Triangles are one of the first patterns documented by technical investors. When trading the stock market in the United States, investors noted that specific patterns tend to form before the price resumes a trend. This is how the concept of ascending and descending triangles originated. In this course, we have already discussed ascending and descending triangles, and triangles as part of the Elliott Waves Theory.
It turns out that Elliott Waves Theory encompasses all triangle interpretation, so we use the rules established by this theory: a triangle must be a five-wave structure, highlighting its corrective nature, labelled with letters: a-b-c-d-e.
Before Elliott Waves Theory, triangles were only used as a continuation pattern in the pattern recognition approach; ascending triangles in bullish trends and descending triangles in bearish trends. However, triangles can form at the end of trends, especially in the currency markets. Often, the price finds it difficult to break a certain level, and after several tests, it fails and the trend reverses.
How to use triangles as reversal patterns
The beauty of triangles is that they form often. And, the rules to trade them are crystal clear, so there’s no room for misunderstanding.
The first condition in such a situation is the existence of a trend. The market must be first trending before hesitating at an area.
In a bullish trend, a series of lower highs becomes visible. This is a sign that the bullish trend is fading and provides an opportunity to trade the pair on the short side.
Luckily, Elliott established great rules for trading a contracting triangle and they come in handy when the triangle reverses a trend.
The triangle on this USD/JPY four-hour timeframe forms at the end of a bullish trend, fulfilling the condition that the market should be trending.
Next, labelling the triangle gives us an understanding of its structure, and a way to potentially trade the pattern. The rule is that the b-d trendline marks the end of the triangular formation and, until the price action breaks it, the pattern provides an excellent opportunity to short the pair.
As for the measured move, it is equal to the length of the longest segment in the triangle – the b-wave in this case – projected from the break in the b-d trendline.
The invalidation or the stop-loss level is placed at the end of the e-wave when the price pierces the a-c trendline.
As you will find out moving forward, triangles mostly appear as reversal patterns, rather than continuation patterns. This is especially true in the currency market, where the market can move on very little and where news trading is a strong part of daily volatility.
- Triangles often appear as reversal patterns in the currency market.
- The b-d trendline marks the end of the triangular formation.
- A strong trend must exist in the relevant timeframe.
- The measured move equals the length of the longest segment of the triangle.