How to Trade a Contracting Triangle
The Contracting Triangle is a common term used in trading to describe the behaviour of an asset’s price. It begins with one significant, downward trend where buyers are constantly increasing their bids for the asset. Sellers continue to decrease their ask prices until they hit a specific price point where no more sellers are willing to sell at that value. At this moment, there is now an equilibrium between supply and demand. Any further buys will cause the bid price to rise, while further sales will cause the asking price to drop.
Next comes the Ascending Triangle pattern, where buyers again slowly increase their prices as sellers begin decreasing theirs until they reach another equilibrium point. Traders usually watch for signals here that indicate how the asset may breakout – who wants it more?
The third and final phase of the Contracting Triangle pattern occurs when the price rises rapidly, usually increasing cell volume. It signals that the equilibrium point has changed. There are now more people wanting to buy than there are willing to sell at that price, so any other pushers will cause prices to surge even higher while any further pullbacks will quickly turn into buying opportunities.
Draw the Triangle
The first thing you will need to do is to draw out the Contracting Triangle. Once you have drawn this pattern, you should see three pushes forming a contracting triangle shape.
Determine Good Entry Points
Once you have established where the next push upwards or downwards is likely to be based on Fibonacci levels of previous swings/pushes, look at other indicators such as RSI and Bollinger Bands which provide further confirmation that an entry into the market is warranted. For example, if the pair has been oversold on the RSI and a new push is expected to come soon, contracting triangles reverses the trend.
Alternatively, if Fibonacci levels suggest a correction should occur soon, look at other indicators such as Bollinger Bands or Stochastics, which will give you information on when to enter into the trade. Suppose either of these two indicators is about to cross upwards through their respective centre line. It provides us with yet another reason to believe that any upcoming contraction will likely be an upward movement rather than downward. Additionally, confirming signals can be developed by looking for high volumes around areas of support/resistance.
Once you have decided on an entry point, all that needs to be done is enter the market at the swing low/high of your choice and hold until the next push occurs. Watch out for potential false breakouts where it looks like a new direction has begun but then turns back into a continuation of the original trend.
Take Your Profit
When taking profit with contracting triangles, there are two main ways that traders choose to do this; they either take their profit once the pair breaks through resistance or support by x pips (5-8 usually suffices) or wait for price action near reversal points such as the 0.236 Fibonacci retracements or a trend line break to take their profit instead.
The contracting triangle is a useful pattern that can provide us with some fantastic opportunities to trade if we identify them accurately. Once mapped out on your charts, this formation becomes much easier to spot and therefore increases the chances that you will act appropriately to secure profits when they become available. The key thing when using this pattern is identifying good entry points before deciding on an appropriate exit point for your trades.
On the whole, it would certainly be advisable for any traders interested in trading the forex market seriously but don’t feel confident enough yet to try their hand at trading these formations. Have a look at Saxo Bank to practice these contracting triangle tips.