GET Financial Education Series - Futures
Technical Analysis: Price Patterns – Lesson 10
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Traders vote with their cheque books. If they believe a Futures contract is going to move higher then they will buy the Futures contract. If they believe a Futures contract is going to move lower then they will sell the Futures contract. When their money is on the line they will do whatever it takes to be profitable. Often the actions of these self-interested traders form price patterns on the chart.
Price patterns are chart formations that provide insights into what Futures traders are thinking and feeling at various price levels. Learning to recognize various price patterns therefore gives you an advantage over traders who are only using fundamentals or technical indicators.
Imagine having the ability to identify trade entry points as a Futures contract breaks out and the ability to accurately project how far a Futures contract is going to move once it has broken out and starting moving. Price patterns give you this ability.
Price patterns are divided into the following two categories:
- Continuation patterns
- Reversal patterns
Continuation Patterns
Futures traders continually ask themselves the question "Can this trend continue?" Deciding whether to enter a new trade in the middle of a trend or whether to exit the trade you are currently in and take your profits is difficult. You can never know if a Futures contract is going to turn around and start moving in the opposite direction. Or can you know?
Continuation patterns give you advanced warning when a Futures contract is likely to resume its trend after a short consolidation period and they also indicate how far the Futures contract is likely to move in that direction. Of course continuation patterns are not infallible - but they do put the odds of success in your favour.
Take some time to become acquainted with the following price continuation patterns:
Pennants
Pennants are continuation patterns that form as the price of a Futures contract moves into a tighter and tighter consolidation range. Pennants can be either bullish or bearish, depending on what the trend was before the pennant began to form. If a Futures contract was in an upward trend before the pennant began to form then it is a bullish continuation pattern. If a Futures contract was in a downward trend before the pennant began to form then it is a bearish continuation pattern. Pennants usually form over shorter periods of time.
Pennants all have the following five characteristics (see Figure 1):
Resistance level (A) - downward-trending level of resistance that is converging with the support level
Support level (B) - upward-trending level of support that is converging with the resistance level
Flag pole (C) - the trend preceding the formation of the pennant. The flagpole spans the distance from the beginning of the trend to the highest point of the pennant (in a bullish pennant), or the flagpole spans the distance from the beginning of the trend to the lowest point of the pennant (in a bearish pennant).
Breakout point (D) - the point at which the Futures contract breaks up above the downward-trending level of resistance (in a bullish pennant), or the point at which the Futures contract breaks down below the upward-trending level of support (in a bearish pennant).
Price projection (E) - the price to which the Futures contract will most likely fall after it has broken out of the pennant formation (in a bearish pennant), or the price to which the Futures contract will most likely rise after it has broken out of the pennant formation (in a bullish pennant). The distance the Futures contract is projected to move is equal to the height of the flagpole.
Figure 1 - Pennant
Flags
Flags are continuation patterns that form as the price of a Futures contract pulls back from the predominant trend in a parallel channel. Flags can be either bullish or bearish, depending on what the trend was before the flag began to form. If a Futures contract was in an upward trend before the flag began to form then it is a bullish continuation pattern. If a Futures contract was in a downward trend before the flag began to form then it is a bearish continuation pattern. Flags usually form over shorter periods of time.
Flags all have the following five characteristics (see Figure 2):
Resistance level (A) - downward-trending level of resistance that is parallel with the support level (in a bullish flag), or an upward-trending level of resistance that is parallel with the support level (in a bearish flag).
Support level (B) - downward-trending level of support, that is parallel with the resistance level (in a bullish flag), or an upward-trending level of support that is parallel with the resistance level (in a bearish flag).
Flag pole (C) - the trend preceding the formation of the flag. The flagpole spans the distance from the beginning of the trend to the highest point of the flag (in a bullish flag), or the flagpole spans the distance from the beginning of the trend to the lowest point of the flag (in a bearish flag).
Breakout point (D) - the point at which the Futures contract breaks up above the downward-trending level of resistance (in a bullish flag), or the point at which the Futures contract breaks down below the upward-trending level of support (in a bearish flag).
Price projection (E) - the price to which the Futures contract will most likely fall after it has broken out of the flag formation (in a bearish flag), or the price to which the Futures contract will most likely rise after it has broken out of the flag formation (in a bullish flag). The distance the Futures contract is projected to move is equal to the height of the flagpole.
