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Stock Trading Made Easy - Continuation Patterns

Continuation patterns are easy to identify and have a solid success rate.

We will be looking at examples of longs only today, although you can also take it short. 

A lot of you will remember our long in COMS about a week or two ago from the 12th... You may also remember that those in the room were advised not to hold this stock overnight. The reason is based on the way COMS acted on the 12th. It had a very large one day move to break the highs of the past few months. Often this is followed by a narrow inside range day and at times even a stronger reversal. Due to this, and the fact that the stock can often gap down strongly the next day after such a large one day move, the easiest money is to exit at the end of the day on a day with such a move.  

What often happens is people think that is the end of it and they stop following the stock as closely.  However, if the market favors, this move can continue over the next few trading days. The key is to know what to look for. One pattern you can look for is a continuation.  IMAGES 1 and 2 show examples of what this setup can look like.

IMAGE 1 - cont. pattern 1
continuation pattern 1
IMAGE 2 - cont. pattern 2
continuation trading pattern 2

The core continuation pattern is a 1, 2, 3 pattern. The first bar in this setup is a wide range bar, opening at lows and closing at highs, often on increased volume. The next bar is of a more narrow range than the first one and is often in the upper half of or slightly higher than the range of bar 1. The third bar is the continuation bar which is a continuation of the first bar's move. To reduce risk, you want to see the lows of the third bar at the time of the entry above the lows of bar 2. 

Entry is above the high of bars 1 and 2, whichever is higher. When taken on the daily this setup is best for one to 2 days, taking most off the table on day 1. You can adjust your stop up throughout the day as new pivot lows are established. This setup is best taken in a stock that is either in a uptrend or sideways trend where is it attempting to break out higher from that congestion area. 

Stop loss
When the low of bar 3 is within the lower half of the range of bar 2, use under the low of bar 2 as the stop loss area. If the low of bar 3 is in the upper half of bar 2 or gaps up above the close of bar 2, use under the day's low of bar 3 at the time of the setup. 

IMAGE A shows the core continuation pattern on the daily. The highs of bar 1 are comparable to the previous high on the 16th. Bar 2 is a narrow range bar in the upper part of bar 1's range. This very closely resembles IMAGE 1. The stop is then placed under the low of bars 2 and 3 as the low of bar 3 is comparable to the low of bar 2.

IMAGE A - core cont.
core continuation pattern

IMAGE B1 shows another example of this setup, returning once again to the COMS mentioned earlier. This setup closely resembles IMAGE 2 from the beginning of this lesson. Notice COMS was setting up as a core swingtrade buy on the daily with bar 1, the wide range bar.  

Bar 2 was a doji, a candlestick pattern in which the open and the close of the bar are the same price or extremely close. Dojis are very common on bar 2 as what you see on this day is indecision which is is epitomized in the nature of a doji candlestick. What happens is that the stock has had such a large run that it needs to take a break to catch its breath and yet interest is still very strong so a selloff does not occur. What you don't want to see happen is a stock that on day 2 moves under the midway point of bar 1 and cannot rally back by the end of the bar. If a stock closes under the midway range of bar 1, risk is very greatly increased. At times you will see bar 2 above bar 1, which is just a variation of this same setup. The narrow range though is something you will want to see in bar 2, preferably half or less of the range of bar 1. 

IMAGE B1 - daily
daily continuation pattern

On bar three in COMS, the third day of the setup, a gap up from the close of bar 2 occurred (IMAGE B2.) Since this was also at the area of a break in the highs of bars 1 and 2 you need to wait 30 minutes to see if the gap holds. Mark the 30 minute high. When that high is broken you can look to enter, placing a stop under the current day's low, the low of bar 3 at the time of entry, due to the gap and the fact that the lows of bar 3 at the time of entry were in the upper half of the range of bar 2. 

IMAGE B2 - intraday
intraday continuation pattern
IMAGE B3 - result
pattern result

You want to pay close attention to the market in these setups as that is what you typically need to rely on to decide whether or not to hold past bar 3. When you have entered a Nasdaq stock, you want to have room to move on the Nasdaq still overhead, so check to make sure there is not significant resistance in the market or your stock which could stall the market and also your position. 

The continuation setup is one that can be taken on all time frames so it is advised to follow the pattern on all time frames you are interested in to get the best feel for them.  IMAGE C and IMAGE D show this setup on the 60 minute chart.  

IMAGE C - 60 min. cont.
continuation trading pattern 60-minute chart 1
IMAGE D - 60 min. cont.
continuation trading pattern 60-minute chart 2

To exit continuation patterns it works well to identify upcoming resistance and place an exit just prior to that resistance area hitting.  In the case of IMAGE C above such resistance was whole number resistance at 85.  You can also use a smaller time frame to assist in your exit, watching for reversal patterns on the 15, 10 or 5 minute intraday charts. An example or such a reversal indicator would be a break under the previous bar as the stock moved into price or moving average resistance.  In IMAGE D, whole number resistance once again aided in halting the stock's move.  This time at 75.  Often in continuation patterns, if using a daily or 60 minute chart you will notice the range of bar three is at least half the range of bar 1's wide range bar.  In many cases, such as in the daily of COMS (IMAGE B3) and APOL (IMAGE A), the range of bar 3 will be very comparable to the move of bar 1.  To best judge potential, pay close attention to the strength in the market as a whole.

Continuation Patterns - Learn how to trade stocks the easy way!


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