Introduction: Triangle

INTRODUCTION

The chart patterns covered in this chapter are called continuation patterns. These patterns usually indicate that the sideways price action on the chart is nothing more than a pause in the prevail­ing trend, and that the next move will be in the same direction as the trend that preceded the formation. This distinguishes this group of patterns from those in the previous chapter, which usu­ally indicate that a major trend reversal is in progress.

Another difference between reversal and continuation patterns is their time duration. Reversal patterns usually take much longer to build and represent major trend changes. Continuation patterns, on the other hand, are usually shorter term in duration and are more accurately classified as near term or intermediate patterns.

Notice the constant use of the term "usually." The treat­ment of all chart patterns deals of necessity with general tenden­cies as opposed to rigid rules. There are always exceptions. Even the grouping of price patterns into different categories sometimes becomes tenuous. Triangles are usually continuation patterns, but sometimes act as reversal patterns. Although triangles are usually considered intermediate patterns, they may occasionally appear on long term charts and take on major trend significance. A vari­ation of the triangle—the inverted variety—usually signals a major market top. Even the head and shoulders pattern, the best known of the major reversal patterns, will on occasion be seen as a consolidation pattern.

Even with allowances for a certain amount of ambiguity and the occasional exception, chart patterns do generally fall into the above two categories and, if properly interpreted, can help the chartist determine what the market will probably do most of the time

TRIANGLES

Let's begin our treatment of continuation patterns with the tri­angle. There are three types of triangles—symmetrical, ascend­ing, and descending. (Some chartists include a fourth type of tri­angle known as an expanding triangle, or broadening formation. This is treated as a separate pattern later.) Each type of triangle has a slightly different shape and has different forecasting implications.

Figures 6.1a-c show examples of what each triangle looks like. The symmetrical triangle (see Figure 6.1a) shows two converging trendlines, the upper line descending and the lower line ascending. The vertical line at the left, measuring the height of the pattern, is called the base. The point of inter­section at the right, where the two lines meet, is called the apex. For obvious reasons, the symmetrical triangle is also called a coil.

The ascending triangle has a rising lower line with a flat or horizontal upper line (see Figure 6.1b). The descending tri­angle (Figure 6.1c), by contrast, has the upper line declining with a flat or horizontal bottom line. Let's see how each one is interpreted.

Figure 6.1a Example of a bullish symmetrical triangle. Notice the two converging trendlines. A close outside either trendline completes the pattern. The vertical line at the left is the base. The point at the right where the two lines meet is the apex.

Figure 6.1b Example of an ascending triangle. Notice the flat upper line and the rising lower line. This is generally a bullish pattern.

Figure 6.1c Example of an descending triangle. Notice the flat bottom line and the declining upper line. This is generally a bearish pattern.

THE SYMMETRICAL TRIANGLE

The symmetrical triangle (or the coil) is usually a continuation pattern. It represents a pause in the existing trend after which the original trend is resumed. In the example in Figure 6.1a, the prior trend was up, so that the percentages favor resolution of the triangular consolidation on the upside. If the trend had been down, then the symmetrical triangle would have bearish implications.

The minimum requirement for a triangle is four reversal points. Remember that it always takes two points to draw a trendline. Therefore, in order to draw two converging trendlines, each line must be touched at least twice. In Figure 6.1a, the tri­angle actually begins at point 1, which is where the consolida­tion in the uptrend begins. Prices pull back to point 2 and then rally to point 3. Point 3, however, is lower than point 1. The upper trendline can only be drawn once prices have declined from point 3.

Notice that point 4 is higher than point 2. Only when prices have rallied from point 4 can the lower upslanting line be drawn. It is at this point that the analyst begins to suspect the he or she is dealing with the symmetrical triangle. Now there are four reversal points (1, 2, 3, and 4) and two converging trendlines.

While the minimum requirement is four reversal points, many triangles have six reversal points as shown in Figure 6.1a.

This means that there are actually three peaks and three troughs that combine to form five waves within the triangle before the uptrend resumes. (When we get to the Elliott Wave Theory, we'll have more to say about the five wave tendency within triangles.)

Time Limit for Triangle Resolution

There is a time limit for the resolution of the pattern, and that is the point where the two lines meet—at the apex. As a general rule, prices should break out in the direction of the prior trend some­where between two-thirds to three-quarters of the horizontal width of the triangle. That is, the distance from the vertical base on the left of the pattern to the apex at the far right. Because the two lines must meet at some point, that time distance can be mea­sured once the two converging lines are drawn. An upside break­out is signaled by a penetration of the upper trendline. If prices remain within the triangle beyond the three-quarters point, the triangle begins to lose its potency, and usually means that prices will continue to drift out to the apex and beyond

The triangle, therefore, provides an interesting combina­tion of price and time. The converging trendlines give the price boundaries of the pattern, and indicate at what point the pattern has been completed and the trend resumed by the penetration of the upper trendline (in the case of an uptrend). But these trend­lines also provide a time target by measuring the width of the pat­tern. If the width, for example, were 20 weeks long, then the break­out should take place sometime between the 13th and the 15th week. (See Figure 6.1d.)

The actual trend signal is given by a closing penetration of one of the trendlines. Sometimes a return move will occur back to the penetrated trendline after the breakout. In an uptrend, that line has become a support line. In a downtrend, the lower line becomes a resistance line once it's broken. The apex also acts as an important support or resistance level after the breakout occurs. Various penetration criteria can be applied to the breakout, simi­lar to those covered in the previous two chapters. A minimum penetration criterion would be a closing price outside the trend­line and not just an intraday penetration.

Figure 6.1d Dell formed a bullish symmetrical triangle during the fourth quarter of 1997. Measured from left to right, triangle width is 18 weeks. Price broke out on the 13^th week (see circle), just beyond the two-thirds point.

Importance of Volume

Volume should diminish as the price swings narrow within the triangle. This tendency for volume to contract is true of all con­solidation patterns. But the volume should pick up noticeably at the penetration of the trendline that completes the pattern. The return move should be on light volume with heavier activity again as the trend resumes.

Two other points should be mentioned about volume. As is the case with reversal patterns, volume is more important on the upside than on the downside. An increase in volume is essen­tial to the resumption of an uptrend in all consolidation patterns.

The second point about volume is that, even though trading activity diminishes during formation of the pattern, a close inspection of the volume usually gives a clue as to whether the heavier volume is occurring during the upmoves or downmoves. In an uptrend, for example, there should be a slight ten­dency for volume to be heavier during the bounces and lighter on the price dips.

Measuring Technique

Triangles have measuring techniques. In the case of the sym­metrical triangle, there are a couple of techniques generally used. The simplest technique is to measure the height of the ver­tical line at the widest part of the triangle (the base) and mea­sure that distance from the breakout point. Figure 6.2 shows the distance projected from the breakout point, which is the tech­nique I prefer.

The second method is to draw a trendline from the top of the base (at point A) parallel to the lower trendline. This upper channel line then becomes the upside target in an uptrend. It is possible to arrive at a rough time target for prices to meet the upper channel line. Prices will sometimes hit the channel line at the same time the two converging lines meet at the apex.

Figure 6.2 There are two ways to take a measurement from a symmetrical trian­gle. One is to mea­sure the height of the base (AB); project that vertical distance from the breakout point at C. Another method is to draw a parallel line upward from the top of the baseline (A) parallel to the lower line in the triangle.