Triangles are chart patterns that occur regularly in the stock market. A triangle is formed when the price area a stock is moving in contracts over time. The narrowing price area creates a triangle-like pattern on the chart. While trading is never easy (and losses still occur with this strategy), triangles do provide an entry point at the breakout, a stop loss level at the opposite side of the triangle (opposite side from the breakout) and a price target based on the size of the triangle.
Symantec Corp. (SYMC) recently broke out of a triangle pattern in early January. The breakout level was $24.60, although since traders may draw the triangle different ways (based on which swing highs and lows are used) that breakout level may vary by trader. An entry could have been taken at $24.60 with a stop loss below $23.90—which is the bottom of the triangle. Based on the Nov. 4 intraday low of $22.76 and the Nov. 23 intraday high of $25.55, the height of the triangle is $2.79. This is added to the breakout point of $24.60, giving a price target of $27.39. As of Jan. 17, the price is well on its way to that target. Target prices are an estimate; the price could fail to reach the target (before hitting the stop loss), or it could move past the target.
The same trading concepts can be applied to stocks that are approaching their breakout level.
TiVo Corporation (TIVO) has formed a triangle pattern right below a major resistance level. The failure to move through resistance in the $23.40 to $23.57 region indicates the price could be heading lower. So far that appears to be the case, as the price has broken below triangle support at $19.75. A stop loss can be placed above triangle resistance of $21.10. Since October, the triangle is $3.25 in height. Subtracted from the breakout price, the downside price target is $16.50. If the September high ($23.40) is included in the triangle, the height is $4.60. This provides a more aggressive downside target of $15.15. This latter target aligns with a support area from mid-2016.
United Natural Foods, Inc. (UNFI) has been moving in a triangle pattern since November. Given the significant volatility in the stock over the last year, the narrowing price area is unlikely to last for long. As of Jan. 17, the stock is bumping against the bottom of the triangle. The downside breakout point is $46.90. A decline below the Jan. 9 swing low of $46.41 would help confirm the move lower. The height of the triangle is $6.20 (based on the Nov. 15 intraday high and Dec. 8 intraday low).
That puts a downside price target at $40.70 if the price continues lower. If instead of using the Nov. 4 intraday low, the triangle is $9.25 in height then this produces a more aggressive downside target at $37.65. In this case, a stop loss on the short trade goes near $49.25.
If the price reverses and heads higher, an upside breakout occurs if the price moves above $49.26. In that case, a stop loss is placed near $46.90, and the upside target is $55.46 or $58.51, depending on which triangle height is used to determine the target.
The Bottom Line
Triangles are common chart patterns that can present a trading opportunity. The traditional approach is to buy if the stock breaks above the pattern, and to short sell if the price breaks below. A stop loss is placed just outside the pattern on the opposite side from the breakout, and a target is set based on the height of the pattern. Triangles work great sometimes, and not so good at other times. Triangles are prone to false breakouts. This is when the price moves out of the pattern, triggering a trade, only to reverse course and break out the other side of the pattern (or continue to oscillate sideways after entry). Also, the triangle price target may not be met, or it may be exceeded which means money was left on the table. Such problems can't be totally avoided. Losing trades are part of trading, and that is why triangles are a popular pattern. Since the triangle target is based on the full height of the triangle, while the stop loss is based on the narrower portion of the triangle (at the right), the potential profit of the pattern outweighs the risk of a losing trade.
Disclosure: The author doesn't have positions in the stocks mentioned.