Triangles are a very popular price action concept but there are a lot of misconceptions about what they really show and how to interpret triangles correctly. Triangles can tell you a lot about market dynamics, momentum shifts and the balance between bulls and bears – if you know what you are looking for.
What is a triangle telling you?
A triangle tells you a lot about the market and the current situation. The easiest way to understand triangles is by looking at an example outside the world of trading. When you throw a ball it will bounce, but each bounce will be lower than the previous one. The ball is losing momentum and gravity takes over until the energy of the ball is completely gone and it does not bounce anymore.
Triangles in the world of trading
In trading, it works almost the same. There are different kinds of triangles, but we will focus on the most important one – the asymmetrical triangle. The screenshot below shows that each bounce has a lower high. At the same time, the higher lows are not moving up with the same strength; clearly, the highs are coming down faster. Price is losing the bullish momentum and each time price tries to move higher, it is being pushed down earlier.
Triangles are a manifestation between the “fight” (imbalance) between long and short positions. Knowing how to interpret such a scenario can help your decision-making process and deepen your understanding about market dynamics.
Of course, there are also asymmetrical triangles that signal bullish strength as the screenshot below shows. It is obvious that price is moving into the resistance area with strong force. Each time price moves down, the bulls take over sooner and drive price back into the resistance area. This is not to be confused with a double top pattern which can look very similar.
Triangles and losing momentum – 3 case studies on how to trade triangles
The screenshot below illustrates how a triangles shows losing momentum. Each time it touches the support level, the following bounce back up becomes smaller as the MACD indicator shows. Just before broke price broke the support level, it tested the upper trendline multiple times but failed to break it. Combining all those points gave some early indications that a break to the downside was more likely than a break to the upside.
The next screenshot below shows another example of how the momentum to the upside is building up each time price moved into the resistance level. Back then, everyone was watching the 10,000 price level at the DAX and you could read about people expecting a reversal to the downside every day. The final triangle clearly supported a breakout to the upside. Price had been moving into the resistance area multiple times and each time the bounce to the downside become shallower. At the same time, the RSI indicator confirmed the losing momentum to the downside.
Yes, shorting into the 10,000 would have provided some good trading opportunities as well, but the real money was mad after the break of the triangle.
Reminder: profitable trading is about connecting the dots and combining the clues your chart patterns provide to build sophisticated trade scenarios. Profitable trading is not only hunting for signals but understanding market dynamics.
The final example shows another multi-bottom and a trendline that is moving down. Especially interesting are all the candle wicks that are sticking out to the top. Multiple failed attempts to break to the upside fooled amateur traders and also showed the lack of bullish support. Although everything pointed to a break to the bottom, the final signal did not come until price broke the support level with the large red candle.
How not to trade triangles
Triangles are a great trading concept, but they will fail – often. However, the biggest mistake traders make is that they enter BEFORE the break of the triangle happened. Take a look at the screenshot below – based on the previous triangles and momentum analysis, one would have expected a break to the downside; the highs were coming faster and price moved into the bottom trendline rapidly. But it did not happen and price broke out of the triangle to the upside.
This highlights that triangles are not the Holy Grail and they will fail. And secondly, the real signal of a triangle happens when the trendline has been broken – not before. Furthermore, a break of the trendline is only valid after price closed outside the triangle AND stayed outside it. Waiting for a full candle to form outside the triangle will make you miss some runaway trades, but it will keep you from taking some failed breakouts as well.
Wrapping things up – how to trade triangles
Here are the most important points and tips when it comes to understanding and trading triangles:
- Analyze the slope and the angle of trendlines
- The angle and the formation of highs and lows are a manifestation of the (im)balance between bulls and bears
- A triangle typically shows losing momentum to one side
- Double tops and/or failed breakouts before the triangle forms are great tells
- RSI or the MACD can help measure the momentum in triangle patterns
- Triangles will fail very often. They key is to wait for a confirmed breakout
Image credit: tradingview.com