A triangle break out is a high probability setup and can often be traded in either direction. A triangle is formed when there is a consolidation between buyers and sellers. The price range narrows progressively forming a nice symmetrical triangle indicating that there is near balance between buy and sell orders. It leads to a squeeze and eventually traders on either the buy or the sell side start closing their positions resulting in an imbalance and hence the breakout. The power behind a breakout can be magnified if there is fundamentals news supporting that side of the trade around the time (or indeed the breakout could be triggered by the news!)
Take a look at one such scenario that took place yesterday, the 2nd of May 2013 on the USD-JPY pair.
It is important to draw the triangles properly and allow the formation for a sufficiently long period of time (the above example is on a 3 minute chart indicating the price action was within the triangle for a fair bit of time). I prefer to see at least 3 touches on either sides of the triangle. Once I have seen at least three touches this is how I plan my trade:
- Mark the latest touches to the triangle as trigger points – in this case they are at 97.34 on the higher side and 97.11 on the lower side.
- Place a Buy Stop order at 97.35 i.e. 1 pip above with a Stop Loss at 97.10 i.e. 1 pip below the trigger points
- Place a Sell Stop order at 97.10 with stop loss at 97.35
- Once any of the above two orders get triggered, make sure the other order is cancelled.
- For target look at higher timeframe support and resistance – place orders only if you have an acceptable reward to risk ratio according to trading plan.
In the above example the initial breakout thrust produced a move of over 100 pips from entry within 2 candles roughly 4 times the 25 pips risk on the trade.