In our previous article, we discussed how we could simplify the zigzag and flat pattern by the chartist figure known as a flag. In this educational article, we will see how triangles can be used in wave analysis.
Within the Elliott wave theory, triangles represent one of the three basic corrective formations. Similarly, in traditional technical analysis, triangles represent consolidation and continuation formations of the trend.
Elliott defined triangles as a formation that have an internal structure subdivided into five waves following a 3-3-3-3-3 sequence. At its time, Elliott identified two triangle variations, which are classified as expansive or contractive.
In general terms, triangles represent the market indecision or the balance between the buying and selling forces.
The following chart shows the model of the triangles in their contractive and expansive variants, under the Elliott Waves theory and Traditional Technical Analysis perspective.
According to the point of view of the traditional technical analysis, we can observe that the triangle pattern is not forced to have five internal segments, as in Elliott’s wave theory. In consequence, a truncated zigzag or truncated flat structure could be simplified by a triangle pattern.
The Trading Setup
The trade configuration of a contracting triangle pattern has the following characteristics:
- Entry Level: A buying (or selling) position will be activated if the price exceeds and closes above the swing of the previous top.
- Profit Target: The first profit target level will take place at 78.6% of the Fibonacci expansion, while the second will be at 100%, and finally, the third profit target level will be at 127.2%.
- Protective Stop: The invalidation level of the trade setup will be located below the lowest swing of the triangle pattern.
The trade configuration of an expansive triangle pattern has the following properties:
- Entry Level: The trade will be activated if the price exceeds the height of the expanding triangle.
- Profit Target: The first profit target level will be at 100% of the Fibonacci expansion. The second profit target level will be at 127.2%.
- Protective Stop: The level of invalidation will be located below the lowest low of the expansive triangle pattern.
The following chart corresponds to the AUDUSD pair in its 12-hour timeframe. We can observe that the price action developed an expanding triangle formation, which began from mid-May 2019 and culminated in mid-July 2019.
From the chart, we detect that the expanding triangle reached its highest level at 0.70821, which corresponded to a false breakout. Subsequently, the price action resolved the next movement with a drop that took it to plunge until 0.66771.
The sell-side entry was activated once the price closed below the lowest level of the expanding triangle at 0.68317. Once activated the sales position, the price reached the first target at 0.67080.
Another possibility of entry that could be considered would be the closing below the last relevant swing, that is, the closing below 0.69105. This option could provide the trader with a higher profit compared to the risk taken compared to the original entry setup.
The next example corresponds to Silver in its daily chart. From the figure, we observe that the price made a record high early July 2016, reaching $21,225 per ounce, after this, the price action performed a corrective movement, once its found support, Silver built a tight contractive triangle.
After breaking below $18,715, Silver activated a bearish scenario that drove the price to fall to the third bearish target at $15.66 per ounce.
After having fulfilled the third bearish target, the price fell and reached $18.435 on April 17, 2017, where Silver began to build a contractive triangular structure that lasted until the end of June 2018.
Once the downward break of the long-lasting triangle occurred, we see that the price made a limited downward movement, which did not yield below $14 per ounce.
Based on the discussion of this article, we can conclude that regardless of the corrective structures that have three or five internal waves, these can be simplified as triangular patterns. Also, we can observe that a corrective wave or a short-range narrow triangle is likely to have an extended move that, in terms of Elliott’s wave theory, could correspond to an extended wave.
On the other hand, extensive triangular formations, or of a wide range, could lead the price to move in a range not as broad as in the previous case.
Finally, in the last example, we recognize how the alternation principle works in Elliott’s wave theory. Just as the first observed triangle is simple, and has a short duration, and the second corrective formation is extensive and complex.