Figure 2 - Flag
Wedges
Wedges are continuation patterns that form as the price of a Futures contract pulls back from the predominant trend and moves into a tighter and tighter consolidation range. Wedges can be either bullish or bearish, depending on what the trend was before the wedge began to form. If a Futures contract was in an upward trend before the wedge began to form then it is a bullish continuation pattern. If a Futures contract was in a downward trend before the wedge began to form then it is a bearish continuation pattern. Wedges usually form over shorter periods of time.
Wedges all have the following five characteristics (see Figure 3):
Resistance level (A) - downward-trending level of resistance that is converging with the support level (in a bullish wedge), or an upward-trending level of resistance that is converging with the support level (in a bearish wedge).
Support level (B) - downward-trending level of support, that is converging with the resistance level (in a bullish wedge), or an upward-trending level of support that is converging with the resistance level (in a bearish wedge).
Flag pole (C) - the trend preceding the formation of the wedge. The flagpole spans the distance from the beginning of the trend to the highest point of the wedge (in a bullish wedge), or the flagpole spans the distance from the beginning of the trend to the lowest point of the wedge (in a bearish wedge).
Breakout point (D) - the point at which the Futures contract breaks up above the downward-trending level of resistance (in a bullish wedge), or the point at which the Futures contract breaks down below the upward-trending level of support (in a bearish wedge).
Price projection (E) - the price to which the Futures contract will most likely fall after it has broken out of the wedge formation (in a bearish wedge), or the price to which the Futures contract will most likely rise after it has broken out of the wedge formation (in a bullish wedge). The distance the Futures contract is projected to move is equal to the height of the flagpole.
Figure 3 - Wedge
Triangles
Triangles are continuation patterns that form as the price of a Futures contract hits a flat level of support or resistance and begins moving into a tighter and tighter consolidation range. Triangles can be either bullish or bearish depending on what the trend was before the wedge began to form. If a Futures contract was in an upward trend before the triangle began to form then it is a bullish continuation pattern. If a Futures contract was in a downward trend before the triangle began to form then it is a bearish continuation pattern. Triangles usually form over longer periods of time.
Triangles all have the following five characteristics (see Figure 4):
Resistance level (A) - horizontal level of resistance (bullish, or ascending triangle), or a downward-trending level of resistance that is converging with the support level (in a bearish, or descending, triangle).
Support level (B) - upward-trending level of support, that is converging with the resistance level (in a bullish, or ascending, triangle), or a horizontal level of support (in a bearish, or descending, triangle).
Flag pole (C) - the trend preceding the formation of the triangle. The flagpole spans the distance from the beginning of the trend to the highest point of the triangle (in a bullish, or ascending, triangle), or the flagpole spans the distance from the beginning of the trend to the lowest point of the triangle (in a bearish, or descending, triangle).
Breakout point (D) - the point at which the Futures contract breaks up above the horizontal level of resistance (in a bullish, or ascending, triangle), or the point at which the Futures contract breaks down below the horizontal level of support (in a bearish, or descending, triangle).
Price projection (E) - the price to which the Futures contract will most likely fall after it has broken out of the triangle formation (in a bearish, or descending, triangle), or the price to which the Futures contract will most likely rise after it has broken out of the triangle formation (in a bullish, or ascending, triangle). The distance the Futures contract is projected to move is equal to the height of the flagpole.
Figure 4 - Triangle
Reversal Patterns
Futures traders continually ask themselves the question "Can this trend continue?" Deciding whether a trend is over and if it is time to trade against the previous trend is difficult. You can never know if a Futures contract is going to turn around and start moving in the opposite direction. Or can you know?
Reversal patterns give you advanced warning when a Futures contract is likely to turn around and begin a new trend, and also indicates how far the Futures contract is likely to move in the opposite direction. Of course reversal patterns are not infallible but they do put the odds of success in your favour.
Take some time to become acquainted with the following price reversal patterns:
Double-tops/Bottoms
Double-tops/bottoms are reversal patterns that form as the price of a Futures contract hits a support or resistance level two times before the Futures contract turns around and moves in the opposite direction. Double-tops are bearish reversal patterns and double-bottoms are bullish reversal patterns. If a Futures contract is in an upward trend it will form a double-top. If a Futures contract is in a downward trend it will form a double-bottom. Double-tops/bottoms usually form over longer periods of time.
