Introduction to Price action II: Continuous price patterns

What are continuous formations?

Continuous formations often appear in the middle of a trend to stop temporarily. Within this time, continuous formation is formed. It has to be said that formations are considered continuous if they follow the previous trend and formation is completed by breaking one trend line of formation in the direction of the current trend. Continuous formations include the flag, pennant, triangle and rectangle.
 

Price formation Flag

A flag is a formation that forms a relatively narrow price range under which consolidation takes place. This price formation consists of approximately 20 candles. The lower part of the flag should not be lower than half of the previous trend. This formation is bounded by two parallel lines in the price chart.
 

How to trade this formation:

Typically, a flag is traded by waiting to break the top line in the case of an uptrend or bottom line in the case of a downtrend. Stop loss is placed below the lowest point of the flag if the speculation is long and vice versa, if the speculation is short in the downtrend, then above the highest point of the flag. Target price should respect RRR of at least 2:1.

Figure 1 shows an example of this price formation with a downward trend:

_{Figure 1: Downtrend flag formation}
 

Chart breakdown

Between points A and B, a flag formed, consisting of two parallel lines. At point B, the bottom line was broken, where the entry could be short with a stop loss above the flag's highest point.

Price formation Pennant

The pennant is created after a previous strong trend movement and the price chart is made up of two converging lines. It takes from one to four weeks to form if we use daily time frame. Thus, they are approximately 10-20 candles. On the chart, this formation resembles a flag on a flagpole.

How to trade this formation:

Typically, a formation is traded very much like a flag. So the conservative approach is to enter the trade only after the trend line that borders the flag is broken. If the flag is created in the uptrend, the traders will speculate on the long side after breaking the top line of the flag. If the formation is created in the downtrend, it is speculated short after breaking the bottom line of the flag. Stop loss is placed at the lowest pennant position for the uptrend or highest for the downtrend.
 

What this formation looks like in Figure 2:

_{Figure 3: Pricing formation pennant in an uptrend}

Chart breakdown

Between points A and B, a formation was formed, consisting of two converging lines. At point B, there was a breakthrough and long speculation could be realized with a stop loss below the lowest point of the given pennant formation.

Price formation Rectangle

After a previous strong trend, a formation is sometimes created, where the market moves for some time in a horizontal direction and forms a rectangle formation. Thus, the formation is formed by two parallel horizontal lines that form support and resistance. So, to create a rectangle, you need at least two highs at a similar level and two lows again at a similar level.

How to trade this formation:

This formation may take several weeks to create, but also several months or even years. Ideally, this formation is created over 3 months. It is true that the longer a formation has formed, the stronger will be the breakthrough one of the levels. When either support or resistance breaks through, it often happens that the price goes back to the line it broke through to test it again. There is a principle that if the price breaks through support, this line becomes a new resistance. If the price breaks through resistance, this line becomes new support.

The formation is usually traded by waiting for one line to break through and enter the trade when the price returns to that line. The target price should correspond to the height of the rectangle from the point where the puncture occurred.

Traders sometimes trade this formation so that they enter short at the resistance level and enter long at the support level. This is repeated until the breakout of one of the lines occurs. In this context, it is important to realize that there is a balance within the rectangle, i.e. neither bulls nor bears prevail. From this point of view, this is an unclear situation, so it is appropriate to close such trades quite quickly.
 

An example of a rectangular formation is shown in Figure 3:

_{Figure 3: Rectangular formation in a downtrend}
 

Chart breakdown:

The figure shows a part of the previous downtrend on the EURUSD currency pair. A rectangle formation was formed between points A and B. The bottom line was broken at point B, so previous support is now a new resistance. The price approached this resistance at point C, where the entry short could have been taken with a target price that corresponds to a rectangle height and a stop loss above resistance.

If we follow the above rules, we would make a profit in this case. However, if we had wanted more than the recommended profit, we would have been unlucky because, as we can see, the price later returned to point D to retest the new resistance and our transaction would have ended up in a stop loss. It is always important to realize that no one knows where the price will move. Therefore, it is always necessary to follow basic rules, set realistic goals, and not be greedy.

Price formation Triangle

Triangle formation is very similar to pennant formation because it is formed by two converging lines. The difference is that the triangle formation can be formed over several months, while the pennant forms during 20 candles on the daily chart. Of course, we can also find the triangle in lower time frames. Triangle formation gradually produces higher lows and lower highs, so the triangle's top line gradually decreases while the bottom line of the triangle gradually increases.

At least two highs and two lows should be identified to create the formation. If the trend line breaks in the direction of the current trend, the continuous formation is confirmed.
 

There are three types of triangular formations:

• A symmetric triangle where both lines symmetrically converge.

• Descending triangle where the top line decreases and the bottom line is horizontal.

• Ascending triangle When the bottom line grows and the top line is horizontal.

How to trade this formation:

From the trading point of view, all three triangles are traded similarly, i.e. the entry after breaking one of the lines in the direction of the main trend. In Figure 4 we have an example of a symmetric triangle:

_{Figure 4: Symmetric triangle in a downtrend}

Chart breakdown:

This triangle was created in 15 min. time frame. The formation was created between points A and D and at point E there was a breakout where the short speculation could have been taken with RRR 2: 1. Because this triangle was created on a small time frame, it would probably be used by traders who trade intraday strategies.
 

We conclude this chapter by saying that knowing the price formations will allow the trader to better understand the price action principles. Unfortunately, price formations do not always follow the theory. Although continuous formation is created in a downtrend, for example, a trend reversal sometimes happens. Another problem is that fake breakouts may sometimes appear, so the loss can occur unexpectedly. This is necessary to take into consideration when trading on Forex and adjusting money management to it.

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