4 TYPES OF BREAKOUTS

BREAKAWAY GAPS

In his book Technical Analysis and Stock Market Profits, Richard W. Schabacker discusses different kind of price gaps. Below are some of the important points he mentions about Breakaway Gaps.

It is always difficult and frequently impossible to be certain whether a Gap is of the Common or Break-away variety at the instant that the Gap appears. This is the principal reason why we cannot place too much credence in the various Gap theories and why we must consider Gaps as of only secondary importance in forecasting. The fact remains that most Gaps which lead decisively out of an established pattern are not closed; they become and remain true Break-away Gaps. And the wider the Gap at a break-out, the less likely it is to be closed.

The Break-away Gap emphasizes the break-out of prices and indicates a sudden change in the technical picture, but the mere fact that prices have broken decisively out of a technical formation is of greater importance than the Gap.

This week’s strong weekly price action on RENAULT SA completed a multi-year symmetrical triangle. On the daily scale chart the breakout took place with a gap opening above the multi-year trend resistance. We can possibly identify the gap as a breakaway gap which could have significant long-term implications. Breakaway gaps are rarely filled and they usually signal a change in trend.

The breakout on the daily scale price chart of RENAULT SA reminded me of a similar, though shorter-term breakout that took place on the Germany DAX Index. The breakaway gap that took place in the beginning of December 2016 was not filled. The breakout from the well-defined consolidation range was followed by a strong trend period.

BULLISH ENGULFING CANDLESTICK PATTERN

Tech Charts Global Equity Markets report highlights some of the mature & well-defined chart patterns in the global equities. Reports usually cover instruments such as ETFs, indices and single stocks from global exchanges. The main objective of the weekly report is to bring member’s attention those text-book classical chart patterns that can eventually be followed by a directional move. In the new Tech Charts Study section I will try to answer member’s questions, analyze previous or current chart pattern breakout signals and discuss different concepts in classical charting.

A well known concept is the support & resistance in technical analysis. Support; an area where demand is formed and resistance; an area where supply is formed, combined with candlestick chart patterns can add value to your market analysis. I frequently discussed and highlighted the Bullish Engulfing candlestick formation on different securities.

A bullish engulfing is a pattern that forms when a small black candlestick is followed by a large white candlestick that completely eclipses or “engulfs” the previous day’s/week’s candlestick. As implied in its name, this trend suggests the bulls have taken control of a security’s price movement from the bears. This type of pattern usually accompanies a declining trend in a security, suggesting a low or end to a security’s decline has occurred.

Where a bullish engulfing candle forms in the context of a trend is one of the most important factors. When a bullish engulfing candle forms at the end of a downtrend or at a support level, the reversal is much more powerful as it represents a capitulation bottom.

CITIZEN WATCH was discussed in April 2017 when the price formed a Bullish Engulfing pattern at a major support. The horizontal support proved to be the lower boundary of a rectangle continuation chart pattern. At the time, the rectangle formation was at its early stages and not clearly identifiable. However, the formation of the bullish reversal candlestick at the support increased the likelihood of a rebound. Bullish Engulfing candlestick is reliable when it forms at a strong support area.

 

Another Bullish Engulfing candlestick formed on RANDGOLD in the beginning of July. The 2 year upward trend line and the lower boundary of a possible rectangle chart pattern met at the same price level (6,350). The formation of a Bullish Engulfing candlestick increased the likelihood of a possible rebound. RANDGLOD is possibly forming a 5 month-long rectangle that can act as a bullish continuation chart pattern.

 

CFDs (CONTRACT FOR DIFFERENCE) – A leveraged derivative instrument

A contract for difference (CFD) is a popular form of derivative trading. CFD trading enables you to speculate on the rising or falling prices of fast-moving global financial markets (or instruments) such as shares, indices, commodities, currencies and treasuries. Some of the benefits of CFD trading are that you can trade on margin, and you can go short (sell) if you think prices will go down or go long (buy) if you think prices will rise. You can also use CFD trades to hedge an existing physical portfolio.

With CFD trading, you don’t buy or sell the underlying asset (for example a physical share, currency pair or commodity). You buy or sell a number of units for a particular instrument depending on whether you think prices will go up or down.