Double-tops/bottoms all have the following four characteristics (see Figure 5):
Resistance level (A) - horizontal, or slightly angled, level of resistance.
Support level (B) - horizontal or slightly angled level of support.
Breakout point (C) - the point at which the Futures contract breaks up above the horizontal level of resistance (double-bottom), or the point at which the Futures contract breaks down below the horizontal level of support (double-top).
Price projection (D) - the price to which the Futures contract will most likely fall after it has broken out of the double-top formation, or the price to which the Futures contract will most likely rise after it has broken out of the double-bottom formation. The distance the Futures contract is projected to move is equal to the distance between the support and resistance levels.
Figure 5 - Double-Top
Triple-tops/Bottoms
Triple-tops/bottoms are reversal patterns that form as the price of a Futures contract hits a support or resistance level three times before the Futures contract turns around and moves in the opposite direction. Triple-tops are bearish reversal patterns and triple-bottoms are bullish reversal patterns. If a Futures contract is in an upward trend it will form a triple-top. If a Futures contract is in a downward trend it will form a triple-bottom. Triple-tops/bottoms usually form over longer periods of time.
Triple-tops/bottoms all have the following four characteristics (see Figure 6):
Resistance level (A) - horizontal, or slightly angled, level of resistance.
Support level (B) - horizontal, or slightly angled level of support.
Breakout point (C) - the point at which the Futures contract breaks up above the horizontal level of resistance (in a triple-bottom), or the point at which the Futures contract breaks down below the horizontal level of support (in a triple-top).
Price projection (D) - the price to which the Futures contract will most likely fall after it has broken out of the triple-top formation, or the price to which the Futures contract will most likely rise after it has broken out of the triple-bottom formation. The distance the Futures contract is projected to move is equal to the distance between the support and resistance levels.
Figure 5 - Double-Top
Head-and-Shoulders Tops/Bottoms
Head-and-shoulders tops are reversal patterns that form as the price of a Futures contract hits a resistance level (forming the first shoulder), then breaks through the first resistance level and hits a higher resistance level (forming the head), and then hits the first resistance level again (forming the second shoulder).
Head-and-shoulders bottoms are reversal patterns that form as the price of a Futures contract hits a support level (forming the first shoulder), then breaks through the first support level and hits a lower support level (forming the head), and then hits the first support level again (forming the second shoulder).
Head-and-shoulders tops are bearish reversal patterns and head-and-shoulders bottoms are bullish reversal patterns. If a Futures contract is in an upward trend then it will form a head-and-shoulders top. If a Futures contract is in a downward trend then it will form a head-and-shoulders bottom. Head-and-shoulders tops/bottoms usually form over long periods of time.
Head-and-shoulders tops/bottoms all have the following five characteristics (see Figure 7):
Left shoulder (A) - horizontal, or slightly angled, level of resistance (head-and-shoulders top), or a horizontal, or slightly angled, level of support (head-and-shoulders bottom).
Head (B) - higher horizontal, or slightly angled, level of resistance (head-and-shoulders top), or a lower horizontal, or slightly angled, level of support (head-and-shoulders bottom).
Right shoulder (C) - horizontal, or slightly angled level of resistance, that is in line with the left shoulder (head-and-shoulders top), or a horizontal, or slightly angled, level of support that is in line with the left shoulder (head-and-shoulders bottom).
Neckline (D) - horizontal, or slightly angled, level of support (head-and-shoulders top), or a horizontal, or slightly angled, level of resistance (head-and-shoulders bottom).
Breakout point (E) - the point at which the Futures contract breaks up above the neckline (head-and-shoulders bottom) or the point at which the Futures contract breaks down below the neckline (head-and-shoulders top).
Price projection (F) - the price to which the Futures contract will most likely fall after it has broken out of the head-and-shoulders-top formation, or the price to which the Futures contract will most likely rise after it has broken out of the head-and-shoulders-bottom formation. The distance the Futures contract is projected to move is equal to the distance between the head and the neckline.
Figure 7 - Head-and-Shoulders Top
Pennants
