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and rally and the apex (as in Fig. 9-2). The volume rules used for other pat- terns are also appropriate for triangles. That means that activity should grad- ually contract as the pattern is being formed. During upside breakouts, it is important for volume to expand (see Fig. 9-3). In downside breakouts, it doesn’t much matter whether volume contracts or expands, though an expansion of activity indicates selling pressure and adds a few points to the bearish case. In Fig. 9-1, for instance, volume expands on the downside
Figure 9-1 Symmetrical triangle.
Figure 9-2 Symmetrical triangle indicating ideal breakout range.
breakout, having contracted as the pattern was forming. The point here is that the battle between buyers and sellers is becoming more finely balanced as the pattern develops. Then, on the breakout, volume expands, thereby signaling from both a price and a volume point of view that control has slipped decisively to one side or the other.
Most patterns give us a clue to the direction of the ultimate breakout in the event that they are completed. The symmetrical triangle does not; it keeps us guessing. Since it should be assumed that the prevailing trend is intact until proven otherwise, it is a good idea to take it for granted that the triangle will eventually break in the direction of the prevailing trend. An example of a continuation triangle is shown in Fig. 9-4. Clues to the con- trary—i.e., in favor of a reversal—would appear if the price was overex- tended in one direction or the other. Alternatively, it may be possible to observe that many stocks have already begun to break in a new direction.
A reversal would be more likely if the pattern formed after the prevailing trend had been in place for a long time than if it had just begun. However, when taken in isolation with no other supporting evidence, the prevailing trend assumption should be applied.
The Underlying Psychology
A triangle pattern is no more than a gradually tightening battle between buy- ers and sellers. At the outset, the large price swings at the left-hand part of the formation indicate relative instability, showing that both sides are out of control. Prices initially rally up at the beginning of the triangle until they
Figure 9-3 Symmetrical triangle at a bottom.
reach a point at which buyers become less enthusiastic and sellers quite moti- vated. Then the price slips back quite a ways, and those who missed the boat earlier are more inclined to buy at these lower prices. Selling is also less intense. The price then rises for a second time, but not to as great an extent before supply once again overwhelms the buyers. This could be because potential sellers, having missed out on the opportunity to sell at higher prices on the first rally, temper their greed and are prepared to settle for less profit. In any event, prices decline and buyers come in again, but each rally and reaction attracts fewer and fewer participants. The initial excite- ment dies down, and market participants await a resolution of the fine bal- ance between them. As the pattern develops and the battle lines come closer and closer, neither side is able to exert as much upside or downside pres- sure. As a general rule, whenever price activity goes quiet, as it does close to the apex of the triangle, the slightest tip in the balance between supply and demand will result in a commensurately larger price move. Usually the more contact points, the more persistent the price move following the break- out. Another clue to the strength of the breakout is the strength of the con- trast between shrinking volume as the pattern is formed and expanding activity on the breakout. The greater the contrast, the more decisive the vic- tory and the stronger the signal.
Measuring Objectives
Traditionally, measuring objectives for triangles at market tops are obtained by drawing a line at the base of the triangle parallel to the upper trendline.
Figure 9-4 Consolidation symmetrical triangle.
This line (CD in Fig. 9-5) represents the objective that prices may be expected to reach or exceed.
The reverse procedure at market bottoms is shown in Fig. 9-6. The same technique is used to project prices when triangles are of the consolidation variety.
In my own experience, I have not found this method to be particularly useful. This is because the actual price move is usually far more than the price objective. I prefer, instead, to treat the triangle like any other pattern,
Figure 9-5 Symmetrical triangle with traditional measuring objective.
Figure 9-6 Symmetrical triangle with traditional measuring objective.
calculating its maximum depth and then projecting this distance at the breakout.
Examples of this alternative method for both a top and a bottom are shown in Figs. 9-7 and 9-8. By adopting this approach, the principle of propor- tionality is preserved. Charts 9-1 and 9-2, featuring Yahoo, show how the two methods might work in the marketplace. The original technique takes a line parallel to the upper down trendline of the pattern and anchors it
Figure 9-7 Symmetrical triangle with alternative measuring objective.
Figure 9-8 Symmetrical triangle with alternative measuring objective.
Chart 9-1 Yahoo, 2001–2002, daily.
Chart 9-2 Yahoo, 2001–2002, daily.
at the bottom of the initial decline. In this instance, the line becomes one of support, as it is able to reverse the July and August declines. In the sec- ond example, the distance between the peak and the initial low is measured and that distance is projected down from the breakout point. In this instance, the objective falls in line with the actual bottom. Both methods result in useful benchmarks, but the proportionate or second technique is the one that calls the final low. I have to add that even though this exam- ple was selected at random, not all price-objective moves work out this accu- rately.
Chart 9-3 shows another example of a symmetrical triangle at a mar- ket top, for Intel. The original measuring objective is represented by the declining dashed line. This time the price immediately breaks below this line, but the two subsequent rallies find resistance there. On the other hand, the ultimate low is made at around twice the objective called for by the proportionate method. This also represented the approximate level of the lows set in the previous June/July period. It is also worth not- ing that while the initial price objective was easily exceeded, this same level turned out to be resistance for the November and December ral- lies.
An example of a triangle bottom is shown in Chart 9-4, for Alcoa. Note how a line parallel to the lower part of the rectangle and anchored at the secondary peak at Aprovided resistance throughout the ensuing advance.
Chart 9-3 Intel, daily.
Weaving Symmetrical Triangles into Head-and-Shoulders Tops Triangles are one of the least accurate of all the price patterns. One of the reasons is that a formation often starts out looking like a triangle, but ends up as something completely different. An example is shown in Fig. 9-9, in which a breakout develops above the dashed trendline marking the top of
Chart 9-4 Alcoa, 1986–1989, weekly.
Figure 9-9 Failed symmetrical triangle.
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.