We looked at some of the price patterns in the last write up. These
were mainly the Major Reversal patterns, namely Head and Shoulders,
Double and Triple tops and rounding patterns. We move on now to look at
the next set of patterns that are called Continuation patterns
The
main difference between the classifications of patterns such should be
evident from the names. Reversal patterns will change the trend.
Continuation patterns, on the other hand, will only interrupt the trend
for a while and the trend is expected to resume once the interruption
is over. What could be the reason for the formations? Mostly, it occurs
whenever the market receives some new informational inputs, the import
of which is not immediately known. For example, if there is an uptrend
in progress in Glaxo and there is some news about a merger
internationally between Glaxo and another MNC group which is also
present in India, one does not readily know if such a merger would
affect the Indian operations and that too in what way. There will of
course be no immediate statements from the company circles about the
issue and therefore the market, at such times, chooses to halt and
consolidate. The word consolidate means strengthen one’s position while
holding the ground. Hence continuation patterns are often of the
consolidation variety.
When markets undergo a period of
consolidation, they naturally stop gaining new territory. Since further
moves in the same direction are halted, the market (or the stock)
begins to retrace the same ground that it had covered earlier. Since
the fresh information (like in the example given above for Glaxo or it
could be something broader like economy related or policy related or
politically related) is being digested and no clear views have yet
formed, the prices tend to move back and forth rapidly within a narrow
confine. Some times these moves remain quite clearly divided between
two fixed levels – a high price where there are enough convinced that
the news is bearish for the market or the stock – and a low price where
the opposing view is held. The prices oscillate between these two areas
several times and thus, a zone of consolidation is formed.
Since
this would keep the market within a fixed zone, one would be able to
draw horizontal trendlines across these clearly demarcated areas. This
would then give rise to a pattern known as the Rectangle. An example of
a rectangle can be seen in the following chart.
Once
the prices break out from the confines of the pattern, the former trend
begins. In the example above it can be seen that Global Tele
consolidated for a long while – more than 3 months – within confined
boundaries and then finally broke downward to resume the decline.
There
will be occasions when the consolidation patterns can be bound by
converging trendlines. These would then look like a cone and hence the
geometric shape is the name given to the pattern – a Triangle. The
reasons for the formation of this pattern are the very same as that of
the rectangle but there is a higher degree of uncertainty associated
with the triangle pattern. Notice this. When the prices can be confined
between converging trendlines, one finds that the tops are getting
lower while the bottoms are getting higher. Pictorially it can be seen
to be thus :
The
pattern shown above has rising bottoms and falling tops. Now we have
already seen as a part of our Dow theory that higher bottoms are a sign
of strength while lower tops are a sign of weakness. So, here we
have a situation, where the market is showing both! When can such a
situation arise? Only when the confusion is extreme and people are
moving back and forth between pessimism and optimism. A good example of
triangle can be seen in the following chart of German Remedies.
After hesitating for a while after a decline, the prices continued with their decline as sharply as ever
Variations
While
what we have seen in the above two cases is the idea patterns, there
can be several variations of the ideal. There is not too much of a
variation in the rectangle. But the triangle, one finds, is subject to
considerable variations. They are :
| Right angled triangles – ascending as well as descending |
| Wedges – rising as well as falling. |
| Expanding triangle. |
The ideal triangle is called a symmetrical triangle.
When
the triangle is formed such that there is either a fixed band of
accumulation or a fixed band of distribution so that one of the lines
of the triangle pattern is horizontal, it forms what is known as a
right angle triangle. It also goes under the names of ascending or
rising or descending or falling triangles. Pictorially, they would look
thus :
 
These
form when there is one or two large buyers (in descending triangle) or
sellers (in ascending triangle) at a fixed price for some reasons
particular to them. However, the market as a whole has entirely other
ideas about the scrip and therefore the participants come in at lower
and lower highs (descending triangle) or higher and higher bottoms
(ascending variety). Once the main buyer or seller is exhausted of his
quantity, the stock breaks out in the main direction and proceeds ahead.
Two examples of rising and falling triangles are featured above.
Wedges
are slightly rarer patterns, which come at the end of long moves. They
are triangular patterns which symmetrical triangles which are
completely sloped upward or downward. They are also thinner patterns
and the rising or falling line would be characterized by a sharp angle.
Pictorially, we could show it thus:
 |
 |
| Rising wedge |
Falling wedge |
Finding good examples of this pattern is difficult. Telco below shows a good example of a falling wedge.
A rising wedge completed the major bull market top in 1994.
The
third variety of triangles is the Expanding triangle. This is an even
rarer variety. It was mentioned along with the major market reversal
patterns last time but not discussed as it belongs to the triangle
pattern family and therefore its discussion was held down for this
occasion. In fact, the wedges also belong to the Reversal pattern group
rather than the continuation pattern variety. It is only the
symmetrical and the right-angled triangles that are true continuation
patterns.
Two divergent lines from a common focus point
characterize the expanding triangle. In that sense, it is the reverse
of the normal triangle and it also goes by the name of reverse triangle
sometimes. Pictorially it would look thus :
It
is a pattern with higher tops and lower bottoms. What market condition
does this signify? We can only have such higher tops and lower bottoms
when there is complete confusion in the market. It is only seen at
market tops as the pattern keeps enlarging as it progresses (market
bottoms are quiet affairs and prices contract). The books describe it
as a situation when the market is completely out of control and when
rumours and news is driving the prices wild. After 3-4 forays to the
top boundary of the pattern, the stock prices reverse with a massive
sell off.
If any good examples of expanding tops are found among the list of our traded stocks it shall be featured subsequently.
Volume patterns in Rectangles and Triangles
Since
these are consolidations where there is no clear-cut view about the
market, it is obvious that the volumes during such patterns will
actually shrink as the pattern progresses. This is true of all the
patterns shown above except the expanding variety. Here the volumes
will be higher in every leg – whether rising or falling, adding to the
already existing confusion.
Breakout from the pattern should be on high volumes as in the case of the Reversal patterns also.
The
pattern is deemed to have been resolved when the prices move past one
of the trendline confines of the pattern. Usually, there are two touch
points on either trendlines confining the pattern i.e two excursions to
the resistance trendline and similarly two down to the support
trendline. |