CFDs are a leveraged product, which means that you only need to deposit a small percentage of the full value of the trade in order to open a position. This is called ‘trading on margin’ (or margin requirement). While trading on margin allows you to magnify your returns, your losses will also be magnified as they are based on the full value of the CFD position, meaning you could lose more than any capital deposited.

When trading CFDs you must pay the spread, which is the difference between the buy and sell price. You enter a buy trade using the buy price quoted and exit using the sell price. The narrower the spread, the less the price needs to move in your favour before you start to make a profit, or if the price moves against you, a loss. Some brokers will not have a spread and act on the market prices.

At the end of each trading day (at 5pm New York time), any positions open in your account may be subject to a charge called a ‘holding cost’. The holding cost can be positive or negative depending on the direction of your position and the applicable holding rate.

CFD trading enables you to sell (short) an instrument if you believe it will fall in value, with the aim of profiting from the predicted downward price move. If your prediction turns out to be correct, you can buy the instrument back at a lower price to make a profit. If you have already invested in an existing portfolio of physical shares with another broker and you think they may lose some of their value over the short term, you can hedge your physical shares using CFDs. By short selling the same shares as CFDs, you can try and make a profit from the short-term downtrend to offset any loss from your existing portfolio.

Advantages to CFD trading include lower margin requirements, easy access to global markets, no shorting or day trading rules and little or no fees. However, high leverage magnifies losses when they occur, and having to continually pay a spread to enter and exit positions can be costly when large price movements do not occur. CFDs provide an excellent alternative for certain types of trades or traders, such as short- and long-term investors, but each individual must weigh the costs and benefits and proceed according to what works best within their trading plan.

Also note that the CFD industry is not highly regulated. The credibility of the broker is based on reputation, life span and financial position. There are many fantastic CFD brokers, but it is important, as with any trading decision, to investigate whom to trade with and which broker best fulfills your trading needs.

Doji form when a security’s open and close are virtually equal. The length of the upper and lower shadows can vary and the resulting candlestick looks like a cross, inverted cross or plus sign. Alone, doji are neutral patterns. Any bullish or bearish bias is based on preceding price action and future confirmation. Doji convey a sense of indecision or tug-of-war between buyers and sellers. Prices move above and below the opening level during the session, but close at or near the opening level. The result is a standoff. The relevance of a doji depends on the preceding trend or preceding candlesticks. After an advance, or long white candlestick, a doji signals that the buying pressure is starting to weaken. After a decline, or long black candlestick, a doji signals that selling pressure is starting to diminish. Doji indicate that the forces of supply and demand are becoming more evenly matched and a change in trend may be near. Doji alone are not enough to mark a reversal and further confirmation may be warranted.

The Hammer and Hanging Man look exactly alike, but have different implications based on the preceding price action. Both have small real bodies (black or white), long lower shadows and short or non-existent upper shadows. As with most single and double candlestick formations, the Hammer and Hanging Man require confirmation before action.

Hammer is a bullish reversal pattern that forms after a decline. In addition to a potential trend reversal, hammers can mark bottoms or support levels. After a decline, hammers signal a bullish revival. The low of the long lower shadow implies that sellers drove prices lower during the session. However, the strong finish indicates that buyers regained their footing to end the session on a strong note. While this may seem enough to act on, hammers require further bullish confirmation. Confirmation could come from a gap up or long white candlestick.

FLAG AS MEASURING PATTERN

The flag forms on a mast, a nearly vertical price movement, either up or down. The length of the mast (in points) from the preceding congestion to the point where the Flag begins to form, will be found to indicate in by far the great majority of the cases the extent of the rapid price movement which proceeds from the last reversal point in the Flag. The price projection by using this half mast technique will give us the possible price target but does not call for a reversal of trend when the price objective is met.

Please note that on weekly scale price charts, depending on the length of the previous chart pattern, I label a 2-3 month-long tight consolidation a flag. These consolidation periods are shorter than a rectangle. Below you will find two examples discussing different levels during the formation of a flag and the possible price targets that are calculated following the breakout.

HAMMER CANDLESTICK PATTERN

At inflection points, markets give clues about the internal dynamics of the price action. These are better identified on candlestick charts. The weekly chart of the IBEX 35 index formed a hammer. This bullish reversal candlestick pattern becomes more important if it forms at important support areas. We can see 3 important technical levels overlapping at 10,000 levels. These are; the lower boundary of the 5 month-long downward sloping trend channel, the 200 day (40 week) moving average and the year-long upward trend line.

