Triangles

Apr 27, 2009: 11:16 PM CST

Though we can get caught up in specifics when analyzing triangles, it’s often best to view them for what they really are:  Consolidations in Price.  Whether they are continuation or reversal patterns can be misleading at times.  Let’s look at a few types of triangles and see if we can get a better grasp on these common yet powerful patterns.

Definitions

Triangles are best defined as a pattern exhibiting two converging trendlines that converge at an apex.

Defines the Three Types of Triangles

There are three basic types of Triangle Patterns:

1.  Symmetrical Triangle:  When the upper and lower trendlines converge at roughly the same angle.

2.  Ascending Triangle:  When the upper trendline is horizontal and the lower trendline is rising with higher lows.

3.  Descending Triangle:  When the lower trendline is horizontal and the upper trendline is descending with lower highs.

A triangle needs a minimum of four points (price ‘tests’) to be valid – two upper tests and two lower tests, which is the same definition for establishing a valid trendline.  The significance of a triangle is similar to that of trendline significance and validity.

Classic Technical Analysis teaches that Symmetrical Triangles are more frequently Continuation Patterns than Reversal Patterns, and that Ascending Triangles are “Bullish” while Descending Triangles are “Bearish.”

The logic behind this is the following:

Symmetrical Triangles represent pauses or consolidations in a trend move.  The expectation is that when the counter-trend movement works itself out, price will break-out of consolidation and resume the prevailing trend.

Ascending Triangles are expected to be bullish, because the assumption is that there is a level of resistance or sellers at a certain price wishing to unload inventory, and buyers continue to purchase shares at higher price levels after each downswing, and once this resistance is lifted, the bullish “valve” is opened and price can move forcefully upwards now that the selling pressure has ended.

Descending Triangles are bearish for the opposite reason – that there is a level of support wherein buyers consistently purchase shares, though sellers are becoming more aggressive on each up-swing in price and when the support is broken – or buyers have purchased all they want to purchase – then sellers will dominate in an impulse-style move down.

Keep in mind these are classic generalizations, and not certainties.  One can always find triangle patterns that defy classical wisdom.

It is generally best to identify triangle patterns as consolidation patterns only and be prepared to expect an impulse out of consolidation once price has broken out of the pattern without becoming overburdened with bias or expectations regarding in which direction the break will occur.

Also, price generally does not ‘wait’ until it reaches the apex, or point at which the two trendlines converge, to break out of the pattern.  Most triangles break out of the pattern between 66% and 75% of the distance from the start of the formation to the apex price.

Measuring Rule

All triangle patterns contain an inherent “Measuring Rule” or Price Projection Expectation.  The rule is to take the height of the triangle – the distance between the upper and lower trendline when the pattern first began (or the highest points) and then whenever price breaks out of the pattern, add or subtract this value from the breakout price to arrive at your price projection target.

Triangle Pattern Measuring Rule

In this example, the descending triangle began at $100 per share and found support at $80 per share, giving us a height of $20.  Price broke out of the pattern at $80 per share and formed a “Throwback” or “Pullback,” which is common in triangle formations.  Generally, the throwback provides the highest probability of a successful trade, if it occurs.  We then subtracted $20 from the support level at $80 to arrive at a price projection target of $60 per share.

When trading a triangle formation, it is best to place stops above or below the opposite trendline (in this example, it would have been best to enter short around $80 per share and place a stop above the upper trendline near $85).  Always make sure your price projection target is larger than your expected stop-loss price.

Triangles can be profitable trading patterns, are often easy to recognize, and offer easy to locate targets and stop-loss prices.

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