How to Predict Price Using Triangle Patterns
02/23/2010 12:01 am EST
I wanted to share two clear recent examples of how to project a final price target from a symmetrical triangle pattern formation.
First, let’s start with daily gold prices in late 2009:
Here is how most chartists project price targets from triangle patterns:
First, observe a symmetrical (or other type of) triangle, which is a price consolidation pattern that moves towards the apex breakout point.
Second, once you see price cleanly/clearly break outside the upper or lower trend line (usually with strong range expansion candles), then measure the height of the triangle by drawing the trend lines back to where the pattern started and measuring that price distance.
You can do this in advance of the breakout. In this case, we drew the upper trend line back to encompass the January 2009 price low and found that the distance between the trend lines was roughly $200 per ounce.
Finally, add the height of the triangle to the breakout price to arrive at your target to play for.
In this case, the breakout occurred at the $975 level, so we added $200 to that price to arrive at a final target of $1,175.
A trader would have placed a stop on the opposite side of the trend line (the $925 level) and exited at the $1,175 target, or if the target was not met, on any clear sell signal (such as the clean break of a moving average—sort of a trailing stop strategy).
This method is the “classic” way as taught by Edwards and Magee, Thomas Bulkowski, and others.
As you see, price slightly exceeded the target, but then plunged not long after. The edge in pattern trading often comes from the larger target in relation to the stop (in this case, a roughly four-to-one ratio).
Next, to show how the concept applies on all time frames, we will see the SPY five-minute chart from February 18, 2010:
Without going into as much detail as above, we see the clear compression in price in the morning, leading to the noon CST triangle breakout at the $110.35 level.
Extending the upper trend line back to where the triangle began, we see a height of roughly $0.65 cents. Added to the breakout of $110.35, we see a price projection target of $111.00 (also round-number resistance). The stop would be under $110.25.
Price formed two upper shadow candles at this zone, fell in a sharp bar (traders were to exit near the $111.00 level if trading this pattern), but like gold, the price slightly exceeded the target before falling into the next trading session (on news of the Fed’s surprise rate increase on the discount rate).
Use these two examples of references of the classic pattern and how to trade this setup. It won’t always work in textbook fashion, but the edge is in the risk/reward relationship and the range alternation principle.
By Corey Rosenbloom of AfraidToTrade.com