Hammer is a bullish reversal pattern that forms after a decline. In addition to a potential trend reversal, hammers can mark bottoms or support levels. After a decline, hammers signal a bullish revival. The low of the long lower shadow implies that sellers drove prices lower during the session. However, the strong finish indicates that buyers regained their footing to end the session on a strong note. While this may seem enough to act on, hammers require further bullish confirmation. Confirmation could come from a gap up or long white candlestick.

If we look at the daily price chart of Spain’s IBEX 35 index we can see the 5 month-long trend channel. Over the past 3 days, the index sold off to test the lower boundary of the trend channel and rebounded to recover the losses. On the daily chart, price formed a piercing line, another bullish reversal candlestick. While it is still early to call for a trend reversal, candlestick patters are suggesting a possible recovery. I will be watching the 10,000 critical support in the next few trading days. It is important for the index to hold above this support.

The Piercing Pattern is viewed as a bullish candlestick reversal pattern, similar to the Bullish Engulfing Pattern. A Piercing Pattern occurs when a bullish candle on Day 2 closes above the middle of Day 1’s bearish candle. Moreover, price gaps down on Day 2 only for the gap to be filled and closes significantly into the losses made previously in Day 1’s bearish candlestick. The rejection of the gap down by the bulls typically can be viewed as a bullish sign, and the fact that bulls were able to press further up into the losses of the previous day adds even more bullish sentiment.

Candlestick patterns are made up of one or more candlesticks and can be blended together to form one candlestick. This blended candlestick captures the essence of the pattern and can be formed using the following: The open of the first candlestick, the close of the last candlestick and the high and low of the pattern. By using the open of the first candlestick, close of the second candlestick, and high/low of the pattern, a Piercing Pattern blends into a Hammer. The long lower shadow of the Hammer signals a potential bullish reversal.

HEAD & SHOULDER FAILURE

Head and Shoulder is a reliable reversal chart pattern that forms after an advance or a decline and the completion of the formation suggests a reversal of the existing trend. Global Equity Markets report focuses mainly on chart patterns with horizontal boundaries. H&S shoulder chart patterns with horizontal necklines are usually highlighted in the weekly reports.

As it is the case with different classical chart patterns, H&S reversals can fail. However, the failure of this specific reversal chart pattern can be more informative than other classical chart pattern failures. Both the failure of a H&S after a confirmed breakdown of the neckline or failure without completing the chart pattern with a decisive breakout, would invalidate the earlier interpretation. The failure, once confirmed, would help us set price targets for the newly established trend. A breach above/below the right shoulder would negate the chart pattern and confirm it as a H&S failure. H&S failure chart pattern price target is calculated by taking the width of the chart pattern between the Head and the neckline and adding it to the highest point of the right shoulder (for H&S top reversal failures). Below are some examples. I plan to highlight more H&S failures in the Tech Charts Alert section as they take place. The next educational video will be on H&S failures and will discuss the fine points of this important chart pattern development.

HEAD & SHOULDER CONTINUATION

Head and shoulder chart pattern can form as a continuation on price charts. In uptrends, a H&S continuation will be similar to a H&S bottom and in downtrends it will resemble an inverse H&S. The implications and interpretations continuation H&S are usually the same with reversals. Price objectives can be derived in the same way as it is calculated on a reversal chart pattern.

Head and shoulder continuation is one of my favorite chart pattern. A head and shoulder continuation that forms in an uptrend, will usually breakout to all-time highs once the chart pattern is completed. Breakout to all-time highs from bullish continuation chart patterns are usually reliable and powerful.

A head and shoulder continuation that forms in a downtrend will usually take out the minor lows and move in the path of least resistance. Price that is already in a downtrend is likely to accelerate on the downside (sometimes in a sharp fall) as it breaks down a well-defined horizontal support.

Below are some examples of H&S continuation chart patterns in up and down trends.

 

Developing and confirmed H&S continuation chart patterns that are highlighted in recent reports

Morphology

  1. the study of the forms of things, in particular
  2. a particular form, shape, or structure

Morph

  1. change smoothly from one image to another by small gradual steps using computer animation techniques.
  • undergo or cause to undergo a gradual process of transformation

If you have read Peter Brandt’s books Diary of a Professional Commodity Trader: Lessons from 21 Weeks of Real Trading and Trading Commodity Futures with Classical Chart Patterns you have come across the term morphology and a chart pattern morphing into another form. 

