This is a little bit reactionary to the way it’s “taught” in the CFA course materials and the majority of examples I have came across, so here’s my view on how to read triangles or price convergence patterns, as I find there to be a lot more information to take out of triangles than “it’s a continuation pattern”. Particularly given the sharp moves I forecast in asset prices in the future driven solely on political uncertainty, trading triangles could become extremely important given how they tend to form after rejections off strong moves fail to gain gound (either given awaiting further information or just off pure price action). Lets dig in:
Hanging to the rails:
First, the most important aspect of any triangle is the slope of the two confining lines, and the most important factor is their individual slopes. They could be equivalent (top line sloping down, bottom line sloping up), upwards/downwards horizontal (top/bottom line is horizontal, approached by bottom/top line) and trending, with both lines going the same way but the one on the “wrong” side of the trend going faster. Thus, we essentially have five cases of triangles which we can use to gauge market sentiments, formed by three varying structures with two duplicates. Another thing to watch out for is if there is extreme difference (beyond 1:3 ratio) in the time that the lines have held. These triangles need to be evaluated on the long line first as that is a closer approximation of trend, and then secondly the short line, most likely for profit targets. However, this is rather easier than the methodology for trading equal length lines (less than 1:2 relationship) and not as interesting once you know how to relate to slopes since the same methodology applies. Hence, the slope discussion takes prevalence here.
Now, in trading triangles, you do not want to enter inside it. The time frame you are looking at is too long relative the trading pattern, and the easy money is in the breakout anyway. Pennants are another matter, but then you need to trade liquid instruments and keep a tight stop after the lines.
Targeting, or knowing where to expect the price to go to, is in triangle trading not the end point of your endeavour, but a function of how you relate to your risk/reward ratio situation and what the profitable view would be more likely to be. First and foremost, the start of the lines are your hallmarks. Basically, the earliest time you can draw both triangles from is the time you should measure the triangle width. The final level of the breakout is likely to end up at the width of the triangle added to the start of the line where the breakout occured. Breakout down is of course range subtracted by line start price. If the triangle started with a strong move, then if the triangle width is larger than the 38.2% fib, I tend to still target triangle width, but if it is smaller, then looking at fibs of the initial move becomes much more important.
Trading “horizontal” triangles:
So, what are the differences between the breakouts between various slope magnitudes? To uncover this, we need to look closer inside the triangle pattern and what the market is acting on. First, the more horizontal a line is, the “stronger” or more confirmed it is, particularly among longer timeframes. (Something that shows up as a nice upwards triangle on the 1 minute chart could be an opposing harami on the 1 hour!) Thus, accumulated market action is required to break a horizontal line to a greater extent than to break a sloping line. Therefore, breakouts aginst the flattest lines tend to be the most forceful in pips terms.
In contrast, the breakouts against the steepest lines tend to be much easier for me personally to trade! Why? Because you have a sequence of opposing points (bottoms or tops) to trade off of. That said, breaking the triangle in this fashion, particularly if it is close to the meeting of the lines, requires you to wait for price to make a new bottom to confirm breaking the triangle. Without the break, you have no clear indication that price action has actually shifted in your favour, and a lot of renko traders will not see anything happening. But once that has occurred, watch carefully and target the start of the line as far as you can viably trace it, and reposition based on the action that occurs there. It is likely to keep falling, but it could provide a double bottom rejection if the breakout price action is very similar to the initial move.
Trading trending triangles:
The same principles apply, the steeper a line is the “weaker” it is. It can of course be enforced by volumes in the nearby reversals, touches right off it, and strong pinbars nearby, or weakened by doji candles and when it is close to the lines crossing. These factors become much more important when trading trending triangles (try saying that out loud 10 times!) as your lines themselves are weak. The one strict difference is that the slope of the less steep line is “leeching” off your breakout: prices may well end up at the same top-to-bottom range, but since the trending triangle had a distinct slope itself, there was less space for the breakout to cover. This is particularly true if there was a strong move prior to the triangle, and it is trending in the same way. Markets here tend to get exhausted and are unlikely to manage a particularly strong breakout with trend.
In these instances, the against-trend breakouts are more interesting since the same principle of triangle-formation-to-breakout-end pip equivalence holds, and could therefore after some quick hooks or other consolidations convince market participants that the trend is firmly broken and jump on a reversal.
Trading equivalent triangles:
These are by comparison plain consolidations if they occur after strong moves, and are therefore more likely to be continuation patterns as market action is not enough to reverse tops or bottoms forming after the strong move. If they occur on their own, without strong prior moves, watch to see if the start of the lines provide further information.
The third rail:
I have briefly touched upon this before, but this is the strength of any prior move and can offer enormously valuable information. First and foremost, if price forms any triangle that does not continue the trend or test the end-point of the move, check closely for Fibonacci retracements and MA action. These can help you set new targets and time frames very easily (next fib, next MA, etc). Secondly, look for hooks, similar argument but they tend to be extremely valuable if coinciding with any turning point inside the triangle or the line starts.
If price forms a triangle and goes horizontal near the end point, expect a reversal as the continued trend move cannot beat the S/R line. If it does, watch closely how much it fans MA’s out or if it touches any fib retracement in the trend direction. If it fans MA’s out quicker than the initial move, then expect the S/R line to effectively “reject” price, and if it is slower, just wait for the MA’s to come close again and trade price crossing them back into the S/R line and triangle levels.
If the third rail is followed by a with-trend triangle, expect it to reverse as soon as the MA’s catch up, or any breakout never to last too long.
I hope this helped, and I will likely need to refer to this closely in the following few weeks and months as I expect policy crisis to be the name of the game.