Pattern recognition is a popular topic especially with new and evolving traders. I've used pattern recognition to make trading decisions for 30 years. It's not the only way to trade but it's been a very successful method for me and I'm happy to share some insights wiht you.
The Setup: The bullish setup is simple to recognize. Firstly, the trend must be up; that is, our 30 day EMA (exponential moving average) must be higher today than what it was yesterday. The triangle you are looking for must have 4 distinct internal swings, which help define and differentiate the pattern from lower probability trades.
- * The first swing high or point 1 must always be in the direction of the trend.
- * The second swing or point 2 is a retracement against the trend;
- * Swing three retests the swing 1 high but fails to clear that high.
- * Swing four is yet another retracement against the direction of the trend but falls short of the swing 2 low.
Rules: Each swing should be a day unto itself and therefore the minimum length of at triangle is 4 days. In my experience, the most profitable length is 6 – 10 days. Don't use this as a hard and fast rule though. I have seen triangles of 4 days in length be very profitable but, in my experience, they are lower probability trades. Generally a triangle beyond 15 days in length will tend to turn the trend and therefore negate the trade unless of course you are using a longer moving average to define the trend.
The rules for a triangle in a downtrend are simply reversed.
The Entry The entry point can clearly be seen after drawing in a trend line from the swing highs of 1 and 3 and the swing lows of 2 and 4 as shown in the diagrams.
A breach of the trend line between swing 1 and swing 3 is our signal to enter the trade.
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