A premature breakout or a false breakout can actually be part of a morphing process, where the stock price consolidates further to form another larger-scale chart pattern. This process can continue until the chart pattern under review is mature.

A good example is a stock the weekly report covered in the first quarter of 2017. Entertainment 1 is listed on the London Stock Exchange. Following the sharp rally that started in July 2016, price chart formed a 5 month-long sideways consolidation that, at the time of analysis, could be identified as a bullish flag/pennant or symmetrical triangle (continuation chart pattern). The breakout from the sideways consolidation failed to materialize into a steady uptrend and the stock continued to move sideways for another 6 months. In other words the chart pattern morphed into another form.

Entertainment 1 is featured in this week’s update in the watchlist section. I view the developing chart pattern as a preparation for a breakout. Year-long sideways consolidation can be identified as a symmetrical triangle and act as a bullish continuation. Diagonal chart patterns are more likely to morph into other forms.

Entertainment 1 price chart after reaching its symmetrical triangle chart pattern price target.

LOGARITHMIC VS. LINEAR CHARTING

The difference between a logarithmic price chart and an arithmetic (linear) price chart can be small when you are analyzing a chart in the short-term. However, as you look at longer-term charts (more than 2 years of price data) you will see major differences.

A linear price scale is plotted on the side of the chart so that there is an equal distance between the prices, and each unit change on the chart is represented by the same vertical distance on the scale, regardless of what price level the asset is at when the change occurs.

A logarithmic price scale is plotted so that the prices in the scale are not positioned equidistantly; instead, the scale is plotted in such a way that two equal percent changes are plotted as the same vertical distance on the scale.

How you construct your price scale will impact the trend lines you draw on your price chart. A good example is the price chart of the Russell 2000 Index ETF (IWM). The chart on the left hand side is plotted on a linear scale. The chart on the right is drawn on logarithmic scale. The upward sloping trend line broke down earlier on the logarithmic scale when compared with the trend line break on the linear scale price chart.

  

Upwards sloping logarithmic trendlines are broken sooner than similar trendlines on linear scale charts.The sell signal can be a little bit late on the linear scale.

The opposite is true for downtrends. Downwards sloping logarithmic trendlines are broken later than similar trendlines on linear scale charts. If you are planning to buy a specific instrument on the breakout of a trendline, you will be slightly late when compared with the buy signal generated on the linear scale chart.

Both have their uses and neither is superior to the other in price analysis. I find it better to use logarithmic scale when analyzing long-term charts. My default parameter for chart analysis is logarithmic scale with 5 years of data displayed as candlesticks.

PREMATURE & FALSE BREAKOUTS

Below two paragraphs are taken from Peter L. Brandt’s Diary of a Professional Commodity Trader – Lessons from 21 weeks of real trading.

“A premature breakout is different from an out of line movement in the sense that a premature breakout can close outside of a predrawn boundary line and even spend several days in breakout mode. Prices then return back to the geometric pattern. However, the initial breakout was only a harbinger of things to come, and within a few weeks a genuine breakout occurs. I call these subsequent breakouts secondary breakouts or pattern recompletions.” – Ch 3, page 38, Identifying the trades and the trading vocabulary

“Unlike the premature breakout, which is followed by a genuine breakout in the same direction, the false breakout results in prices either developing a much larger pattern or strongly moving in the opposite direction. Some traders refer to false breakouts to the downside as a bear trap and false upside breakouts as a bull trap. This means that traders who normally position themselves in the direction of the initial price thrust get stuck on the wrong side of the market.” – Ch 3, page 40, Identifying the trades and the trading vocabulary

In the first week of August, price of Royal Dutch Shell breached the upper boundary of a year long ascending triangle at 56.5 levels. In the following week, it reversed back into the chart pattern. After spending few weeks inside the chart pattern boundaries, the stock gained momentum and is now challenging for the second time the upper boundary of the bullish continuation chart pattern. A confirmed (secondary breakout) can complete the bullish continuation chart pattern with a possible price target of 67 levels. Royal Dutch Shell might be a good example to apply the concept of premature breakout to chart patterns. For false breakouts (bull & bear traps) you can refer to the U.S. Dollar Index chart in the review section of this report.

