From the June 01, 2012 issue of Futures Magazine • Subscribe!

Trading stocks with triangles

Price patterns are a powerful, elegant tool for market analysis. Not only can you apply them without additional indicators or tools, but because patterns reflect price directly, there often is little to no lag between signals and subsequent price movement. These relationships are just as strong in equities as they are in commodity markets. 

Stock traders can use price patterns to set up positions, time trades with a fundamental basis or as a signal to take money out of the market. They can operate as an early warning system because of their minimal lag, or as a buy or sell trigger within a larger trading approach.

Among price patterns, one of the most useful and simple is the triangle. As with all price patterns, triangles fall into one of two broad categories: Reversal or continuation. Reversal patterns signal that the previous trend will reverse upon completion of the pattern. Continuation patterns signal that the trend will continue upon completion of the pattern.

Playing with shapes

When the price of a stock trades in a range as time goes by and that range becomes smaller, it can be described as a triangle pattern. The process involves the contraction of price with the convergence of trendlines creating the triangle shape (see “Tightening price”).

 

Triangle patterns generally mark a consolidation of the trend and are concluded with a strong breakout in either direction. Clearly, identifying a triangle pattern allows for trading opportunities not only during the formation of the pattern, but when price breaks out at the end of the formation.

How a triangle pattern plays out depends on the type of triangle it is. They generally fall into one of three categories:

  1. Symmetrical triangles
  2. Ascending triangles
  3. Descending triangles 

Each pattern can be described in different terms with respect to price behavior and can be expected to generate a different type of price signal.

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