Continuation Patterns, validating and negating CPs, when to trade CPs

19th October 2013, 12:06 AM

Pay Attention
Continuation patterns or CPs are very powerful price patterns normally created at the beginning of a
new trend or after a breakout.

IMPORTANT: CP patterns are NOT detected by the automatic SD indicator. You have to draw them
manually.

A CP pattern is preferably formed by an ERC candle at the first leg + basing/marubozu1 candles at the
base + an ERC at the second leg. That's the ideal CP but it's not always like that, perfect conditions do not
appear always.

Some CP's have an arrival and departure 50% bar, what we should not have is stair step ladder basing like
the one u took.

(1) Marubozu candles are candles are candles with tight bodies, almost no shadows (wicks or tails) or no
shadows at all. They are great as CPs and PCPs. Why are they good as CPs? Because the show strength
and no hesitation in price. Ideally they shouldn't be too wide and located at the break of a TL or after the
break of an important SD zone
WHEN TO TRADE CPs:

• Trading with the trend, with the momentum of the timeframe where it's been detected

• When price is departing from a higher TF SD area on a location AND momentum type of setup

• CPs on Momentum + Location trade setups near or at the HTF proximal line (refer to that
lesson to learn more about about it)

• At historical areas of Support and Resistance

• When a SR area is broken, a CP right at the retest of that area usually works really well
These areas can be easily located using the SupportAndResistance indicator included in
the indicators standalone package (it displays blue and red beads at the last week/month
highs/lows)

• At the breakout of flip zones

• Make sure the CP obeys the trendline rules

EXTRA TIPS ON CONTINUATION PATTERNS:

• A candlestick with just a 50% base does not necessarily mean it has to be a CP pattern

• Not every CP pattern with a 50% candle is a CP pattern, in fact there are high probability CP
patterns that are made of Marubozu candles or engulfing patterns that do not have 50% basing
candle

• Many non 50% bases are CP patterns

• CP patterns candle color is indifferent. Either Blue or Red candles can be found in a CP demand or
CP supply patterns

• Normally we'll want a bearish candle in a CP demand or a bullish candle at the CP supply, but at
flip zones and retests of important SR/SD zones, the candle color is indifferent... We just need a
pause in the market

WHEN NOT TO TRADE CPs:

• When the basing structure is not good:

• More than 6 candles at the base

• Wicky candles at the base

• 1 single doji candle. Confirmation needed. There are nuances and each scenario needs to
be analyzed. If the doji is a HTF candle and both departure and accomplishments are good
as well as a clear trend then they are ok to be taken (the full doji).. An example can be
since on Yahoo Stock

• A high wave candle (wide candle body and long shadows) as a base, confirmation needed
 • Stair step formation (3 methods formation, 3 white horses/3 black crows), 50% candles
with higher highs or higher lows, closing opening above/below previous candles
open/close and even highs/lows

• When Trendline has been solidly broken

• A H4 CP demand must always stay above an ascending H4 TL when price hits it

• If there is a full H4 OHCL candle closed below the TL, the CP demand will be negated

• The CP and TL must be on the entry TF

• At Higher Timeframes SD areas when opposing SD area is in control

• If H4 is in an uptrend and WK demand is in control, selling a H4 CP at the WK supply area

is not high odds. See this live example on failed GBPUSD'S H4 CP supply at the Weekly
supply area

• CPs are continuation patterns, not good for trading at the extremes because at the
extremes we have no room for continuing the trend, it's most likely to get a
reaction/rebound, thus making the CP lower probability

• V and inverted V shapes areas (peaks and valleys) are the ones we should use to trade
HTF areas and extremes for better odds

• When its width is bigger than the average width of a basing candle on that instrument and
timeframe

• Personality. Sometimes we'll come across very wide 50% CP candles. Each instrument has
its own "personality", an average width of zones at each TF, some tend to consolidate
more, others tend to rally with small ERC candles, others with strong ERC candles

• Look at any given TF and instrument, draw a bunch of zones, measure their width. If you
happen to see a zone that is much wider than the average, those tend to either be
penetrated fully or retrace at the proximal line

