FORMATING OF TRIANGLES

These patterns are created when the market interest and the volume of a stock start falling.

    After dealing with several major patterns, we shall now consider the minor ones. Since most of the former occur at the end of a sustained bull or bear market, these are also known as ‘reversal’ patterns. On the other hand, most of the minor formations occur in the middle of an uptrend or downtrend and, therefore, are usually clubbed as ‘continuation’ patterns. However, traders should note that some minor patterns may act as reversal as well as continuation, depending on the place at which they occur and the manner in which the final breakout takes place. The triangle pattern is the best example of this.
    Triangles are formed when the market loses interest in a counter. The market activity in any stock usually reduces when the direction of the move (up or down) is not clear. During this sideways movement, the volatility, or the trading range within which the price moves, also comes down. This explains why the triangle is the widest during the formative stage and narrows as time progresses. Since triangles are formed when the market’s interest in a counter falls, the volume also usually falls during this period. There are three types of triangles: symmetrical, ascending and descending. Since each has distinct properties, let us consider each one separately. 

Symmetrical Symmetrical triangles are formed when neither the bulls nor bears have an upper hand in a directionless market and can be identified when the stock makes lower highs and higher lows. If you connect these lower highs, you get a falling trend line. This resistance line is also known as supply line. Similarly, the uptrend line that is formed when you connect the higher lows is also known as support or demand line. As is evident from the HDIL chart, both these trend lines form a symmetrical triangle. The time taken to form this pattern is very important and usually takes 1-3 months. If it is formed in a smaller time frame, say 10-15 days, it is called a ‘pennant’.
    Though a symmetrical triangle is commonly considered a continuation pattern, there are instances when it acts as reversal pattern and, hence, one needs to wait for the final breakout—when the price goes above the resistance line or falls below the support line—to identify the direction of next move. For instance, a breakout on the upside when the market is in an uptrend, can be considered a continuation pattern. However, a downward breakout after an uptrend should be considered a reversal pattern. Similarly, an upward breakout after a downtrend is a reversal pattern, while a downward breakout after a downtrend is a continuation pattern. The symmetrical triangle formed in the HDIL chart is a continuation pattern and the price continued to drop after the downward breakout.
    Since the trading range comes down during the formation of a symmetrical triangle, the chance of a false breakout is high (any increase in volatility can result in the price going above or below these lines). To avoid this, one needs to introduce strict breakout rules. First, the breakout has to occur on the basis of closing, which means that any intra-day penetration of lines is usually ignored. Some traders also apply the price-based rule, that is, the price should move at least 3% above or below the breakout point; or the time-based rule, that is, the price needs to close above or below the breakout points for three consecutive days. Like any other trading pattern, the breakout should be supported by volume, especially when it is an upward breakout. An accelerated price movement, gap formation, etc, can also be considered as breakout confirmation. Once the breakout is confirmed, the next step is to identify the possible target price. This is arrived at by measuring the widest distance of the symmetrical triangle and adding/deducting this value to/from the final breakout point. 

Ascending Unlike a symmetrical triangle, the resistance line is almost horizontal here, which means that the highs need not be at the exact price and are close to each other. The lows, on the other hand, keep on increasing on a successive basis. This hint at the bulls slowly gaining control, though they are not able to break the resistance level. As is evident in the Canara Bank chart, an ascending triangle is usually formed in the middle of an uptrend and, therefore, can be considered a bullish continuation pattern. However, investors need to be careful about its appearance even in the middle of a downtrend because it can signal a possible trend reversal. Irrespective of the place at which it is formed, the ascending triangle indicates accumulation and, therefore, has a definitive bullish bias even before the breakout occurs. However, the downward breakout is not ruled out and, hence, traders should take positions only after an upward breakout is confirmed. The other rules mentioned for a symmetric triangle are applicable here as well. 

Descending A descending triangle is a mirror image of the ascending triangle and is formed when the supports are at the same level but the highs keep coming down, that is, form a falling resistance line. Descending triangles are formed when a group of investors wants to sell a large quantity, but only above a certain price level. Since these investors stop selling once the price goes below the threshold, this level acts as a support. There may even be instances of these sellers buying small quantities at that price to support the counter from falling below it. Once the sellers finish their quota, they withdraw the artificial support and the price starts tumbling. The descending triangles are usually formed in a downtrend and, therefore, are treated as a continuation pattern. However, one should pay attention if one notices a descending triangle in an uptrend because it can act as a trend reversal signal (see ABB chart). Irrespective of where it is formed, a descending triangle is a distribution pattern and, hence, has a bearish bias even before the breakout. However, it is better to wait for a final downward breakout before assuming trading positions. The other rules about volume, target, etc, are also applicable here. 

Next: Flag, wedge
    and pennant

Source: Narendra Nathan, The Economics Times,  26/11/2012