Trading What I See

After a gap down, the market decided to go sideways for a while. What developed was a TRIANGLE pattern. But there are two triangles showing on the chart, and understanding the difference between them can be the difference between making and losing money.

Unless the volume decreases markedly during triangle formation, you don’t really have a triangle — just two converging trendlines. This morning the volume bars went down nicely as the pattern formed. There were other ways to draw the original triangle. I could have used yesterday’s high and today’s early low. In fact I did that for a while. But understanding how triangles usually act led to the yellow trendlines you see now.

The blue trendline was an early possibility, so let’s talk about it first. If a triangle extends all the way to its apex, you will often have what is called an “end run.” Price will push out the tip, move a slight distance, and then end up going in the opposite direction. That’s what happened to the blue triangle.

Not only did price go to the end of the triangle, but the “breakout” had absolutely no increase in volume. From any type of congestion pattern you need volume for an upside breakout or the move is likely false. That’s when I started looking for a better set of trendlines.

The first volume spike occurred, depending upon how you want to view it, on the “end run” or on the actual breakdown from the final triangle. A large percentage of the time you will get a pullback for a better entry, and this one was perfect — right back to the lower trendline.

Where are we going? Let’s check with my favorite charting book, which is also the book that taught me how to draw trendlines. In Technical Analysis of Stock Trends, 8th Edition [see my review] John Magee says:

A decisive breakout from a Symmetrical Triangle is likely to carry at least as far as the height of the Triangle measured along its first reaction. This is a conservative measurement. The move may go much farther.

How much farther? How about a long pause at the Fibonacci 127% retracement level of today’s first up move, followed by a drop to the 162% level before the market closed. Trendlines and Fibonacci, guidelines along the market’s path.