SUPPORT & RESISTANCE

A stock (ETF, Index etc.) price is either in a trending phase or in a consolidation period. During strong trend periods prices move uninterrupted from one price level to another. During consolidations prices move in both directions without producing any meaningful or sustained price change and will form well-defined support and resistance areas on the charts. A support range represents a concentration of demand, and a resistance range represents a concentration of supply.

A resistance level is an approximate level or fairly well-defined price range, where previously advancing stock meets resistance in the form of strong selling. A support level is an approximate level or price range where a preceding decline meets support, in the form of strong buying. A possible explanation for appearance of such well-defined price boundaries in the form of support and resistance can be the fact that the public tend to remember previous levels the stock has traded.

The longer the time which the stock spent in that range, therefore, the greater the number of transactions, the more important that range becomes for future technical consideration. In applying support and resistance study to price charts, the weekly scale time frame is usually more informative than daily scale. Weekly charts show much more plainly the levels at which congestion of significant duration appeared.

Rectangle chart pattern is a good case study for the application of support and resistance analysis. The upper and lower boundary lines of this familiar and dependable chart pattern are resistance and support levels. Until a decisive breakout occurs in either direction, the boundaries of the rectangle chart pattern (given that it is well-defined with almost perfect horizontal boundaries) provides good reference levels. When a breakout occurs, penetrating one of these levels, that level changes its role. If it is an upward break, the resistance becomes support and if it is a downward break the support becomes resistance.

888 Holdings formed a year-long rectangle chart pattern in 2016. The boundaries of the rectangle was well-defined and the price respected the support and resistance areas. While one can have several different strategies to analyze and trade such price changes, two strategies that are common are:

  1. Trading price changes between the boundaries: Once the price chart forms a well-defined (more than 2 tests of resistance or support around the same price range) pattern boundary, one can buy at support and sell at resistance.
  2. Trading price change after a breakout is confirmed: Breach of the chart pattern boundary usually changes the balance between the supply & demand and results in a directional move. Buying at the breakout or selling at the breakdown confirmation is another common strategy.

Another good example for a well-defined trading range is the price chart of Columbia Sportswear. The multi-month trading range on Columbia Sportswear was discussed in the May 27, 2017 report. The analysis drew attention to a possible rebound from the lower boundary (support) of the 17 month-long range at 52 levels to the upper boundary at 63 levels. Columbia Sportswear price continues to remain between the boundaries. Tech Charts Global Equity Markets report will continue to bring member’s attention such chart pattern developments as well as breakout opportunities.

VOLUME AS A CONFIRMING INDICATOR

Volume is an important indicator that can be used to confirm certain price movement. It is always positive to see increasing volume when a stock is advancing. An advance on expanding volume is deemed more robust than an advance on contracting volume. Likewise, it is good to see an increase in volume during a breakout from a lengthy consolidation range.

Another way to use volume indicator is to confirm price action at market tops and bottoms. After a sharp sell-off, a spike in volume is usually considered a selling climax and suggests a possible bottom. If consecutive attempts to reach new highs are accompanied by lower volume it is usually considered a non-confirmation and forecasts a possible trend reversal.

I classify volume indicator as “good to have”. It is “good” to see an increase in volume during a breakout. However, it is not a “must”. A breakout from a well-defined lengthy trading range can take place with low or “average” volume. This should not put the breakout in question. It is possible for the volume to pick up at the latter stages of the uptrend. Ignoring a genuine breakout because of low volumes can result in a missed opportunity. Below is a great example studying the volume pattern during a major breakout that took place on SUNAC CHINA HOLDING. Price completed a year-long rectangle with a strong breakout. Given the length of the consolidation and the magnitude of the breakout, the volume at the breakout and the weeks following the breakout was not significant. Only after the trend accelerated in the first part of 2017 that the volume started increasing. This is only one example and can’t be generalized for all breakouts. However, it is a good case study highlighting the importance of price action as the leading indicator.

WHEN EVERYTHING BECOMES CORRELATED…

During market corrections, equities, indices and even commodities and FX can become correlated. What you think as a hedge might not act as a pure hedge. During those times there are few actions to take (there can be more depending on your strategy and your access to different derivative instruments):

  1. Reduce risk across the board irrespective of the technical condition of a specific position.
  2. Try to find a good hedge via derivative instruments or by shorting index ETFs.
  3. Treat each chart with its own merit and manage each breakout irrespective of the overall market condition.

