The triangle is a useful chart pattern, especially when it occurs in the context of a trend. A triangle is formed when the price makes converging highs and/or lows. It shows that movement in the stock is becoming smaller and provides some areas to watch for a breakout. If the price moves outside the triangle, it is an indication that the price could keep moving in that breakout direction. A breakout that occurs in the same direction as the overall trend is especially noteworthy if looking to initiate a new position. A breakout in either direction is noteworthy if already in a position, as it provides context for whether to keep holding the position or to consider exiting it.

IHS Markit Ltd. (INFO) stock has had a great year, up 31% in 2017. After peaking in June at $47.92, the stock has been moving in a triangle pattern. The rising trendline (bottom of the triangle) intersects near $46 – therefore, a drop below that level, especially a closing price, would signal a downside breakout. A rally above the upper trendline at $47 would imply an upside breakout. The height of the triangle at its widest point is $4.58 (it then narrows). This can be added or subtracted to the breakout point to provide an approximate target point. If a downside breakout occurs, the target is $41.42, while an upside breakout would target $51.58. (See also: Corporate Inversions: IHS and Markit Merge.)

Technical chart showing a triangle pattern in IHS Markit Ltd. (INFO) stock

Dr Pepper Snapple Group, Inc. (DPS) stock has been forming a triangle since mid-June. The triangle occurs well off the April high of $99.47, following an abrupt fall on April 26. A daily close below $90 would break the triangle to the downside and provide a target of $82. On the other hand, closes above $92, and especially above $93, would signal an upside breakout and a retest of the $99 to $100 area. That $100 area warrants caution, as it has been probed twice in the past 14 months and has been rejected both times. Similarly, the $82 downside target saw the price bounce aggressively off of it in late 2016. The triangle is right in between strong support and resistance areas. (For more, see: Dr Pepper Snapple Q2 Earnings Lag, Sales Top Estimates.)

Technical chart showing a triangle pattern in Dr Pepper Snapple Group, Inc. (DPS) stock

The triangle on the chart of Restaurant Brands International Inc. (QSR) stock started in June. In that month, the stock reached a low of $56.15 and a high of $62.94. Those set the extremes for the triangle, and the price action has been narrowing since. Traders should watch for a downside breakout below $59. Based on the size of the triangle, the downside target is $52.21. With multiple swing highs just below $63, traders should also watch for a breakout above that level. If a breakout above $63 occurs, the target is $69.79. (See also: Restaurant Brands Q2 Earnings Beat, Revenues Miss.)

Technical chart showing a triangle pattern in Restaurant Brands International Inc. (QSR) stock

The Bottom Line

The triangle is a useful pattern. It can be traded, but it can also be used for analytical insight. If already in a position, a breakout in the opposite direction is not ideal and signals that the price could move against the position for some time. Alternatively, a breakout in the trade direction signals that the trade should be kept on.

Triangles also provide a way to control risk. Traditionally, a stop-loss order is placed outside the triangle on the opposite side from the breakout. For example, with an upside breakout, the stop-loss is placed just below the lower trendline at the time of the breakout. Alternatively, the stop-loss can be placed below a recent swing low (if going long) or above a recent swing high (if going short). Because the target is based on the thickest part of the triangle and the risk is based on the narrowest part of the pattern, triangles can offer very favorable risk/reward trades. (To learn more, check out: Analyzing Chart Patterns: Triangles.)

Charts courtesy of StockCharts.com. Disclosure: The author does not have positions in the stocks mentioned.