1-2-3 Continuation Pattern

Hey Gang,

Just a reminder: I'm am going to be out of town visiting family back up north over the next two weeks. I'll be sending out a few of these while away to give you something to learn from while I'm gone. I will be starting the regular market action column again on July 1st. Have a wonderful time while I'm away and I look forward to getting back in the markets when I return!

All my best,
Toni


1-2-3 Continuation Buy Pattern



Description: This pattern refers to a three bar pattern where a narrow range bar following an initial momentum bar creates a build-up in momentum, leading to a continuation pattern in the direction of the first bar when the second one breaks higher on the third bar.

Criteria:

1. Wide range bar breaking out of support.
2. Narrow range bar near/at the highs of the previous wide range bar. Often this narrow range bar is also an inside range bar.

Entry: Switch to a smaller time frame and take a breakout from the base on Bar #2, using the entry criteria for a breakout, or use above the highs of the narrow range bar of Bar #2.

Stop: Under the lows of the base or last major pivot low on the smaller time frame, under the lows of the narrow range bar, or under the lows of the third bar at the time of the setup.

Target: Bar #1 = Lows of Bar #2 to highs of Bar #3. Watch for resistance levels overhead such as previous congestion zones or whole number resistance.


Ideal 5 Tech Tools Traits:

Pace: Above average momentum on the first bar, but not wider than an average wide range bar. In other words, if the largest bars tend to be $2, then one that is significantly larger than that will be less likely to form as strong of a follow-through on a 1-2-3 continuation pattern as compared to normal. The pace within the second bar should end up being more gradual overall on the counter-trend moves, such as the pullbacks from highs after an upside move on the first bar.

Volume: Lighter than average volume on Bar #2, followed by increasing volume as the highs of Bar #2 are broken.

Correction Periods: Higher probability of success if the setup triggers on Bar #3 as it is coming out of a correction period.

Support/Resistance:

* This pattern tends to be the strongest when it is coming off a larger time frame support level. A base on Bar #2 that pulls into a moving average support level as it sets up, particularly the 20 period sma, will increase the odds of success.
* Often the highs of Bar #1 and Bar #2 will be at a resistance level such as whole number price resistance. If a significant resistance level is just above the highs of those bars, then it will add risk, since the security will more often stall at that point.
* Watch for prior highs such as the highs of the third wave of selling on ATVI shown below in Figure 2, for resistance to assist with targets.

Trend Placement/Trend Development: Look for a setup near the beginning of a new trend, such as after three waves of selling, as was the case in the daily setup on ATVI shown in the example which follows. This pattern is also strong when it takes place on a larger time frame breakout.


1-2-3 Continuation Buy Example

Example #1: Activision Inc. (ATVI) 1-2-3 Continuation Buy Setup


© 2007 Chart provided by Townsend Analytics Ltd.

Pros on Daily 1-2-3 Continuation in ATVI:
1. The momentum heading into the base on the 15th was stronger than average to the upside.
3. The base on the 15th had two pullbacks within the range before it broke higher. This is typical of a correction.
3. The volume on the 15th was much lighter than the previous session and then increased as the range broke.
4. ATVI broke higher into the very end of the day on the 15th and morning of the 16th. This is a typical correction zone intraday and is a great time for bases on the 30-60 minute charts to break.
5. The base on the 15th lasted right into the 30 minute 20 sma support, which was followed immediately by the breakout.
6. ATVI had three waves of selling on the daily charts ahead of the continuation pattern. This trend development is typically followed by a larger correction.
7. ATVI had hit strong daily support at previous lows, making a bounce highly probable.
8. There was a lot of room from the time of the breakout until the next major resistance from the highs of the third wave of selling on the daily time frame would hit. This left quite a bit of potential for the setup.


Cons on Daily 1-2-3 Continuation in ATVI:
1. ATVI did not form a base along the highs of the range on the 15th before breaking, but rather moved from the lows of the range over noon and through the highs in the afternoon.
2. The volume did not increase much on the breakout on 2/16 as compared to the prior day’s base.
3. After the initial wave of buying on the 16th, it pulled back more sharply before its second wave of buying as compared to the mid-day correction on the 14th, which slowed the overall momentum and kept it from hitting an exact equal move as easily when coming into the target zone.


1-2-3 Continuation Short Pattern

Description: The criteria for a 1-2-3 Cont. Buy Setup can also be reversed for a short. Simply change “support” to “resistance” and “buy” to “sell” and vice versa to give the short criteria.


1-2-3 Continuation Short Example: Shaw Group Inc. (SGR)

© 2007 Chart provided by Townsend Analytics Ltd.

Pros on Weekly 1-2-3 Continuation in SGR
1. SGR triggered a daily Avalanche breakdown with the first bar of the 1-2-3 Cont. Short Setup. This created room for larger downside follow-through by virtue of its placement in the larger trend.
2. The second bar formed in the lower half of the first with no increase in upside momentum as it came off the support from January’s lows.
3. Within the second bar on the weekly time frame, SGR formed a strong consolidation and broke lower on the third test of lows within that consolidation and heading into bar 3 on the weekly time frame.
4. Volume declined as SGR consolidated in the second bar of the continuation pattern.
5. No immediate support to stall the continuation move.
6. The momentum at the beginning of bar 3 was as strong as heading into bar 2, allowing for SGR to hit an equal move target on the weekly time frame.


Cons on Weekly 1-2-3 Continuation in SGR:
1. No easily discernable base along the lower end of the daily base to allow for a tighter stop.
2. The base on the daily time frame did not quite hit the 20 day sma resistance and might have attempted to test that resistance better before breaking lower.
3. The volume did not show much increase once bar 2 broke to provide volume confirmation of a stronger selloff developing