A Bottom Triangle/Wedge consists of a group of patterns which have the same general shape as Symmetrical Triangles, Wedges, Ascending Triangles and Descending Triangles. The difference is that the formations grouped together as this type are reversal and not continuation patterns. These patterns have two converging trendlines. The pattern will display two highs touching the upper trendline and two lows touching the lower trendline.
This pattern is confirmed when the price breaks upward out of the Triangle/Wedge formation to close above the upper trendline.
Volume is an important factor to consider. Typically, volume follows a reliable pattern: volume should diminish as the price swings back and forth between an increasingly narrow range of highs and lows. However, when the breakout occurs, there should be a noticeable increase in volume. If this volume picture is not clear, investors should be cautious about decisions based on this Triangle/Wedge.
Following are important characteristics for this pattern.
Occurrence of a Breakout
Technical analysts pay close attention to how long the pattern takes to develop to its apex. The general rule is that prices should break out - clearly penetrate the upper trendline - somewhere between three-quarters and two-thirds of the horizontal width of the formation. The break out, in other words, should occur well before the pattern reaches the apex of the Triangle/Wedge. The closer the breakout occurs to the apex the less reliable the formation.
Duration of the Triangle/Wedge
This pattern is a relatively short-term. While long-term Triangles/Wedges do form, the most reliable patterns take between one and three months to form.
Volume
Investors should see volume decreasing as the pattern progresses toward the apex of the Triangle/Wedge. At breakout, however, there should be a noticeable increase in volume.
Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to reach its target. The shorter the pattern the sooner the price move. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration.
Target Price
The target price provides an important indication about the potential price move that this pattern indicates. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern should be considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.
Inbound Trend
The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least two times the duration of the pattern.
Look for a region of support or resistance around the target price. A region of price consolidation or a strong Support and Resistance Line at or around the target price is a strong indicator that the price will move to that point.
Moving Average
Watch for the 200 day moving average to flatten. When prices cross above the 200 day moving average (usually about two-thirds to three-quarters of the way through the pattern), the pattern is considered more reliable.
Volume
A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern. In addition, the volume during the duration of the pattern should be declining on average.
The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable.
Short Inbound Trend
An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.
This pattern is a result of converging trendlines of support and resistance which give this pattern its distinctive shape. This occurs because the trading action gets tighter and tighter until the market breaks out with great force. Buyers and sellers find themselves in a period where they are not sure where the market is headed. Their uncertainty is marked by their actions of buying and selling sooner, making the range of the price movements increasingly tight. As the range between the peaks and troughs marking the progression of price narrows, the trendlines meet at the "apex,".
The narrowing of the trading action and the decreasing volume of trade reflect the indecision in the market. Finally consensus or decision in the market is reached and this is reflected as the price breaks out of the Triangle/Wedge. A spike in volume on this breakout date reflects stronger consensus that the financial instrument should move in that direction.
Recognia has loaded five years of financial data into its database and our pattern recognition technology has identified over 4 million patterns. Our research and development team has started analyzing these patterns to develop statistics which reflect the actual historical performance of these patterns. We will be posting periodically as we continue our analysis.
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