T he goal of any trader is tofind patterns in the marketsthat offer favorable tradeprobabilities, regardless ofthe specific technique. Chart patterns areuseful trading tools because they arevisual representations of the crowd psy-chology that repeats itself in the markets.

Market participants tend to react toexternal events in fairly pre d i c t a b l eways. News about a companys earningsor the Feds stand on interest rates, aswell as internal events such as when astock or market index breaks an impor-tant resistance or support level, triggerreactions among traders and investorsthat play out again and again in the mar-ket.

This activity is reflected in patternsthat develop on price charts, including

triangles. Traders can take advantage oftriangle patterns because they are madeup of a series of predictable actions andreactions.

The triangle is a common chart patternthat is named for its converging tre n d-lines. There are three basic types of trian-gles: symmetrical, ascending anddescending (see Figure 1, opposite page).

A symmetrical triangle resembles apennant, bound by downward andu p w a rd sloping trendlines. It is cre a t e dwhen the buyers are not aggre s s i v eenough to create a higher high in priceand sellers cannot create a lower low. Theresult is a steadily narrowing price rangeaccompanied by decreasing volume.

An ascending triangle is bound by a

horizontal trendline on top and anu p w a rd sloping lower trendline. Adescending triangle is the opposite.

The symmetrical triangle is the mostcommon variety, but all types appearfrequently. That has its advantages anddisadvantages. The upside is that tradesetups will be plentiful; the downside isthat this frequency will result in agreater number of losing trades.

As Figure 1 shows, all triangles repre-sent market congestion or consolidation.Price moves back and forth in a progres-sively narrower range, until enoughpressure builds that they break out ofthe pattern.

In a sustained uptrend, buyers are morea g g ressive than sellers, cre a t i n g

ACTIVE TRADER November 2001 www.activetradermag.com 25

The best way to avoid false breakouts (for all chart patterns) is to watch volume. A breakout that occurs on a volumeincrease is more reliable.

H e r e s a look at how triangle

patterns develop, what they

represent and how you can use

a few simple guidelines to

trade them more effectively.

BY KATIE TOWNSHEND

T R I A N G L E ST r a d i n g

TRADING Strategies

demand for a market that leads to risingprices. A triangle pattern occurs whent h e re is a shift in this re l a t i o n s h i p .When the market pauses, failing tomake higher highs and higher lows, itimplies buyers and sellers are moreequally matched. This appears as ana rea of sideways price movement (con-solidation) on a chart, which can takethe shape of a number of chart patterns,including triangles and horizontal trad-ing ranges (re c t a n g l e s ) .

Triangles can form within trends or atturning points. The former are calledcontinuation patterns, which means theyinterrupt an existing trend and imply thetrend will continue when price exits thetriangle. The latter are referred to asreversal patterns, which mark significanttops and bottoms of longer-term trends.Triangles are more common as continua-tion patterns.

A triangle, re g a rdless of the type,should have at least five points connect-ing the trendlines that define it (seeFigure 2, right). Triangles can form onany time frame, although they are easi-est to identify on daily or intradaycharts. They are best traded on a short-term basis because long-term outsideinfluences, such as Fed policy, are less

likely to interrupt or skew the pattern.Some sources define triangles as validonly if they are less than three months induration on a daily chart.

Whatever the time frame, breakoutsshould occur about two-thirds of theway into the formation ofthe triangle that is, two-thirds of the way before theconverging lines of the pat-tern would meet (the apex).It is sometimes worthwhileto trade breakouts thatoccur as early as halfwaythrough the pattern, but thereliability of the bre a k o u tdecreases beyond the two-thirds mark. Late breakouts,close to the apex of the tri-angle, are highly unlikely toresult in profitable trades.

The best way to avoidfalse breakouts is to watchvolume. A b reakout thatoccurs on increased volumeis more reliable (as is truefor all chart patterns).C o n v e r s e l y, as trianglesdevelop, volume shoulddecrease. This implies mar-ket participants are indeci-

sive and are moving to the sidelines.

In the past, a great deal of chart analysiswas (or was thought to be) purely sub-jective. However, careful study of pat-

26 www.activetradermag.com November 2001 ACTIVE TRADER

There are three basic types of triangle patterns: symmetrical, ascending and descending. All triangles represent marketconsolidation.

FIGURE 1 TRIANGLE VARIETIES

Symmetrical Ascending Descending

The symmetrical triangle is the most common type of triangle. The best breakouts occur when price breaks out of the triangle between 50 and 66 percent of the distance from the beginning of the triangle to the point where the converging trendlines would meet.

FIGURE 2 THE SYMMETRICAL TRIANGLE

1

24

53

50% 66%

terns can provide reasonable estimatesof their re l i a b i l i t y. In his book,Encyclopedia of Chart Patterns, ThomasBulkowski analyzed triangle patterns in500 stocks over a period of five years(1991 to 1996). The table above showsthe statistical probabilities of success oftrading each pattern based on

Bulkowskis analysis. In each case,Bulkowski waited for the breakout toenter trades.

