When it comes to trading, triangles are a typical and well-recognized pattern. All triangle formations, but particularly contracting triangles, provide for a crystal-clear visualization of ongoing market movements, hence they are often considered to be among the most essential patterns.
The recognizable shape of a triangle is what gives rise to the pattern known as the triangle. The formation of this pattern is denoted by the meeting of two trend lines, one of which is flat and the other of which is either falling or rising. Price fluctuations will occur between these two trend lines. The most popular kind of triangle pattern is a contracting triangle, although there are many more.
While expanding triangles do exist, they are quite uncommon, thus we will only be discussing contracting triangles here.
What is a Contracting Triangle?
A contracting triangle is a pattern in which two trend lines intersect following a price break on one of the lines. The contracting triangle was originally recorded by Ralph N. Elliott. He devised the rules of a contracting triangle, which are the foundation of the Elliott Waves Theory.
Traders use the guidelines to anticipate price fluctuations by drawing a contracting triangle.
The contracting triangle pattern is defined as a five-wave structure, with the waves labeled A to E, and subdivided 3-3-3-3-3.
The corrective nature will be present in each of the five waves of triangles. The triangles usually come before the last wave of a larger degree, and once they’re done, there’s a sudden, quick shift in the opposite direction. A contracting triangle pattern is characterized by a wedge-shaped relationship between the first and fifth waves.
Contracting Triangle Strategy
Contracting is a concept that has puzzled many investors. The answer is shown by the two trendlines in the above chart.
The two will eventually collide if their projections are accurate. They’re bound to meet at some point. This means that the a-c and b-d trendlines form a triangle that is gradually becoming smaller. They narrow and indicate a cross in the far future.
The trading strategies for a contracting triangle are as follows:
Keep an eye on the b-d trendline, as a break there might provide important insight into future price action. A triangle’s breakout is gradual; its price usually retraces 61.8% of the longest leg of the triangle before continuing in the direction of the break. This is because price tends to retest the b-d trendline after breaking out of a triangle.
If the price action now indicates a break below the b-d trend line, it is a possible indication of a bearish trend. Experienced traders can determine the longest leg of the triangle by using a Fibonacci retracement tool. (a-wave)
Traders then project the 61.8% ratio (also known as the golden ratio) from the end of the e-wave. Before executing the measured move, they wait for a break and retest.
Buy Signal
- Using a Fibonacci tool, determine the length of the triangle’s longest leg. It’s usually either leg a or b in a contracting triangle.
- Then, locate the 50% retracement level and mark it with a horizontal line.
- If the triangle is bullish and follows a rising trend, then it is more likely to break higher than to behave as a reversal pattern.
- Therefore, set BUY orders for when the price reaches the top portion of the newly created 61.8% level.
Sell Signal
- Using a Fibonacci tool, determine the length of the triangle’s longest leg. It’s usually either leg a or b in a contracting triangle.
- Then, locate the 50% retracement level and mark it with a horizontal line.
- If the triangle is bearish and follows a bearish trend, then it is more likely to break lower than to behave as a reversal pattern.
- Therefore, set SELL orders for when the price reaches the lower portion of the newly created 61.8% level.
Conclusion
As one of the most effective patterns the market generates, contracting triangles become even more powerful when incorporated into a defined strategy with distinct entry, stop, and take profit levels. Like any trading method, good forex money management can be the difference between a profitable and unsuccessful trading results. I would always be sure to practice any new forex strategy on a demo account until you familiarise yourself with how it works and start to see good results. All triangle formations, but particularly contracting and expanding triangles, provide for a crystal-clear visualization of ongoing market movements, hence they are often considered to be among the most essential chart patterns.
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