Breaking Down The Triangle Chart Pattern
Chart patterns can take a lot of work out of the analysis process. A trader can utilize patterns to understand what's a higher probable move, whether a reversal or continuation play. First, it's important to note, the pattern will never bring certainty but rather a clean at risk reward ratio and likely and improved trading plan when you combine a proper deconstruction, selection, sequence, and understand the stakes at hand when trading in the market or any pattern.
A Clear Pattern of Continuation
We recently discussed that there are two patterns to focus on continuation patterns and reversal patterns. Continuation patterns are built on the idea that sentiment of the trend has cooled off but will likely soon resume. It is important to understand that the momentum behind the prior trend is very difficult to completely reverse and therefore from a probability perspective and continuing move is the highest probability move.
While we are going to look at a multitude of patterns, the triangle is the easiest to recognize and cleanest to trade based on developing a protective stop and a price target.
The attached USDJPY chart shows four triangles of similar variety over a two-year period. Two trend lines converging is the clear tell of a triangle. What is more, a triangle often takes a lot of time to play out before completion. One simple way to think of it is that the enthusiasm of the prior trend often evaporates before the new trend continues.
By nature, traders are often rather impatient. Therefore, a correction that lasts nearly as long as the prior trend advancement wave took often knocks the currency pair in the triangle off the trader's watch list. To be fair, unless you are a comfortable range based trader it is likely best to not trade the triangle until it is complete.
Every trade that you enter has an opportunity cost due to the margin and potential rollover involved and therefore, sitting in a trade that isn't moving can come with high opportunity costs if other players are moving cleanly.
Right off the bat, it may be best to know that you might knock out of a trade that you believe to be a trader. A very common error for traders trying to pick the end of a triangle is that they anticipate the ending too soon. As stated above, patients often run thin for FX traders and a failed trade or two, even if the pattern holds, can discourage staying with the larger trend.
Once you notice converging trendlines, you can use the lower extremes in a larger uptrend as a protective stop. Effectively, you are using price action to set your stops. On the other side, and a larger downtrend, you can utilize price action highs as a protective stop. A final note, don't be too discouraged if you get stopped out because the resumption of the trend is often worth joining, even if you are late.
The price targets of triangle patterns make this a very popular pattern to trade even if they take long to develop. The calculation is rather simple and it involves the height of the pattern regardless of the direction of the prior trend.
What is important, is that you extend the targets from the end of the pattern or price termination point.
For example, if the pattern is 1000 pips high you do not take the target from the pattern low. Rather, the thousand pip target is extended from the end. You may very well notice when a triangle has ended because the resumption of the larger trend is often sharp. The price that marks the start of the trend resumption and end of the triangle is critical because when price breaks that point on a larger correction, the trend may very well have reversed.