a triangle. Later on, though, the price action unfolds into an upward sloping head-and-shoulders top. The upside breakout in the triangle therefore gave a false indication of the direction of the next significant price move. This is just one example of how a triangle can offer misleading signals. One way to reduce the probability of a whipsaw triangle breakout is to consider only formations where the price has had contact or close contact with the break- out line on more than two occasions. In fact, the more times the better, since this would reinforce the line as a resistance or support area, thereby mak- ing its penetration more likely to succeed. Bearing in mind some of the rules for determining the significance of a trendline established in Chapter 4, another filtering approach would be to exclude triangles where the angle of ascent or descent is particularly steep.
triangle. If an opportunity is missed on the breakout, the pullback or retrace- ment move offers a second chance, usually under far more quiet conditions.
If it is possible to construct a retracement trendline, as in Fig. 9-11, the upside penetration of the line is a good entry point, since it indicates a reassertion of the original breakout. This is especially true if the retracement move is accompanied by shrinking volume and the breakout above the retracement trendline by slightly or significantly expanding activity, as in Fig. 9-11.
Spinning Right-Angled Triangles into Rectangles
One difficulty in interpreting these formations is that many rectangles begin as right-angled triangles. Consequently, a great deal of caution should be used when evaluating these elusive patterns. An example is shown in Fig. 9-12, where a potential downward-sloping right-angled triangle develops into a rectangle.
Marketplace Examples
An example of a right-angled triangle at a bottom is shown in Chart 9-5, for Intel. If you believe that the June 1986 decline qualifies as a shoulder, it could be argued that this pattern is a reverse head and shoulders, with the horizontal trendline representing the neckline. You could also say that the
“horizontal” line is not quite horizontal, and so the triangle would be more accurately called a symmetrical one. Frankly, I think we would be pushing
Figure 9-11 Bullish right-angled triangle with a retracement.
the envelope on this one. It really doesn’t matter what the pattern is called;
the fact is that it was a clear-cut battle between buyers and sellers that was resolved in favor of the buyers, and that’s ultimately what counts. Also note the substantial increase in volume as the price breaks to the upside and the fact that the lower trendline has been touched six times. If the standard for
Figure 9-12 Failed bearish right-angled triangle.
Chart 9-5 Intel, 1986–1987, daily.
triangles is a double contact only, then this is definitely an impressive line of support. Once again I applied the two price-objective techniques. The parallel-line method caused the price to find temporary resistance in the month of January. When it finally broke above the line, a very sharp rally followed. The proportionate approach was well exceeded, but it is inter- esting to note that the objective level ultimately became support in the form of a neckline for a failed head-and-shoulders top formation.
Chart 9-6, for Analog Devices, shows another ascending triangle. This time it is formed above the low point for the move and is therefore a consolida- tion pattern. Note how volume shrinks as the pattern develops. It also expands a little on the breakout, but nothing to get excited about.
Northrop Grumman, in Chart 9-7, provides us with a fairly large descend- ing triangle top. The original (dashed) descending line had to be redrawn because of the two 1987 rallies. It is worth noting that when the price fell through the extended dashed line for a second time, it actually experienced a pretty wide gap just prior to completing the pattern.
Right-Angled Failures
To the flexible trader or investor, a pattern failure offers great opportu- nity. This is probably more true of right-angled triangles than of any other formation. We saw earlier how a right-angled triangle can transform itself
Chart 9-6 Analog Devices, 1991–1994, weekly.
into a rectangle. However, the moves following right-angled breakdowns are usually a little more dramatic. There are two types of failure. The first develops when the price penetrates the horizontal trendline and then moves back through it. Examples for a bottom and a top are shown in Figs. 9-13 and 9-14. In Fig. 9-13, the false upside breakout develops close
Chart 9-7 Northrop Grumman, 1984–1990, weekly.
Figure 9-13 Failed bullish right-angled triangle.
to the apex, so it is possible to set a fairly close stop under the rising trend- line. It would even make sense to exit the position once the price slips below the horizontal line again. However, the odds of a failure increase greatly when the rising line in a bullish pattern is penetrated. This is because this line is often a strong area of support. False breakouts often result in a strong move in the opposite direction to that expected, so it is even possible to go short on a break of the rising trendline. The buy stop would then be placed above the line at Xand moved progressively higher until a better place is found at a lower level. Figure 9-14 shows another false break, this time from what looked like a descending pattern. The dis- tance between the breakout point and the descending line is quite sub- stantial, which means that any short positions, triggered from the false downside break, would be more timely covered on a rally above the hor- izontal trendline at X.
