TRADING Strategies

Trading

TRIANGLES

Heres 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

he goal of any trader is to

find patterns in the markets
that offer favorable trade
probabilities, regardless of
the specific technique. Chart patterns are
useful trading tools because they are
visual representations of the crowd psychology that repeats itself in the markets.
Market participants tend to react to
external events in fairly predictable
ways. News about a companys earnings
or the Feds stand on interest rates, as
well as internal events such as when a
stock or market index breaks an important resistance or support level, trigger
reactions among traders and investors
that play out again and again in the market.
This activity is reflected in patterns
that develop on price charts, including

triangles. Traders can take advantage of

triangle patterns because they are made
up of a series of predictable actions and
reactions.

The triangle is a common chart pattern

that is named for its converging trendlines. There are three basic types of triangles: symmetrical, ascending and
descending (see Figure 1, opposite page).
A symmetrical triangle resembles a
pennant, bound by downward and
upward sloping trendlines. It is created
when the buyers are not aggressive
enough to create a higher high in price
and sellers cannot create a lower low. The
result is a steadily narrowing price range
accompanied by decreasing volume.
An ascending triangle is bound by a

horizontal trendline on top and an

upward sloping lower trendline. A
descending triangle is the opposite.
The symmetrical triangle is the most
common variety, but all types appear
frequently. That has its advantages and
disadvantages. The upside is that trade
setups will be plentiful; the downside is
that this frequency will result in a
greater number of losing trades.
As Figure 1 shows, all triangles represent market congestion or consolidation.
Price moves back and forth in a progressively narrower range, until enough
pressure builds that they break out of
the pattern.

In a sustained uptrend, buyers are more

aggressive than sellers, creating

The best way to avoid false breakouts (for all chart patterns)
is to watch volume. A breakout that occurs on a volume
increase is more reliable.
ACTIVE TRADER November 2001 www.activetradermag.com

25

FIGURE 1 TRIANGLE VARIETIES

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

Symmetrical

demand for a market that leads to rising

prices. A triangle pattern occurs when
there is a shift in this relationship.
When the market pauses, failing to
make higher highs and higher lows, it
implies buyers and sellers are more
equally matched. This appears as an
area of sideways price movement (consolidation) on a chart, which can take
the shape of a number of chart patterns,
including triangles and horizontal trading ranges (rectangles).
Triangles can form within trends or at
turning points. The former are called
continuation patterns, which means they
interrupt an existing trend and imply the
trend will continue when price exits the
triangle. The latter are referred to as
reversal patterns, which mark significant
tops and bottoms of longer-term trends.
Triangles are more common as continuation patterns.
A triangle, regardless of the type,
should have at least five points connecting the trendlines that define it (see
Figure 2, right). Triangles can form on
any time frame, although they are easiest to identify on daily or intraday
charts. They are best traded on a shortterm basis because long-term outside
influences, such as Fed policy, are less
26

Ascending

Descending

likely to interrupt or skew the pattern.

sive and are moving to the sidelines.
Some sources define triangles as valid
only if they are less than three months in
duration on a daily chart.
In the past, a great deal of chart analysis
Whatever the time frame, breakouts
was (or was thought to be) purely subshould occur about two-thirds of the jective. However, careful study of patway into the formation of
the triangle that is, twothirds of the way before the
FIGURE 2 THE SYMMETRICAL TRIANGLE
converging lines of the patThe symmetrical triangle is the most common
tern would meet (the apex).
type of triangle. The best breakouts occur when
It is sometimes worthwhile
price breaks out of the triangle between 50 and
to trade breakouts that
66 percent of the distance from the beginning
occur as early as halfway
of the triangle to the point where the
through the pattern, but the
converging trendlines would meet.
reliability of the breakout
decreases beyond the twothirds mark. Late breakouts,
close to the apex of the tri2
angle, are highly unlikely to
4
result in profitable trades.
The best way to avoid
false breakouts is to watch
volume. A breakout that
5
occurs on increased volume
3
is more reliable (as is true
1
for all chart patterns).
Conversely, as triangles
develop, volume should
50% 66%
decrease. This implies market participants are indeciwww.activetradermag.com November 2001 ACTIVE TRADER

Type of triangle Continuation/

reversal

Duration

Failure rate
(after breakout)

Continuation

Short-term
(<3 mos.)

5%

Reversal

Short-term
(<3 mos.)

6%

20%/15%

62%

Continuation

Short-term
(<3 mos.)

2%

19%/10%

57%

Reversal

Short-term
(<3 mos.)

3%

Ascending
(uptrend)

Continuation

Short-term
(<3 mos.)

