On-screen text: Disclosure: For illustrative purposes only.
Narrator: A symmetrical triangle is a price pattern that forms when support and resistance levels converge. This continuation pattern, or pattern that occurs mid-trend, is likely to continue following the trend after a breakout.
In this video, we'll discuss how symmetrical triangles form, how to use them to identify potential buy and sell signals, and what actions you may consider if a breakout occurs.
First let's discuss why this pattern exists. Symmetrical triangles occur when a stock is consolidating or trending sideways. Consolidation is regarded as a period of investor indecision that ends when a trend stops moving sideways and either continues or reverses direction.
Basically, consolidation occurs when buyers and sellers are equally unsure if a trend is going to continue. During this period of indecision, support and resistance levels inch toward each other. This creates a symmetrical triangle.
Now that you understand how a symmetrical triangle forms, let's learn how to identify the pattern. First, the stock price needs to touch the rising support level at least twice and the diminishing resistance level at least twice as well.
If this pattern continues, support and resistance levels will eventually cross. When they do, this cross-point is called the apex. While stocks rarely reach the apex, it's an important element to consider when setting price targets, which we'll explain later.
The next way to confirm a symmetrical triangle is by examining its time frame. Triangles usually take between three weeks and three months to form. If this pattern forms in less than three weeks, it's generally considered a pennant.
Now that you know how to identify a symmetrical triangle, let's discuss how they can be used to identify potential buy and sell signals.
On-screen text: Disclosure: Stock trading involves high risks, and you can experience a significant loss of funds invested.
Narrator: While some traders are confident trading within support and resistance levels, other traders wait until a breakout is identified to buy the stock.
One way to identify a breakout is volume. While the triangle is forming, volume will slowly diminish.
Without increased volume, it could be a false breakout.
However, in addition to volume changes, there are other ways to identify a breakout—such as waiting for a certain amount of time. If the stock has risen for three straight days after the breakout, this could be considered a confirmation.
Now that you know potential basic buy signals and how to identify a breakout, let's discuss how to determine potential sell signals. It's important to set a price target for the stock.
Traders may use two methods to estimate the minimum price projection, or price target. The first method is to measure the height of the triangle's base and add it to the value at the triangle's apex.
Second, use a parallel trendline to set the target. This is done by tracing a line parallel to the support level, starting at the first contact point of the triangle at resistance. This parallel line marks the potential price target.
On-screen text: Disclosure: For illustrative purposes only. Past performance is not indicative of future results.
Narrator: Keep in mind that in many cases, the breakout may continue in the same direction as the trend preceding the triangle. This means that a previously uptrending stock may continue moving upward and a downtrending stock may continue moving downward.
Though this is a typical market reaction, it isn't a rule. That's why many traders think it's important to wait until the breakout is identified before making any investing decisions.
On-screen text: Disclosure: A trailing stop or stop loss order will not guarantee an execution at or near the activation price. Once activated, they compete with other incoming market orders.
Narrator: When you set a price target, many traders use a stop loss to help protect against setbacks. Setting a stop loss can help reduce your losses if the stock breaks in an unexpected direction or if the breakout proves to be false.
While there is no guarantee of success, being able to use price patterns to identify potential buy and sell signals can help improve your trading strategies.
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