green bar on chart), but the
probability appears low.
Price did make a huge move
higher on an “up gap,” and
with high volume, which
suggests upside momentum
is still present. On the following day, there was a selloff,
but on low volume. So, bulls
may still be in control.
Let’s take a deeper dive
into these common patterns.
CONSOLIDATION OR CON TINUATION?
Consolidations usually form before a trend
begins, while continuations take place
when a trend pauses before resuming.
Here’s what some of the more common
Price gaps occur frequently, as you can see
from looking at any price chart. Gaps come
in different types—common, breakaway,
exhaustion, continuation—but we won’t
explore those details for the moment. For
now, keep in mind that gaps look like blank
spaces on a chart, often accompanied by
high volume. Several gaps are highlighted
in Figure 1.
FIGURE 1: Gaps come in all shapes and sizes. Sometimes prices open higher or lower than the previous day's
close. This can happen for any number of reasons and indicates if bulls or bears have the upper hand, even if it's
for a short period of time. Source: thinkorswim® from TD Ameritrade. For illustrative purposes only.
Look for areas of consolidation, continuation, and reversal. You’ll discover different
characteristics in each of these categories.
Consolidation—After the initial downtrend
in Figure 1, price consolidates for about
four months before an uptrend begins.
During consolidation, traders are unsure
about price direction. The uptrend starts
only when price breaks out of the rectangle’s top edge on high volume.
Continuation—Once an uptrend begins,
notice several pauses within the trend,
although the trend continues. During these
pauses, continuation patterns such as flags,
pennants, and triangles emerge. Notice
gaps between price bars. These can also
provide clues about price movement.
Reversal—The trend could end here (last
Nobody knows when a trend is going to
begin or end. But you can analyze the mar-
kets from the perspective of “crowd behav-
ior.” And that could potentially increase
your chances of knowing which way price
Crowds create momentum in the markets, but they can also influence you to
make hasty trading decisions like buying at the top of a trend or selling at the
bottom of one. How can you objectively
analyze crowd action and gauge your
PAT TERNS TO THE RESCUE
You may have heard of chart patterns with
esoteric names like head and shoulders or
broadening bottoms. Chart patterns tell a
story about the battle between bulls and
bears. When you see this battle play out, it
exposes directional bias, which ultimately
may help you manage options trades.
Chart patterns are visual, and analyzing
them is more art than science. As an option
trader, you want momentum. And that
means looking for strong price breakouts
when, for instance, volatility picks up and
raises premiums. You don’t need to know
every chart pattern. But it’s helpful to consider a few from three broad pattern categories—consolidation, continuation, and
reversal—to get started.
THE CROWD EFFECT
First, start by pulling up a chart on
your thinkorswim® platform from
TD Ameritrade. Go back in time far
enough to observe a trend, beginning to end.
YOU’VE HEARD IT SAID: “THE TREND IS YOUR FRIEND, UNTIL IT ENDS.” BUT
DOES IT STAY YOUR FRIEND ALL ALONG THE WAY? HOW ABOUT THE
MORE REALISTIC, “THE TREND IS YOUR FRIEND WHEN IT STARTS, BUT
ONCE IT GETS GOING, IT DRIVES YOU NUTS!” TRENDS CAN BE ALLURING.
AND DECEPTIVE. SOMETIMES A TREND PRETENDS TO END, MAKES YOU
RUN FOR THE HILLS, AND THEN—TRENDS SOME MORE.