Introduction
The triangle pattern, also called the coil, appears in three varieties:
1. symmetrical, 2. ascending, and 3. descending.
Generally, a triangle pattern is considered to be a continuation or consolidation pattern. Sometimes, however, the formation marks a reversal of a trend.
Symmetrical triangles are generally considered neutral, ascending triangles are bullish, and descending triangles are bearish. From a time perspective, triangles are usually considered to be intermediate patterns. Usually, it takes longer than a month to form a triangle. Seldom will a triangle last longer than three months. If a triangle pattern does take longer than three months to complete, Murphy advises that the formation will take on major trend significance.
The symmetrical triangle, which can also be referred to as a coil, usually forms during a trend as a continuation pattern. The pattern contains at least two lower highs and two higher lows. When these points are connected, the lines converge as they are extended and the symmetrical triangle takes shape. You could also think of it as a contracting wedge, wide at the beginning and narrowing over time.
What does a symmetrical triangle look like?
Converging trendlines of support and resistance gives the triangle pattern its distinctive shape. This occurs, Kahn explains, because the trading action gets tighter and tighter until the market breaks out with great force. Buyers and sellers find themselves in a period where they are not sure where the market is headed. Their uncertainty is marked by their actions of buying and selling sooner, making the pattern look like an increasingly tight coil moving across the chart.
As the range between the peaks and troughs marking the progression of price narrows, the trendlines meet at the apex, located at the right of the chart. The base of the triangle is the vertical line at the left of the chart which measures the vertical height of the pattern.
A symmetrical triangle shows two converging trendlines, one is ascending, the other is descending - creating a sideways symmetrical triangle. The formation occurs because prices are making both lower highs and higher lows. Elaine Yager, Director of Technical Analysis at Investec Ernst and Company in New York and a member of Recognias Board of Advisors, notes that the pattern should display two highs and two lows, all touching the trendline as - a minimum of four reversal points is necessary to draw the two converging trendlines. The diagram has these points noted.
Bulkowski divides symmetrical triangles into two groups:
1. symmetrical bottoms - prices trend down then form lower highs and higher lows. Breakout can be either downward or upward. 2. symmetrical tops - prices trend up then form lower highs and higher lows. Breakout can be either downward or upward.
Why is the symmetrical triangle pattern important?
A symmetrical triangle pattern is relatively easy to identify. In addition, triangle patterns can be quite reliable to trade with very low failure rates. There is a caution concerning trading these patterns, however. As mentioned previously, a triangle pattern can be either continuation or reversal patterns. Typically, they are continuation patterns. To achieve the reliability for which the triangle is well known, technical analysts advise waiting for a clear breakout of one of the trendlines defining the triangle.
Triangle patterns are usually susceptible to definite and dependable analysis, with the proviso that the investor must wait for a reliable, as opposed to a premature, breakout. Bulkowski advises that, in general, the failure rate for triangles drops significantly if the investor waits for a valid breakout and, once that breakout occurs, the pattern proves strongly reliable.
Murphy advises that a minimum penetration criterion would be a closing price outside the trendline and not just an intraday penetration. Similarly, Schabacker warns of the false moves and shake-outs which most commonly attend the triangle.
Is volume important in a symmetrical triangle pattern?
Volume is an important factor to consider when determining whether a formation is a true triangle. Typically, volume follows a reliable pattern: volume should diminish as the price swings back and forth between an increasingly narrow range of highs and lows. However, when breakout occurs, there should be a noticeable increase in volume. If this volume picture is not clear, investors should be cautious about whether the pattern is a true triangle.
This traditional volume pattern develops because of investor sentiment during the creation of a triangle. Investors are uncertain. This uncertainty means that they are buying and selling sooner, which translates into a narrowing of the highs and lows, creating the coil shape, indicative of the triangle . Because investors are uncertain, many are holding on to their stocks, awaiting the markets next move. When breakout finally does occur, theres a surge in market activity because investors are finally certain enough about the direction of the market to release their pent-up supply or demand.
What are the details that I should pay attention to in a symmetrical triangle pattern?
1. Occurrence of a Breakout - Technical analysts pay close attention to how long the triangle takes to develop to its apex. The general rule, as explained by Murphy, is that prices should break out - clearly penetrate one of the trendlines - somewhere between three-quarters and two-thirds of the horizontal width of the formation.6 The break out, in other words, should occur well before the pattern reaches the apex of the triangle. . Adherence to this rule is strongly advised by Yager, She adds that the closer the breakout occurs to the apex the higher the risk of a false breakout.
