Day trading with the symmetrical triangle formation is a great way to take advantage of late day breakouts. Some traders will look for symmetrical triangles on a very short timeframe (ie. 30 minutes); however, I like to see this pattern develop over a few hours after a strong morning advance. Symmetrical triangles are considered to be direction neutral, however, I have found them to be very reliable when traded with a strict set of rules.
Here is an ideal setup of the symmetrical triangle as I trade it.
Let’s review a few rules that I use to successfully trade the symmetrical triangle. I want to mention that I only trade this pattern if it is a continuation in the primary direction.
I will discuss these rules in terms of the bullish version of this pattern. The rules for the bearish version can be reversed.
1) The Advance: There should be a strong advance before the formation of a symmetrical triangle. Notice the advance in our diagram above.
2) Retracement: For my day trading style, this rule is very important. The retracement created from the top of the early morning advance should be no more than 50% of the advance, but ideally only 38% to 40%. The smaller the retracement, the better the odds of continuation.
3) The Setup: The symmetrical triangle should be viewed as a 4 point formation, with lower highs and higher lows until it breaks out. The top of the early morning advance is considered to be point 1 while the reaction off of that level is considered point 2. A rally to point 3 will lead to a reversal below Point 1 and a decline into point 4 will lead to a bottom at a higher level than point 2.
4) Volume: This is key. Once the early morning advance is complete, volume should die down and stay relatively low during within the formation of the triangle. However, as you can see, a strong expansion should occur on the breakout bars. This is one rule which can be different for the bullish and bearish triangle. Markets don’t need heavy volume to fall but should have heavier volume when they rise. When looking for a bearish continuation breakout, volume is not all that important.
5) Breakout: Many novice traders will look for stock to break out right at the apex of the triangle. This is not what we want. You want to see the breakout occur about 75% of the way into the triangle.
5) Price Projections: The price projection can be calculated by taking the highest point on the upper trendline and subtracting the lowest point of the lower trendline and adding that difference to the breakout point from the triangle. For example, if the triangle started at 50 and retraced down to point 2 at 40, the upside target would be 10 points higher than where the stock broke out.
6) Money Management: There is the possibility of a false breakout and therefore, stops should be placed beneath the lower uptrend line after breakout. Additionally, once the position moves in my favor by 1%, I set the stop to break even.
Stay true to these rules and you will stay on the right side of this pattern most of the time. Remember, it does not come up all that frequently so have patience and only take the setups that fall within the rules.