• A wider than average 50% candle can be considered a failed ERC, that is, an ERC that failed
to have the candlestick body to close at more than 50% of the whole candle range. If the
top down analysis contains a lower TF within that zone, we'll be allowed to trade it, else
wait for confirmation. If you don't do this, you will see CPs all over the chart where it's
just a strong ERC candle that failed to become a confirmed ERC candle

• When more than 3 CP patterns have been created in the same direction

• After 3 or more CP patterns, trading is not recommended in that direction because that
TF will be considered over-extended. We'll be allowed to draw a more aggressive TL, a
reversal could happen

• Zones can be easily taken out or overshot, it's advisable to trade them based on
confirmation, waiting for 1 lower TF WoW trade than the TF where the CP patterns have
been detected
 • See in a post lower some graphical examples of the 3 CP rule

WHEN TO TRADE H4 CPs WHEN D1 IS YOUR ENTRY TF

• When there are strong D1 ERC (Extended Range Candles) with a great imbalance

• When this happens it's likely there will be H4 CP patterns within those D1 ERC candles

• Price is so strong that the pause is minimum and the H4 CP patterns are formed

Example of non-valid CP H4 supply with these scenarios:

• H4 descending TL had been solidly broken

• H4 CP supply was at a HTF supply area (Weekly)

• CPs are not high odds at at the SD range when the opposing HTF is in control

• CPs would have been great in this GBPUSD WK supply area, if price had pulled back to the
CP when the pattern was first created, on the way down

• The CP is not good on the way up, since a CP is a continuation pattern not a reversal
pattern
Example of valid CP patterns when price is rallying from HTF Weekly demand area (GBPUSD):

• Price is rallying from fresh WK demand area

• CP patterns on H4 are higher odds

• We need the CP demand areas to make higher highs and follow the rules, that's taken for granted

• Some of the levels shown did not produce any entries, but the levels were valid

An example on GBPUSD D1 chart on how to use CP patterns at flip zones and areas of support and
resistance:

• D1 supply broken, now flip area of demand and support

• Last week highs right within the flip zone. You can easily see them by using the
SupportAndResistance indicator
COLLECTION OF VALID CP PATTERNS FORMATIONS
This is a collection of the type of bases you should be looking for as far as CP patterns is related.
The attached image is 2000 x 2000 pixels so you will need to open it and ZOOM IN.

NOTE: Don't mix terms here. In order to know if a CP is tradable or not we need to do a top down analysis
of at least a 3 timeframes sequence.
The examples below are just taking into account the CP formation, no multiple timeframe analysis. We
are not dealing with tradable zones, just the structure and bases.
COLLECTION OF NON VALID CP PATTERNS FORMATIONS
This is a collection of the type of bases you should avoid when trading CP patterns.
The attached image is 2000 x 2000 pixels so you will need to open it and ZOOM IN.

NOTE: Don't mix terms here. In order to know if a CP is tradable or not we need to do a top down analysis
of at least a 3 timeframes sequence.
The examples below are just taking into account the CP formation, no multiple timeframe analysis. We
are not dealing with tradable zones, just the structure and bases.
STOP TRADING IN THE SAME DIRECTION AFTER 3 CP PATTERNS HAVE BEEN CREATED

After 3 or more CP patterns, trading is not allowed in that direction because that TF will be considered
over-extended. This scenario will allow us to draw a more aggressive TL, a bigger retracement would have
high probabilities of happening or even a reversal IF a bigger TF imbalance or flip zone has been reached.

CP zones can be easily taken out or overshot, thus it's advisable to trade them based on confirmation,
waiting for 1 lower TF WoW trade than the TF where the CP patterns have been detected. Do not regret
if you see one of those CP patterns work and you didn't take it, we all want to follow rules as mechanical
as possible, we want to focus on the rules and not on the exceptions to those rules. Trading is very easy if
we look at the charts in hindsight where we can easily see what has happened and patterns have worked
or not.