To take the measurement, begin by drawing the two converging trendlines. Measure the length of the triangle from its base to the apex. Next, plot the distance along the horizontal width of the pattern where the breakout should take place. If prices remain within the trendlines beyond the three-quarters point of the triangle, technical analysts will approach the triangle with caution. In much the same manner as Yager, Murphy warns that if prices dont breakout of the trendlines before that point, the triangle begins to lose its potency and prices will simply drift out beyond the apex with no surge in either direction.
2. Price Action - Unlike ascending and descending triangles which give advance notice of their intentions, the symmetrical triangle tends to be a neutral pattern. Murphy advises that the symmetrical triangle is generally a consolidation pattern. This means an investor can look to see the direction of the previous trend and make the basic assumption that the trend will continue. However, many experts advise investors that because the breakout direction could go either way that they wait until the breakout occurs before investing in or selling the stock. Schabacker refers to a symmetrical triangle as a picture of hesitation.
3. Measuring the Triangle - To project the minimum short-term price objective of a triangle, an investor must wait until the price has broken through the trendline. When the price breaks through the trendline, the investor then knows whether the pattern is a consolidation or a reversal formation.
To calculate the minimum price objective, calculate the height of the formation at its widest part - the base of the triangle. The height is equal determined by projecting a vertical line from the first point of contact with the trendline on the left of the chart to the next point of contact with the opposite trendline. In other words, measure from the highest high point on one trendline to the lowest low point on the opposite trendline.
Both these points will be located on the far left of the formation. Next, locate the apex of the triangle the point where the trendlines converge. Take the result of the measurement of the height of the triangle and add it to the price marked by the apex of the triangle if an upside breakout occurs and subtract it from the apex price if the triangle experiences a downside breakout.
For example, working with a symmetrical triangle, assume the highest high of the pattern occurs at 100 and the lowest low at 80. The height of the pattern is 20 100 - 80 = 20. The apex of the triangle occurs at 90. The pattern has an upside breakout. Using the measuring rule, the target price is 110 90 + 20 = 110.
4. Duration of the Triangle - As mentioned before, the triangle is a relatively short-term pattern. It may take up to one month to form and it usually forms in less than three months.
5. Forecasting Implications - Once breakout occurs, the symmetrical triangle tends to be a reliable pattern. Bulkowski calculates failure rates ranging between 2% and 6% for symmetrical triangles after a valid breakout.
6. Shape of Symmetrical Triangle - The pattern should display two highs and two lows, all touching the trendline - a minimum of four reversal points is necessary to draw the two converging trendlines.
7. Volume - Investors should see volume decreasing as the pattern progresses toward the apex of the triangle. At breakout, however, there should be a noticeable increase in volume. Like reversal patterns, volume is more important on the upside than the downside. Therefore, an investor will be particularly interested in seeing an increase in volume on breakout if the pattern is moving upwards. Similarly, if prices are experiencing an uptrend, investors should be looking for volume to increase as prices move up and fall as prices fall back.
8. Premature or False Breakouts - Bulkowski calls them premature false breakouts and Schabacker refers to them as false moves or shake-outs. Both agree that triangles are among the patterns most susceptible to this phenomenon. Because the pattern can be either a reversal or continuation pattern, investors are particularly susceptible to false moves or, at the very least, confused by them. In addition, because volume becomes so thin as the triangle formation progresses to the apex, it takes very little activity to bring about an erratic and false movement in price, taking the price outside of the trendlines.
To avoid taking an inadvisable position in a stock, some investors advise waiting a few days to determine whether the breakout is a valid one. Typically, a false move corrects itself within a week or so. A key sign of a possible false move is low volume. If theres no pick up in volume around the breakout, investors should be wary. Typically, a good breakout from a triangle formation will be accompanied by a definite surge in volume.
There are situations, however, where a false move will occur with high volume. According to Schabacker, these are the most dangerous variety of false moves. The only advice experts can give to investors who fall prey to one of these false moves is to reverse their positions as soon as they become aware of the true movement of the stock.
