While most traders may consider triangles in forex trading to be continuation patterns, they can also serve as reversal signals when the market is approaching a significant support or resistance level. We will cover how you can identify and trade contracting triangles in Australian forex and which ones to focus on for different currency pairs.
A contracting triangle occurs when both resistance and support levels converge at equal distances from where they began. The apex of the range forms somewhere between the 38% and 62% Fibonacci extension levels, with any price action extending beyond this point representing an invalidation of the pattern. Why these two numbers? If we project outward from either side of the base price, we get 38% (100%-62%) and 62%.
Identify the trend
Identifying the direction of the trend can help you determine which triangle is more likely to be a reversal pattern and make it easier to select which pair to trade. It will prevent you from entering at a lousy price and reduce your risk and reward levels accordingly.
For example, if we were trading in a bearish momentum environment for AUD/USD, we would want to find contracting triangles on lower time frames such as the 15-minute chart since those are more likely to be reversal patterns that align with our bias. On the other hand, if we were looking for bullish signals with USD/JPY, we would focus on higher time frames such as the daily chart, where we would be more likely to find continuation patterns.
Determine the time frame of the triangle
The lower the time frames you look at, the lower timeframe the pattern will usually be. For example, if we were looking for a reversal signal on AUD/USD with a contracting triangle on the daily chart, this would be considered an ultra long-term pattern.
In contrast, triangles on the weekly or monthly chart would not be as significant and more likely to act as continuation signals. In other words, trading an ultra long-term triangle is best left for swing traders who can afford to stay in their position much longer. If you are day trading, focus only on contracting triangles that happen within one week.
Identify volume trends
In general, the more contraction occurs in a triangle, the higher the volume level it will have. If you can identify a contracting triangle with high volume levels, this means the pattern is likely to be valid and could cause a sharp movement once the price breaks out of its boundaries.
Identify support and resistance levels
As the name suggests, these are lines that act as barriers for traders entering into positions on either side of them. Since triangles usually form between two areas of high activity (resistance and support), it’s best to look for ones where significant price action happened during one or both directions of trade.
It doesn’t mean failing to enter trades beyond these points is wise since it’s unlikely they will offer enough room for the market to move in that direction, but at least it helps you avoid entering with an invalidated triangle.
Identify breakout signals near resistance and support levels
Now that you have identified the list of potential triangles forming on your chart(s) to those with high contracting volume levels and significant price action within defined boundaries, it’s time to look out for any breakout signals between these points.
It could be anything from candlestick patterns such as hammers or shooting stars to Ichimoku Cloud Breakouts or traditional trend-line breakouts. It also helps if the signal comes when the price is sitting close to one of these lines, making it more likely that traders will act on them since they are already buying into this activity level.
Look for contracting triangles within contracting channels
A contracting channel is formed when there are two parallel lines that traders buy and sell into, with the upper line acting as resistance while the lower one acts as support. As with regular contracting triangles, it’s best to trade them near their area of the price action (that is, at their boundaries), where they will attract more interest from other market participants.
However, it also helps to identify these patterns directly within a contracting channel since volume levels tend to be higher in these areas, again making them more likely to provide you with good trading signals.