Autochartist In-Depth: Trending Patterns

Understanding market trends is key, whatever your trading style. To get the most effective chart pattern setup, the direction and strength of the prevailing trend must be known.

There are basically two types of chart patterns: trending and non-trending. Trending pattern types identified by Autochartist consist of rising and falling wedges, channels up and down, and those head and shoulders patterns which feature steeply angled necklines. Some flag formations can also fall under the banner of trending patterns, if the tilt of the flag is steep enough.

For the most part, however, flag formations and head and shoulders patterns are generally considered non-trending, and can be found and traded in other market cycles. Wedges and channels are strictly trending patterns, and ideally should be set up with medium or high initial trend readings.

In trending wedges and channels, it is the the lower (supporting) line of an uptrend which provides the backbone of the pattern, since the formation relies on continued support; as such the line can be considered a 'decision level'. Conversely, with a downward trending pattern it is the upper line (resistance) which keeps pushing prices lower.

Let's look at examples of both uptrending and downtrending patterns.

The chart above is a rising wedge pattern, as prices trend higher with a strong initial trend reading. The support or 'backbone' of the pattern has been tested four times over the length of the pattern, confirming the wedge's quality. The high initial trend reading also suggests that the pattern is developing as part of a larger overarching trend.

Next is an example of a downtrending pattern, which shows a very low initial trend reading. Not all trending pattern alerts will have a high initial trend, because the lines and levels that form a pattern can develop within any market cycle. Where patterns have a low initial trend, it can be worth bearing in mind the lack of any larger trend guiding the pattern to completion.

Identifying patterns as they form

The customisation of alerts makes provision for traders with different tolerances for the strength of a trend. Just because a pattern isn't a perfect pairing for the underlying market cycle does not mean that the lines and levels are without merit. In the example above, the downtrend line resistance could be very helpful to identify a breakout to the upside.

However, because the initial trend reading is low, the underlying trend is likely to be weak or not even a trend at all. This would mean that a better pattern to keep an eye out for would be a triangle or rectangle.

There are several potential entry points in order to take best advantage of a trading pattern's predicted pattern of market movement. To a certain extent, the most effective setup depends on the strength or weakness of the initial trend.

High-trend and low-trend patterns

For high initial trend readings, look for the continuation of the trend and capitalise on the follow-through. Either short the downtrend line resistance of a falling/down pattern, or go long on the uptrend line support of a rising/up pattern. As they take advantage of movements against the trend, these actions would be considered 'swing' entries. The other alternative with patterns showing a high initial trend is to capitalise on the breakout, which would be considered 'continuation' trades.

With patterns showing low initial trend readings, and where the bars are medium, look for a potential stall or reversal of the trend where the 'backbone' may be broken as the trendline is pierced. Even though these are likely scenarios, remember that even a low initial trend reading could still lead to a continuation.

Setups and entry strategies

As already mentioned, trending patterns include rising/falling wedges and channels up/down. These patterns are ideally traded in continuation of market trends, either uptrending or downtrending as appropriate, and when Autochartist's initial trend reading is medium or high. Continuation entries can be swing trades off downtrend line resistance or uptrend line support. They can also be breakout entries when the trending momentum is very strong and the market offers little to no correction.

 

The falling wedge pattern in this example has a high initial trend reading, which indicates a potential continuation setup. The uniformity and clarity are very strong, which suggests the pattern will be less prone to whipsaws and random volatility. However, keep in mind that the time when this pattern has developed is important as well - a pending economic release, or the open of a major exchange, could provoke pattern-breaking market movement.

The two primary entry considerations for the example are:

• the short at the resistance line (1), which would be a corrective or 'swing' short
• the support line (2) downward breakout, which would be a continuation entry.

Since the initial trend is strong, the reversal would not be a primary trade consideration. Follow the trend, particularly when the initial trend is high. Here it appears as if the price could trigger the swing short (1).

If the initial trend is strong but there is no correction, look for the downward breakout play (B) as prices push through the supporting level.

When the initial trend shows a medium rating, there is a degree of uncertainty and it is therefore important to proceed with caution. Remember there is still some trend strength, so there is the chance of a corrective or 'swing' entry - although the lower initial trend means the support-line backbone of the pattern could be tested and broken. When the initial trend is medium, any continuation breakout is likely to have relatively low momemtum.

When the initial trend is below medium but a trending pattern forms nonetheless, the uncertainty generally means it's best to look for a non-trending pattern alert instead.

Autochartist in-depth: non-trending patterns

The final part of our guide to Autochartist looks at chart patterns in which the markets trade sideways, forming part of accumulation or distribution cycles. Find out more.