It is also advisable to be increasingly suspicious of triangle patterns where the breakout occurs very close to the apex. Because trading is so thin at this point, there is an increased likelihood that a false move could occur. Also, false moves are more likely with symmetrical triangles, maintains Schabacker. With the right-angle triangles, the trend is suggested by the pattern itself. Therefore, a deviation from that trend is more likely to raise the suspicion that it may be a false move.
How can I trade this pattern?
Edwards and Magee offer different trading strategies depending on whether you already have a position in the stock or whether you do not have a position in a stock experiencing a triangle formation. If an investor already has a position in a stock, he or she may be locked into that position as the formation takes shape because it is not possible to definitively predict which way the breakout will take the price of the stock. The key is waiting and watching for a valid breakout before making an investment decision.
If an investor does not have a position in a stock, Edwards and Magee advise staying away from the stock when its in the process of forming the triangle pattern. Consider a position when a dependable breakout has occurred. After such a breakout, if on the upside, buy on the next reaction if the Major Trend is up, or if on the downside, sell short on the next rally if the Major Trend is down.
Given contradictory nature of the direction of breakouts from triangles, all experts advise caution with triangles while theyre in the process of forming. . . . it might be better policy to note such formations in the making, and wait until the decisive breakout before making the new commitment. Once a valid breakout has been detected, however, the same experts agree that triangles are a reliable pattern to trade. As mentioned, this pattern has a tendency to premature breakouts and false moves.
To avoid mistaking a false move for a valid breakout, experts advise waiting a few days to see if the breakout is dependable. According to Murphy, a minimum penetration criteria would be a closing price outside the trendline and not just an intraday penetration. Investors do have time once a breakout has occurred.18 According to Bulkowski, when considering symmetrical triangles, an investor will have over five months to reach the ultimate high after an upside breakout and less than half that time after a downside breakout.
Because premature breakouts where prices close outside of the trendline are so common, dont dismiss the pattern if it has experienced such a breakout. According to Bulkowski, however, premature breakouts do not predict the final breakout direction or success or failure of the formation.
Be wary of breakouts from triangles where the breakout does not occur until the apex of the triangle. Experts, including Edwards and Magee, maintain that the most reliable breakouts occur about two-thirds of the way along the triangle.
The triangle pattern should not show too much white space, states Bulkowski. If theres too much white space in the middle portion of the triangles created as price moves from lows to highs, then the pattern may not be a triangle. In a valid triangle, price should bounce back and forth in a fairly regular pattern, as price moves toward the apex.
Bulkowski advises that it is very common for a triangle formation to experience a throwback where prices break upward and then fall back to the formation or a pullback where prices break downward and then rise up again to meet the formation. Throwbacks and pullbacks tend to complete within a couple of weeks and the breakout continues as before.
Converging trendlines of support and resistance gives the triangle pattern its distinctive shape. The Bullish triangle has 2 peeks on the resistance line and 3 waves on the bottom support line.
Example
Conseco CNCEQ formed a rather large symmetrical triangle over a 5-month period before breaking out on the downside.
- The stock declined from 50 in Mar-98 to 22 in Oct-98 before beginning to firm and consolidate. The low at 22 probably was an over-reaction, but the long-term trend was down and established for almost a year.
- After the first 4 points formed, the lines of the symmetrical triangle were draw. The stock traded within the boundaries for another 2 months to form the last 2 points.
- After the gap up from point 3 to point 4, volume slowed over the next few months. There was some increase in volume in late June, but the 60-day SMA remained in a downtrend as the pattern took shape.
- The red square marks the ideal breakout time-span from 50% to 75% of the pattern. The breakout occurred a little over 2 weeks later, but proved valid nonetheless. While it is preferable to have an ideal pattern develop, it is also quite rare.
- After points 5 and 6 formed, the price action moved to the lower boundary of the pattern. Even at this point, the direction of the breakout was still a guess and its was prudent to wait. The break occurred with an increase in volume and accelerated price decline. Chaikin Money Flow declined past -30% and volume exceeded the 60-day SMA for an extended period.
- After the decline from 29 1/2 to 25 1/2, the stock rebounded, but failed to reach potential resistance from the apex. The weakness of the reaction rally foreshadowed the sharpness of the decline that followed.
- The widest point on the pattern extended 10 1/2 points. With a break of support at 29 1/2, the measured decline was estimated to around 19. By drawing a trend line parallel to the upper boundary of the pattern, the extension estimates a decline to around 20.
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