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Monday, December 3, 2007

SYMMETRICAL TRIANGLE PATTERN – Part 2: Important Characteristics

Go back to Part 1: Symmetrical Triangle Formation.

Important Characteristics of Symmetrical Triangle Pattern

Existing Trend:
There should be an established existing trend (either uptrend or downtrend) in order for the pattern to qualify as a continuation pattern.

Shape of Symmetrical Triangle:
* There should be at least 4 reversal points to draw two converging lines, i.e. two successively lower peak (high) points forming a downward sloping upper line and two successively higher trough (low) points forming an upward sloping lower line, which converge if both line were extended right.
* There should be some distance between the two peaks as well as the two troughs
In other words, prices should increase and hit the descending upper line then decline for at least twice (forming at least two peaks). Prices should drop and hit the ascending lower line then bounce up for at least twice (forming at least two troughs).
* Prices should bounce back and forth in a fairly regular pattern as prices move towards the apex.

Volume should be diminishing; heavy at the beginning and contracts as the pattern develops.
However, when breakout occurs, there should be a significant increase in volume.

This is because during the development of the pattern, investors / traders are still indecisive. Some are holding on to their stocks, awaiting the market's next move, whereas the others are buying and selling sooner, which translates into a narrowing range of the peaks and troughs.
When breakout finally occurs, volume should increase significantly, because investors finally have enough conviction about the market direction and they are eager to release their pent-up supply or demand.

On a daily chart, this pattern usually may take about 1 to 3 months to form.
If the pattern duration is less than 3 weeks, it is usually considered as a bullish / bearish pennant.

Generally, the longer it takes to form the triangle (or the longer the timeframe of the triangle formation), the stronger the breakout would be.

Breakout Direction:
For Symmetrical Triangle, the breakout can happen in either direction (upside or downside).
Hence, the direction of the breakout can only be determined after the breakout has occurred.
Although triangle as a continuation pattern is supposed to break out in the direction of the existing trend, this is not always the case.

Potential Price Target:
1) Compute the height of the triangle at its widest part (on the left of the chart).
The height is determined by projecting & measuring a vertical line from the highest high point on upper line to the lowest low point on the lower line.
2) To compute the potential price target:
When the breakout is to the upside of the upper line: Add the result to the breakout point at the upper line to get the potential price target.
When the breakout is to the downside of the lower line: Subtract the result from the breakout point at the lower line to get the potential price target.

Return to Breakout Level:
After the breakout occurs, it is common that prices may return to the apex or the support / resistance level around the breakout level for an immediate test of this new support / resistance before resuming their moves in the direction of the breakout.
However, the prices should not reenter the triangle and move outside the opposite line of the breakout line.

When Breakout Should Occur:
The breakout from a triangle pattern should occur well before the pattern reaches the apex of the triangle (i.e. should be somewhere between two-thirds and three-quarters of the horizontal width of the triangle).
If breakout does not occur beyond the three-quarter point, it might mean that prices would continue to drift out to the apex and beyond. In other words, the pattern may no longer valid.

False Breakout:
Premature / false breakouts or "shakeouts" often happen to this pattern as well.

The following are a few points to take note in order to try to avoid false breakout:

* A minimum penetration criteria for a breakout should be price closes outside the upper line (for breakout to the upside) or lower line (for breakout to the downside), not just an intraday penetration.
Some investors / traders may apply certain price criteria (e.g. 3% - 5% break from the upper / lower line depending on the stock’s volatility) or time criteria (e.g. the breakout is sustained for 3 days) to confirm the validity of the breakout.

* Normally, a breakout from a triangle pattern occurs due to an “event” or new development that is able to provide enough conviction to the investors / traders to move strongly one way or the other.
Therefore, some possible confirmation for a valid breakout could be price gaps or accelerated price movements, which are accompanied by a significant increase in volume.

* When a breakout is not accomplished by high volume, investors / traders should be cautious. Because a good breakout from a triangle formation should occur with a surge in volume. However, not all breakouts with high volume are reliable either. A false breakout may also occur with high volume.
Therefore, the price action on the following days should be watched carefully. It is wise to wait a few days to determine whether the breakout is a valid one. Hence, some investors / traders prefer to take positions when the prices return to the breakout level to test the new support / resistance before resuming their moves to the breakout direction (although this return does not always happen), because this may offer an opportunity to participate in the breakout with a better reward to risk ratio.

* When the breakout occurs very near to the apex, investors / traders should be extra cautious. Because the chances of a false breakout are very high as the volume is thin at this point. Hence, it would only take very little activity to cause an erratic and false movement that takes the price outside of the upper or lower lines.

To read about other chart patterns, go to: Learning Charts Patterns

Related Topics:
* Learning Candlestick Charts
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)
* Option Greeks
* FREE Trading Educational Videos You Should Not Miss