In addition to complex mathematical charting tools, technical analysts can also use simple geometric patterns to unveil signals that can indicate where the market could go next. Among some of the simplest and most effective patterns are triangles.
Triangles come in three basic types—ascending, descending and symmetrical—and depending on their shape, they can be used to determine the continuation of a trend or a breakout to a new price level. They normally appear at the consolidation of a trend, where prices funnel in higher highs or lower lows toward a singular point that indicates a transition to a new range.
Unlike some other chart patterns where extensive analysis and even guesswork may be required, the formation of triangles is considered to be a reliable signal that a new price range or price trend may be at hand. However, the trends they point to can often also be confirmed with use of other indicators, such as moving average convergence-divergence and stochastics oscillators.
The principle behind triangles is based on the observation that the typical behaviour of consolidation patterns is diminishing price movement. The formation of the triangle pattern represents a temporary pause in an ongoing trend before continuation of the trend direction.
During this period, volume contracts as market participants trading near either support or resistance show less conviction about the tendency of the price. In this situation, the price of an asset often gets confined between two support and resistance lines, which can be horizontal or diagonal. The period of consolidation ends when the asset price breaks through support or resistance. Triangles can be identified on a chart when price touches support and resistance lines at least two times each to form a converging pattern that finalises at a point called the "apex."
An ascending triangle is characterised by a horizontal pattern of highs and sequentially higher lows, which show decreasing selling pressure every time the price approaches the diagonal line of support. The pattern can be identified by an upward sloping support line and a flat top line indicating steady resistance.
The ascending triangle is normally considered to indicate bullish conditions in which the price trend is likely to move upward following the breakout from the formation. Traders should note that the ascending triangle can at times be followed by a breakout downward, especially when it has been preceded by a downward trend. The pattern can be verified with two or more highs near the resistance line.
Trading volume is likely to diminish while the triangle is being formed, and it will likely increase when the breakout upward occurs. A common approach for trading currencies with this pattern is to set a stop about 10 pips below the highest low in the line of support and set a limit equal to the height of the triangle above the line of resistance. Traders are encouraged to wait for a closing price before taking a decision to make a trade.
Contrary to the ascending triangle, the descending triangle is a bearish signal that will most often indicate the beginning of a downtrend. The pattern shows consecutive lower highs that reveal diminishing resistance and a horizontal bottom line indicating steady support. The pattern can be verified with two or more lows near the support line.
As with ascending triangles, trading volume is likely to diminish while the triangle is being formed, and it will likely increase when a breakout occurs. A common approach for trading with this pattern is to set a stop about 10 pips above the lowest high in the line of resistance and set a limit equal to the height of the triangle below the line of support.
A symmetrical triangle can be either a bullish or bearish signal, depending on whether it occurs during an uptrend or a downtrend. The symmetrical triangle, sometimes called a "coil," is characterised by converging upward and downward support and resistance lines. Like ascending and descending triangles, symmetrical triangles also form in an environment of diminishing trading volume. However, unlike ascending and descending triangles, symmetrical triangles can have lengthy formation periods.
Once the consolidation period reaches a point of exhaustion at the convergence of the support and resistance lines, where sellers are unable to push prices lower and buyers can't push price to a new high, the price is likely to take a firm trend upward or downward. The direction of the trend is often indicated within the first two-thirds of the triangle, when a breakout occurs either above trendline resistance or below trendline support as sellers or buyers push for control.
The end of the triangle pattern is often brought on by a market event, such as an unexpected news announcement or economic data report, which moves trader sentiment decisively onto a particular course. Attention to both price and volume is helpful for confirming the formation of a symmetrical triangle. To verify a breakout, the price should rise clearly outside of the triangle pattern alongside a visible increase in volume.
Like ascending and descending triangles, traders can place a stop 10 pips below or above the last price swing in the formation and then a limit equal to the height of the triangle.
Identifying triangle patterns in price movements can be a simple and effective way to forecast potential price breakouts. With as few as two repeated price swings, traders can identify trends that will likely precede a decisive price movement higher or lower.
Traders will want to be attentive to trends for both support and resistance, and be careful to distinguish triangular movements that indicate a breakout in the direction of a trend from wedge patterns that could precede a price reversal. Attention to changes in trading volume is also important, because this will signal both the formation of the triangle and the move to a breakout.
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Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…