I usually go with option 3. As long as you are dealing with risks you can handle, I find option 3 a better way to navigate through volatile periods. Timing market reversals and anticipating turning points is a difficult task. Trying to outsmart the markets, usually takes one to the path of emotional decision making. We should avoid emotional decisions at all times.

Strong markets will usually help breakouts reach their price objectives. A rising tide will lift “most” of the boats. Below are some examples of recent breakouts that reached their chart pattern price targets. With the help of strong trends in Global Equity benchmarks, some breakouts will rally towards chart pattern price targets.

Irrespective of the overall market condition and correlation, there will be breakouts on some of the stocks that will trend towards chart pattern price targets. These can be stocks that are either benefiting from the developing market trend or experiencing inflows due to company specific factors. Below are some examples from the recent breakouts that are trending towards their chart pattern price targets while global equity benchmarks are experiencing setbacks.

During market corrections when most of the instruments become correlated, there will be stocks that will hold on to their gains after their breakouts. These are the stocks that usually pullback to the previously broken chart pattern boundaries and form short-term consolidations. Below are some examples from the recent breakouts that are possibly pulling back to previously cleared chart pattern boundaries.

The most challenging ones are stocks with genuine breakouts that reverse course and experience hard re-test due to overall market conditions. These are the stocks one should pay close attention for a possible failed breakout. There has been several cases where a stock breached the chart pattern boundary and recovered without negating the chart pattern. One’s staying power in those type of situations will depend on their risk management protocols. As long as the chart pattern is not negated, it will always allow re-entry once the stock recovers from the short-term correction. Below are some examples of recent breakouts that are challenging their chart pattern boundaries but are still above the chart pattern negation levels.

During market corrections, lack of momentum will result in further sideways consolidation on some of the names on our watchlist. These are the stocks that I keep on my radar for possible breakouts once the momentum is back. Especially the stocks that hold close to the chart pattern boundaries are the possible candidates for breakouts in the next cycle. Below are some of the examples from the watchlist that are still range-bound before a possible breakout.

GAPS

Gap is a price range where no shares change hands. Gap on daily charts form when the lowest price an instrument trades ends up being higher than the highest price of the preceding day. Or when the highest price of one day is lower than the lowest price of the preceding day. For a gap to develop on a weekly basis, it should follow the same dynamics on weekly close and open.

Which gaps are significant? Which gaps are closed, and which remain not filled on price charts? Answers to these questions can be the foundation of gap trading. There is a wrong belief that all gaps will eventually get filled. This is not true.

THE COMMON GAP

This type of gap usually forms in a trading range. A news flow or a short-term sudden change in sentiment can cause such gaps and they are usually filled in following trading days. They are not significant and do not have forecasting value. Common gap or Area gap usually forms in consolidations rather than reversals. As a result this can be the only forecasting value they add to the decision making process. A common gap that forms in a consolidation increases the likelihood of that consolidation becoming a continuation pattern rather than a reversal.

The chart above shows NATIONAL INDUSTRIS GROUP daily scale price chart between November 2023 and October 2024. The stock is listed on the Kuwait Stock Exchange. Price chart formed a possible 7 month-long ascending triangle. Inside the well-defined consolidation we can see several gap openings which were immediately filled. They have limited forecasting value, other than the knowledge that they will get filled somehow. Such information can become the basis of a short-term trading strategy.

BREAKAWAY GAP

Breakaway gap also appears in relation to a consolidation area. Though it forms at the time of the completion of the consolidation pattern as price breaks away from the pattern. A strong breakout will usually take place with a gap opening adding conviction to the breakout. Breakaway gaps can form at the time of a breakout from a continuation pattern or a reversal. False breakouts rarely happen with a gap opening. A breakout with a gap is stronger than a breakout that takes place during the day. As a result one can expect the ensuing move to carry prices much higher than initially forecasted.

While rare occasions can take place, breakaway gaps are not filled especially if they are accompanied by higher volumes following the breakout.

