Breakaway gap— This signals an attempt
to change a trend’s direction. In this case,
it occurred after a downtrend, and on high
volume. This suggests the bulls may have
finally taken over, but it took them about
five months to gain their strength.
Common gap—A news event or earnings release likely caused this reaction. Although
price gapped up on high volume, after the
reaction, prices retraced back.
Continuation gap—This takes place in the
middle of a move and confirms the trend’s
direction, in this case a bullish one. Note
how the low of the gap bar acted as a strong
support level—prices hit this level and
These can be consolidations or continuations. They have relatively equal levels of
highs and lows. To form a rectangle, price
comes close to, or touches, these levels at
least four or five times.
In Figure 2, notice how volume stays
low when price moves within the rectangle, except when it touches a top or
bottom. When price approaches a top or
bottom, some traders think it may be a
reversal, and take positions accordingly.
Yet, when things don’t go as expected,
That’s why there’s so much
momentum when price
breaks out of a rectangle,
regardless of whether a
trend starts or continues.
These are pauses in a trend that explode
with strong momentum, usually in the
original trend’s direction. They look like
a parallelogram with a slope, opposite
that of the prevailing trend. Flags often
portray a tug-of-war between buyers and
sellers. In the flag formation in Figure
3, note the slight uptick in volume when
price touches the flag’s lower level. Although the prevailing trend is bullish, the
bears try to take control over the bulls
during this consolidation. Even after price
breaks out of the flag, bulls have some
hesitation. After a few low-volume trading days, the bulls regain their strength,
and bullish momentum picks up. A strong
breakout like this suggests bullish directional bias—think short put verticals and
long call verticals.
FIGURE 2: Rectangles. During a consolidation, price usually moves up and down between the top and bottom of
a rectangular pattern. Source: thinkorswim® from TD Ameritrade. For illustrative purposes only.
FIGURE 3: Flags as continuation. During a trend, price may move in the opposite direction for a time. Source:
thinkorswim® from TD Ameritrade. For illustrative purposes only.
go to the Charts
tab, bring up a
chart, and select
menu, select patterns to identify.