An example of an upside failure is shown in Chart 9-7, for Northrop Grumman. This 1988 failure is a classic case because the breakout developed againstthe direction of the main trend. The scene had been set earlier with a breakdown from an almost three-year right-angled triangle top. Volume for the failed pattern contracted as the pattern was developing, a normal phenomenon. However, it expanded in a very deceptive way on the break- out, thereby offering a false sense of security. Just after the price fell below the rising trendline, volume expanded rapidly. This was a clear-cut signal, since this bear market characteristic left no doubt that the sellers were now in control.
Figure 9-14 Failed bearish right-angled triangle.
The second way in which an ascending triangle can fail is when the ris- ing or falling trendline is penetrated prior to a breakout through the hor- izontal line. In Fig. 9-15, buyers are gaining confidence as each decline is terminated at a higher level. Technically oriented people see this price action and buy in anticipation of a successful pattern completion. Such expectations are dashed when the price breaks below the ascending triangle;
hence, there is the potential for a sharper than average decline. An example for a failed ascending triangle is shown in Fig. 9-16. If such a failure is
Figure 9-15 Failed bullish right-angled triangle.
Figure 9-16 Failed bearish right-angled triangle.
accompanied by expanding volume, this really emphasizes the fact that market participants have made a mistake. The high volume indicates that a large number of people are trying to unwind their positions, while others are trying to climb on board the new trend before the train has left the station.
The Underlying Psychology of Failed Right-Angled Triangles In the case of a failed ascending triangle, confidence rises as the price ral- lies to the horizontal trendline, but each decline is smaller than its prede- cessor. A move above the overhead resistance indicated by the horizontal line is therefore expected, and positions are taken accordingly. At the same time, sellers feel quite comfortable liquidating every time the price rises to the line. Since this happens on a number of occasions, there is no pressure to accept a lower price—that is, until the ascending line is violated. Then everybody wants out. On the one hand, the original sellers realize that it is no longer possible to attain the higher prices associated with the horizon- tal trendline. On the other hand, those who bought in anticipation of the upside break lose heart. Such a rationale explains why such failures are so often followed by substantial price moves.
Chart 9-8, for Linear Technology, offers a good example. In this instance, the price looked as if it were in the process of forming a descend- ing right-angled triangle. The June–August period even took on the air of
Chart 9-8 Linear Technology, 1981–1983, daily.
Chart 9-9 WorldCom, 1993, daily.
Chart 9-10 Analog Devices, 1998–2003, weekly.
a symmetrical triangle. However, the descending triangle was never com- pleted, and prices broke to the upside. Chart 9-9, for WorldCom, on the other hand, shows two examples of a failed ascending and one of a failed descending triangle. Notice how the volume shrinks as all three triangles are formed. It also expands as the two on the right experience false break- outs. Also featured is a large rectangle top formed in early 1994.
Finally, Analog Devices, in Chart 9-10, experienced a failed ascending pat- tern between late 2001 and early 2002.
Summary
Symmetrical Triangles Quick Review
• Price characteristics:A narrowing trading range confined between two con- verging trendlines moving in different directions.
• Volume considerations: Volume contracts as the pattern forms. Upside breakouts should be accompanied by expanding volume.
• Measuring implications:The maximum depth of the pattern is projected in the direction of the breakout. Alternatively, for bullish patterns, draw a line parallel to the pattern’s lower trendline and anchor it at the initial rally. The extended line becomes the price objective. For bearish patterns, draw a line parallel to the pattern’s upper trendline and anchor it at the initial decline. The extended line becomes the price objective.
• Strongest breakouts:Come from a point one-half to two-thirds of the distance between the start of the pattern and the apex.
• Signs of false breakouts:Weak volume accompanying an upside breakout.
Right-Angled Triangles Quick Review
• Price characteristics:A narrowing trading range confined between two con- verging trendlines, one of which is at a right angle to the vertical axis. The price is expected to break through the right-angled line in the direction of the sloping trendline.
• Volume considerations: Volume contracts as the pattern forms. Upside breakouts should be accompanied by expanding volume.
• Measuring implications:The maximum depth of the pattern is projected in the direction of the breakout. Alternatively, for bullish patterns, draw a line parallel to the pattern’s lower trendline and anchor it at the initial
rally. The extended line becomes the price objective. For bearish patterns, draw a line parallel to the pattern’s upper trendline and anchor it at the initial decline. The extended line becomes the price objective.
• Strongest breakouts: Come from a point one-half to two-thirds of the distance between the start of the pattern and the apex.
• Signs of false breakouts: Contracting or weak volume accompanying an upside breakout.
• Pattern failures: Occasionally come with a violation of the sloping trend- line.