The chart above shows CARVANA CO. daily scale price chart between May 2023 and October 2024. The stock is listed on the New York Stock Exchange. After a strong uptrend between May 2023 and July 2023, the stock entered into a lengthy consolidation. The 6 month-long sideways price action was identified as an H&S continuation chart pattern. Breakout form the pattern’s horizontal neckline took place with a gap opening. The gap was a breakaway gap that was followed by a continuation/runaway gap. While the latter gat filled, breakaway gap was not filled during the pullback in April 2024.

The chart above shows the volume pattern throughout the formation and at the time of the breakout as price formed the breakaway gap. The surge in volume is clearly visible. This increased the likelihood of the breakaway gap.

CONTINUATION OR RUNAWAY GAPS

We have seen that both the common gap and breakaway gaps develop in association with price formations of the area or congestion. Common gap in the consolidation area and breakaway gap as the pattern completes, right above or below the pattern boundary. The runaway gap, on the other hand, as well as exhaustion gap which will be discussed next, are not related to the consolidation. The form during the rapid advance following the breakout from the consolidation.

At the time of the breakout, with the formation of breakaway gap we will see volume picking up. After an initial thrust, price will start moving sideways in a profit taking attempt. The price will resume with a strong momentum once again with a pick up in volume. During this second phase of strong momentum, a wide gap is likely to appear which can be identified as a continuation or runaway gap.

In hindsight it is easy to identify runaway gaps. It is important to recognize them as they appear on price charts. There is no danger in confusing them with common or breakaway gaps. It becomes necessary though not to confuse it with an exhaustion gap. Any gap which shows up in a fast advance or decline after prices moved away from the pattern boundary may be a runaway gap. What will differentiate between a continuation gap and an exhaustion gap is the volume pattern.

The gap that followed the breakaway gap was a continuation or runaway gap. The increase in volume was clearly visible after a calm period. The runaway gap alerted the trader to pick up in momentum and the possibility of the uptrend to extend much higher than current levels.  

EXHAUSTION GAPS

The two gaps that are not difficult to differentiate between each other but more difficult to come to a conclusion at the time they appear are Continuation and Exhaustion gaps. The exhaustion gap suggests the completion of the movement and an early reversal. The exhaustion gap appears after an extensive move. It occurs usually at the end of a rapid mark-up or mark-down and is rarely the first gap in such price action. The exhaustion gap is more often than not wider than the continuation gaps.

The chart above shows NASDAQ 100 INDEX between January 2024 and October 2024. The example focuses on Gaps that were formed during the sharp correction in July 2024. After an extended period of uptrend, the index broke down trend line support with the first gap opening. Gap labelled with 1 was a breakaway gap. After a short pullback or a pause in the developing downward move, Gap labelled with 2 formed as the trend accelerated. This was the first continuation/runaway gap. Gap 3 was similar to Gap 2 as it resumed the downtrend towards the strong support area formed by the April 2024 low and the 200-day average. In one last attempt of selling where main capitulation and a surge in volume took place, Gap 4 formed. Gap 4 was the widest between all and can be identified as the exhaustion gap.

ISLAND REVERSAL

An island is a compact area of price congestion separated by gaps from the preceding and following price movements. If price gap into the congestion and then gap out again on the same side, with gaps forming at the same level, we have an important pattern, the island reversal. The island can form in one day and is perfectly fine. The most important requirement for an island reversal is the fact that the two gaps at the either end of the island occur opposite each other, at the same price level. At least some part of each gap must come at the same price level.

An island reversal is composed of an exhaustion gap and a breakaway gap. The exhaustion gap is the final euphoric activity in the uptrend followed by the second gap out of the island. The importance of these two information combined is the fact that it forecasts a sharp reversal in the opposite direction of the existing trend.

The chart above shows the daily scale price action of INTUITIVE SURGICAL between July 2022 and April 2023. The stock is listed on the Nasdaq Stock Exchange. Labelled on the chart are 5 different gap openings. Gap that is labelled 1 was a breakaway gap that reversed the downtrend of Aug-Sep 2022 with a breach of the upper boundary of a downward trend channel. Gap 2 and 3 were clearly the continuation/runaway type which resumed the existing uptrend. As the trend matured, volume declined, showing a divergence between the price and volume. Non confirmation was followed by one last gap (GAP 4) in the uptrend which was identified as an exhaustion gap. After 2 days of price action which formed the island another gap this this one the downside formed out of the island consolidation area. With that we have the island reversal pattern confirmed and a forecast made for further development of a downtrend.