Triangles: Reversal Or Continuation
by Stuart Evens
Look at most any book on the subject of technical analysis, and you'll come across triangles. These formations are usually one of the first chart patterns that novice technicians study, and it deserves some examination.
Triangles are classified as reversal patterns in some reference works, while they are described as continuation patterns in others. Robert Edwards and John Magee, in their Technical Analysis Of Stock Trends, have a chapter titled "Important Reversal Patterns -- The Triangles." John Murphy, on the other hand, in his Technical Analysis Of The Futures Markets, has triangles as a subheading under the chapter titled "Continuation Patterns."
On reading these chapters on triangles, however, we find that both works instruct the reader about triangles behaving as both reversal and continuation patterns. What is common to both discussions, and in fact most discussions on triangles, is that once triangles are properly identified, subsequent price action tends to react in predictable ways. What technicians have found over the years is that after prices break out of the triangle pattern, it is highly probable that prices will continue moving in that direction. Knowing this gives us the opportunity to trade in that direction, and to profit if we are correct.
Let's take a look at the different types of triangles, how they are formed, what they look like, and how to draw them on the price chart. Then we'll examine the subsequent behavior of the stock used as an example after prices break out of the formation. Finally, we'll see how we can use the triangle to make trades based on our interpretation of the chart; profitable trades, if our assessment of the pattern is correct.
There are three general types of triangles, and each is named based on appearance: ascending, descending, and symmetrical. A triangle gets its appearance from the convergence of two trendlines drawn on the price chart. One side of the triangle is formed by drawing a trendline connecting adjacent peaks of price bars. Another side of the triangle is formed by drawing a trendline connecting adjacent troughs of price bars. These two lines converge at the apex of the triangle to form one of the three types of triangles. No third side of the triangle is actually drawn on the chart, but if a vertical line were drawn at the opposing side of the pattern, connecting the two trendlines, a triangle is the shape that would be formed.
The ascending triangle is so named because of the relationship of the two trendlines to each other. One side of the triangle, formed by a trendline connecting the adjacent peaks of price bars, is approximately horizontal. The line is horizontal because each peak rises to about the same price level. The other side of the pattern, formed by the trendline connecting adjacent valleys of price bars, slopes upward, meeting the horizontal line at the triangle's apex. In Figure 1, in this chart of 3M, this line slopes up because each successive valley occurs at a higher low than the previous valley.
FIGURE 1: ASCENDING TRIANGLE, 3M. A line connecting the upper reversal points forms a relatively horizontal line. The minor lows are connected by a trendline to form the other side of the triangle pattern. Because this line slopes up, the triangle is an ascending triangle.
Excerpted from an article originally published in the January 1999 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 1998, Technical Analysis, Inc.