2%

63%

Descending
(downtrend)

Continuation

Short-term
(<3 mos.)

4%

63%

Symmetrical
(uptrend)

Symmetrical
(downtrend)

Breakout
distance
(to apex)

Average/
most likely
decline

Average/ Met predicted

most likely price target
rise
37%/20%

19%/10-20%

81%

41%/20%

79%

44%/20%

89%
67%

These statistics are based on daily price bars in 500 stocks from 1991 to 1996.
Source: Encyclopedia of Chart Patterns by Thomas N. Bulkowski (Wiley Trading Advantage, February 2000)

terns can provide reasonable estimates

of their reliability. In his book,
Encyclopedia of Chart Patterns, Thomas
Bulkowski analyzed triangle patterns in
500 stocks over a period of five years
(1991 to 1996). The table above shows
the statistical probabilities of success of
trading each pattern based on

Bulkowskis analysis. In each case,

Bulkowski waited for the breakout to
enter trades.
Not entering the market too early
helps keep your failure rate low. Wait for
price to break out of the triangle as a clue
to where the trend is going. This eliminates guessing and greatly reduces the

FIGURE 3 THE TRIANGLE AS CONTINUATION PATTERN

A symmetrical triangle breaks out to the upside. In this case, the market
continued in the direction of the trend that preceded the triangle, making
this triangle a continuation pattern.
Education Management (EDMC), daily

45.00
40.00
35.00
30.00

chance of being wrong on the direction

of the move.

Figure 3 (lower left) provides an example of a symmetrical triangle. In this

case, price broke out to the upside of the
formation, making it a continuation pattern. The best way to trade this kind of
setup is to enter as soon as the breakout
occurs, going in the direction of the previous trend.
Figure 4 (opposite page, top) is an
intraday chart that shows the volume
characteristics of a good triangle pattern.
Volume fell off as the pattern developed
and surged when price broke out
through the upper boundary of the pattern as traders and investors reacted to
the price movement and took a new
interest in the stock.

25.00
20.00

15.00
Volume
10,000
5,000
0
June July Aug. Sept. Oct. Nov. Dec. 2001 Feb. Mar. Apr. May June July Aug.
Source: CQGNet

ACTIVE TRADER November 2001 www.activetradermag.com

Price targets are derived from the width

of the triangle, which will always be
determined by the left side of the triangle. The price objective equals the maximum width of the triangle projected up
or down from the breakout point. Even if
you catch a breakout in your charts after
the fact, as long as the stock price has not
moved beyond the breakout point by a
distance greater than the width of the triangle at its widest point, it is not too late
to enter a trade.
In his book, Bulkowski analyzed the
likelihood of different kinds of triangles
27

FIGURE 4 VOLUME CONFIRMATION

A descending triangle forms in an uptrend on an intraday chart. Notice the
declining volume as the triangle develops, and the volume surge when price
breaks out of the pattern.
JC Penney Company (JCP), 30-minute

28.00
27.71
27.00

26.00

25.00

24.00
Volume
1000
500
10:30 12:30
Source: CQGNet

12-08:30

12:30

13-08:30

12:30

16-08:30

FIGURE 5 PRICE PROJECTIONS

The maximum width of a triangle can be used to establish a price target. The
difference 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 target
price before exceeding it by a couple of points and then consolidating.
54.00

Philip Morris Companies Inc. (MO), daily

Target

52.00
50.00

48.00
46.00

42.00
Volume

150,000
100,000
50,000
19

Source: CQGNet

28

26

2
April

to reach their price targets and found

that more than half the successful trades
met their objectives. Symmetrical and
ascending triangles within uptrends had
the highest probability of meeting their
price objectives. Doing so favors trading
triangles that break out in the direction
of the trend in force prior to the formation of the triangle. By definition, these
are continuation patterns.
In the ascending triangle in Figure 5
(left), the price target would be identified by taking the difference between
points A and B ($4) and adding that
amount to the breakout level (point C).
The resulting price objective of $52 was
reached and exceeded.

44.00

12

Wait for price

to break out
of the triangle
as a clue
to where the trend
is going. This
eliminates guessing
and greatly reduces
the chance of being
wrong on the
direction of the
move.

16

23

1
May

14

21

You will be hard-pressed to find a system that can identify the types of triangle patterns shown here, so finding trade
setups is really a matter of time and
effort. One guideline: Keep a close eye
on sector indices. For example, if the
retail index is trending nicely and begins
to consolidate, consult the charts of its
component stocks. More than likely,
some of the leaders will be consolidating
in what turns out to be triangle patterns.

www.activetradermag.com November 2001 ACTIVE TRADER