Patterns are valuable aids for any trader in identifying possible edges based on what chart patterns have a possibility of occurring.
The trader should understand that certain chart patterns keep on occurring due to the fact that traders make decisions based on the same emotions repeatedly, and that these emotional decisions again, and again, create the same patterns on a chart.
Chart patterns and movement are nothing else than a visible representation of human decisions and their resulting actions. But keep in mind that it requires only one trader somewhere in the world to deviate from the previous action, to make the chart pattern non-repeating or unsuccesful.
What does the triangle pattern tells us?
A group of traders may independently decide that they will sell the fx pair when the price reaches a certain target. If that target becomes lower and lower, because sellers come in at lower and lower prices, the top line of the triangle will point downwards.
At the same time, there may be a group of traders who may decide that the price offers value at a certain minimum. When the price reaches that minimum, they come in as buyers, underpinning the lowest price. If the lower price gets higher because there are traders that are prepared to come in as buyers at an increasing higher price, the bottom line will point upwards. (It represents two views on the same situation)
The two lines converge because there are two motivations active in the market. Traders on either side of the triangle hold their views based on why there are trading the pair. It could range from a need for a currency because of an increase in demand for whatever reason, to amateur traders thinking they know what the market is going to do.
The two lines converge in a triangle.
Obviously, the price cannot get stuck and “die” where the two lines converge. It has to break out of the triangle in one of three directions.
The price can break upwards, downwards or sideways.
It could break upwards through the top descending line of the triangle if the buyers “win” and push the price up. It could break the bottom line if the sellers “win” and push the price down, or it can move sideways (range) if no side wins and the price remains in an “expectation” phase. In the expectation phase, the price waits for something to happen in the market to give it a push in some direction.
Triangle patterns are popular because they are so easy to spot, have a good risk to reward potential and provide clear price objectives.
The expected break-out distance is the same as the length of the vertical axis of the triangle. So, if the vertical axis equals 50 pips, the expected distance between the point of break-out of the triangle to the target price, is expected to also be 50 pips.
The stop-loss distance can be anything that makes sense to the trader, but many traders use either the price at the opposite triangle line plus X pips plus spread pips, or the price on the other side of the break-out candle plus X pips plus spread pips.
- The triangle breakout often happens around 2/3’s of the triangle. The nearer it happens to the intersection of the ascending and descending lines (apex), the better the chance that it will range (move sideways) after breakout.
- Some traders try for an additional edge by only trading break-outs in the direction of the previous momentum. They consider the triangle formation a “resting phase” in the momentum direction.
- Other traders trade breakouts in the direction of previous momentum unless it coincides with a price action indicator such as previous high/low (support/resistance) or price action candles such as pinbars. (Note that a pinbar can be a continuation indicator.)
- The more indicators that occur together (confluence) the better the potential edge of the trade.
The ascending triangle is a triangle that is formed by higher lows (ascending trendline) and flat resistance.
Many traders consider the ascending triangle a bullish pattern because of the higher lows, expecting the breakout to mostly occur to the top.
The profit target is also equal to the height of the triangle and the stop placed at the opposite end of the triangle or, more often, the previous low.
The descending triangle is a triangle that is formed by lower highs (descending trendline) and flat support.
Many traders consider the descending triangle a bearish pattern with an expected downward breakout.
The profit target is also equal to the height of the triangle and the stop placed at the opposite end of the triangle or, more often, the previous high.
There are a wide range of variations on the triangle breakout trade. Some traders only trade the breakout once it is confirmed by a retest, while others trade only after the 5th or 7th candle in the case where candles “coil” (move sideways or range), after the breakout.
The most important aspect of any trading strategy, is that you should have it written down in a step-by-step checklist, so that the trader knows exactly what to look for, when to enter and when to exit. If you act in any way not listed in your strategy, it means you are trading a different strategy, which should in turn be written down and traded as a checklist.
Unsuccessful traders change their strategies mid-trade by making small changes to create a trade where their strategy does not dictate a trade, or, as they experience it, the strategy “falls short”. This is rarely anything else but traders thinking they “know” where the trade is going to go.
This often happens where traders make mid-candle decisions, only to see the trade change direction and close the opposite of what it seemed mid-candle.