up, it moved lower, moved back up, and then broke out to the upside from the handle. The link above discusses that pattern in detail.
The Triangle Continuation Pattern
Triangles are everywhere, but I only trade them if they form a certain way, and only in very strong stocks near 52-week highs. The handle in the cup and handle pattern is often a triangle. To avoid confusion with the very generic triangle pattern you read about in trading books, I typically call this version a “contraction pattern”.
A triangle is simply a contraction in the price, but it must align with very specific criteria in order to be tradable.
Here is the sequence of how the pattern must form:
- Overall uptrend.
- Price pulls back (downswing 1)
- Price rallies but can only reach the prior high or lower (no new highs, or only very marginal)
- Another price drop (downswing 2)
- Price moves up again and forms a consolidation in the middle to upper portion of the triangle (which we can now draw). If the consolidation is taking up most of the triangle, which is now quite narrow, that is also fine. The consolidation can also form just above the top line of your triangle.
- A consolidation is three bars or more where the price moves sideways.
- Volume ideally drops off during the consolidation or at least has one or more really low volume days. Don’t want volume increasing on the consolidation.
- Price breaks above the consolidation to trigger a long trade.
Charts from TradingView.
The consolidation must look tight, and ideally the whole triangle, on a Log chart relative to other triangles and consolidations that resulted in favorable trades. “Tight” is a relative term as I only compare the current triangle to other formations within the same stock’s price history.
A very large and loose contraction (does not appear tight) is much more likely to be a topping pattern, and thus we don’t want to trade it. Measure the height of the contraction patterns so far in the uptrend. If the current one is quite a bit larger, don’t trade it.
I take trades if the consolidation is in the middle to the upper portion of the triangle. I will even take trades if the consolidation forms just above the triangle. If the price consolidates at the bottom of the triangle, I usually won’t make a trade, because the price hasn’t moved up off the recent low to confirm the price isn’t dropping anymore.
Here are a few examples of triangles.
Some trades will lose, and some don’t take off like how we want. This one broke out and then drifted sideways. That’s ok. It was still a valid trade, so we stick with it.
The stock below broke out from a consolidation a bit above the triangle. The first consolidation was very loose (not drawn in), so it was left alone. The next consolidation was tighter, but ultimately, the price couldn’t hold and broke to the downside.
The Cup and Handle Scanning process works well for finding these types of stocks. To find stocks that move more, drop the ‘proximity to 52-week high’ filter to 75%.
The following video helps explain the pattern and criteria even more.
My Complete Stock Swing Trading Course reveals the whole process of finding explosive stocks to trade, including WHEN to trade this strategy, and when to back off.
Variations of the Contraction Pattern
The following chart shows a couple of variations, or at least how they are drawn makes them look like a variation. These variations are described in the video above. The first trade (on the left) does have two down waves, but I connected the first and third down waves. On the next trade, the contraction is so small that the consolidation breakout basically kicks off the next up wave and breaks the whole pattern to the upside. In this case, the price had been so tightly squeezed the consolidation became the price swing. This would be an advanced trade.
Also, if a valid contraction and consolidation forms, but the price drops below the consolidation and then quickly rallies above the consolidation, that is still a valid long trade. A false breakout to the downside actually helps signal there is strong buying pressure. This occurs on the third trade (on the right).
When starting out, stick to the patterns where you can see all the distinct price waves and criteria as discussed in the video and in the list above.
Double Consolidation Continuation Pattern
I used to think of this as a sign of weakness, but it is often a sign of strength that occurs just before an upward thrust.
Here’s how the pattern forms:
- Overall uptrend
- Pulls back
- Forms one consolidation near the low
- Breaks above the consolidation and immediately forms another consolidation
- Price breaks above the high of the second consolidation to trigger a long trade
These consolidations are often only a few days, but should be at least three days. If you draw rectangles around the two consolidations they should be touching or overlap. We want them close together. Too far apart and the strategy loses its power.
A buy stop limit order goes just above the second consolidation high point (after day three). A stop loss goes below the consolidation low. See the Profit target article for how to set profit targets.
Volume should be relatively low during the latter half of the first consolidation. It may pick up on the second consolidation slightly. When the price breaks out of the second consolidation, it should be on larger volume.
The Cup and Handle Scanning process works well for finding these types of stocks. Since the stocks will have recently pulled back, drop the proximity to 52-week high filter to 80% or 75% and reduce 3-month performance to >10% (this is an estimate, it should be slightly higher than whatever the S&P 500 return is for the last 3 months).
When a Stock Gets Too Extended
After a breakout to new highs, which may occur as a cup and handle pattern, there may be one or two continuation patterns before a bigger pullback. Sometimes we get three. That doesn’t mean there can’t be more, but one to three is typical.
Beyond that, the stock becomes very well know. Retail traders are piling in because a stock that keeps going up seems like easy money. Patterns at this point start to become larger, more choppy, loose.
Do you know what is happening? Smart money (in earlier) is unloading on non-so-smart money (getting in late) causing volatility and larger price swings as the institutions with big positions distribute their sell orders in waves, taking advantage of higher volume and retail buying interest in order to exit their trades and lock in profit.
Once these continuation patterns become looser, the consolidations get bigger and more choppy, and volume is high all the time (even on consolidations), it is time to step away. Don’t trade the continuation patterns when they start looking like this. Scan for stocks that are forming nice tight patterns, with the proper volume structure.
Context is Critical When Swing Trading Continuation Patterns
If you try to trade these patterns in an average stock, you will have poor results. These patterns are meant to be traded in stocks that are already strong, in uptrends, with strong percentage performance to the upside. The stocks should be stronger than the S&P 500. You can check this by comparing the stock to the S&P 500 on the same chart (percentage scale, same y-axis).
The following chart shows an example of this. The stock, which is used in the double-consolidation example above, started outperforming the S&P 500 and continued to do so. This means it is a stronger than average stock. AND it was only traded when the price was in an overall uptrend, and had started to move back up following a pullback.
When doing this comparison, zoom in to the recent low in the stock and/or S&P 500. This will show you whether the stock is stronger coming out the decline.
Position sizing is a critical element of any trading strategy. Buy too little and your account won’t grow. Buy too much and you could face ruin.
I use a position sizing method called Fixed Dollar, with a Twist. You can read all about it, and other position sizing methods in How Much Stock to Buy.
You will also want to check out the Trend Channel Trading Strategy for another swing trading method to add to your arsenal.
Cory Mitchell, CMT
My Complete Stock Swing Trading Course focuses on trading explosive price moves.
Learn how to read market conditions, how to find potentially explosive trades, where to get in and get out, how to fine-tune trade selection, and how to manage risk.
This is a complete method for swing trading stocks, revealed in step-by-step video format.
Disclaimer: Nothing in this article is personal investment advice, or advice to buy or sell anything. Trading is risky and can result in substantial losses, even more than deposited if using leverage.