Not entering the market too earlyhelps keep your failure rate low. Wait forprice to break out of the triangle as a clueto where the trend is going. This elimi-nates guessing and greatly reduces the

chance of being wrong on the directionof the move.

Figure 3 (lower left) provides an exam-ple of a symmetrical triangle. In thiscase, price broke out to the upside of theformation, making it a continuation pat-tern. The best way to trade this kind ofsetup is to enter as soon as the breakoutoccurs, going in the direction of the pre-vious trend.

Figure 4 (opposite page, top) is anintraday chart that shows the volumecharacteristics of a good triangle pattern.Volume fell off as the pattern developedand surged when price broke outthrough the upper boundary of the pat-tern as traders and investors reacted tothe price movement and took a newinterest in the stock.

Price targets are derived from the widthof the triangle, which will always bedetermined by the left side of the trian-gle. The price objective equals the maxi-mum width of the triangle projected upor down from the breakout point. Even ifyou catch a breakout in your charts afterthe fact, as long as the stock price has notmoved beyond the breakout point by adistance greater than the width of the tri-angle at its widest point, it is not too lateto enter a trade.

In his book, Bulkowski analyzed thelikelihood of different kinds of triangles

ACTIVE TRADER November 2001 www.activetradermag.com 27

A symmetrical triangle breaks out to the upside. In this case, the market continued in the direction of the trend that preceded the triangle, makingthis triangle a continuation pattern.

FIGURE 3 THE TRIANGLE AS CONTINUATION PATTERN

June July Aug. Sept. Oct. Nov. Dec. 2001 Feb. Mar. Apr. May June July Aug.

4 5 . 0 0

4 0 . 0 0

3 5 . 0 0

3 0 . 0 0

2 5 . 0 0

2 0 . 0 0

1 5 . 0 0

1 0 , 0 0 0

5 , 0 0 0

0

Source: CQGNet

Education Management (EDMC), daily

Volume

Type of triangle Continuation/ Duration Failure rate Breakout Average/ Average/ Met predictedreversal (after breakout) distance most likely most likely price target

(to apex) decline rise

Symmetrical Continuation Short-term 5% 37%/20% 81%(uptrend) (

to reach their price targets and foundthat more than half the successful tradesmet their objectives. Symmetrical andascending triangles within uptrends hadthe highest probability of meeting theirprice objectives. Doing so favors tradingtriangles that break out in the directionof the trend in force prior to the forma-tion of the triangle. By definition, theseare continuation patterns.

In the ascending triangle in Figure 5(left), the price target would be identi-fied by taking the difference betweenpoints A and B ($4) and adding thatamount to the breakout level (point C).The resulting price objective of $52 wasreached and exceeded.

You will be hard - p ressed to find a sys-tem that can identify the types of trian-gle patterns shown here, so finding tradesetups is really a matter of time ande ffort. One guideline: Keep a close eyeon sector indices. For example, if theretail index is trending nicely and beginsto consolidate, consult the charts of itscomponent stocks. More than likely,some of the leaders will be consolidatingin what turns out to be triangle pat-t e r n s .

28 www.activetradermag.com November 2001 ACTIVE TRADER

A descending triangle forms in an uptrend on an intraday chart. Notice thedeclining volume as the triangle develops, and the volume surge when pricebreaks out of the pattern.

FIGURE 4 VOLUME CONFIRMATION

10:30 12:30 12-08:30 12:30 13-08:30 12:30 16-08:30

2 8 . 0 0

2 7 . 0 0

2 6 . 0 0

2 5 . 0 0

2 4 . 0 0

2 7 . 7 1

1 0 0 0

5 0 0

0

Source: CQGNet

JC Penney Company (JCP), 30-minute

Volume

The maximum width of a triangle can be used to establish a price target. Thedifference between A and B is added to the breakout level (C) to determine a price projection. In this case, the stock paused when it reached the targetprice before exceeding it by a couple of points and then consolidating.

FIGURE 5 PRICE PROJECTIONS

12 19 26 2 9 16 23 1 7 14 21April May

5 4 . 0 0

5 2 . 0 0

5 0 . 0 0

4 8 . 0 0

4 6 . 0 0

4 4 . 0 0

4 2 . 0 0

1 5 0 , 0 0 0

1 0 0 , 0 0 0

5 0 , 0 0 0

Source: CQGNet

Philip Morris Companies Inc. (MO), daily

Volume

Target

A

B

C

Wait for price to break out of the triangle as a clue to where the trendis going. This eliminates guessingand greatly reduces the chance of beingwrong on the direction of them o v e .