Hello friends and welcome to another informative podcast by Angel One.
In the years before breathalyzers, when traffic police suspected that a driver was drunk or driving under the influence, they often hauled him out of his vehicle, chalked a straight line on the concrete and challenged the driver to walk along the said line in order to prove that he was sober. If the unlucky driver was unsuccessful in walking along the straight line, the police would apprehend him and send him for a blood test that would confirm or refute their suspicions.
I bet you're wondering why I'm telling you a story about traffic police SOPs in the days gone by. Well, very simply because just like the policemen watch for a driver who cannot walk along the line, in using the ascending triangle pattern too, traders are trying to identify places where the stock wavers (or displays a breakout) from lines drawn on a stock graph.
"What lines?" you ask. We're talking about the lines that emerge from a series of price highs and price lows. The stock price highs are consistent, allowing for a horizontal line to be drawn along them on the stock graph. Meanwhile, the stock price lows are progressively higher (or less and less low), allowing for a diagonal, ascending line to be drawn along them on the stock graph. The lines meet to form a triangle - an asymmetrical triangle that isn't closed exactly - but a triangle nonetheless. Traders are waiting and watching for a breakout or in other words - they are waiting for the stock price to move beyond identified support and resistance levels. Put simply, a breakout is defined by a price movement wherein the stock price rises beyond any recent high or slides below any recent low.
Now, for this pattern to appear in a stock graph, at least two price highs and two price lows must stand in the required formation. However, experienced traders say that the higher the number of trendlines the more likely the price breakout and the higher the proportion of the price breakout.
The cops wait for drivers to waver from chalk-drawn straight lines so as to slap them with a fine. What are traders looking to benefit from when a stock crosses the line, or makes a breakout? Well the breakout point gives them a clear picture of where to place their next move - an ascending triangle pattern gives them a good idea of what trading move to make (that is whether to buy or to sell). It also gives them an inkling about where to place their entry point (meaning buy price), their profit goal (meaning sell price) and their stop loss.
Traders will usually buy shares to sell them at a higher rate later if the breakout happens above the triangle. Conversely they will sell shares (sometimes intending to buy them back at a lower rate later) if the breakout happens below the triangle formation.
Traders will usually place their target price in relation to the thickest point in the triangle. This value of the height of the triangle is added to or subtracted from the breakout point to arrive at a target price.
A trader buying stock upon witnessing a breakout from an ascending triangle pattern will usually place his stop loss just below the lower (diagonal or tilted) leg of the triangle.
Traders usually anticipate the stock price to move in the same direction that the stock graph had mapped before the triangle. They hedge their predictions based on this premise. Incidentally (fun fact alert!!), this expectation of continuity is the reason why ascending triangle patterns are also referred to as continuity patterns.
There are two types of ascending triangle patterns. A wide pattern (where it looks like the meeting point of the horizontal line and the diagonal line is a long way off) and a narrow pattern (where the horizontal line and the diagonal line are already very close). The wider the pattern, the higher the potential risk or reward.
Of course like all things stock market, the ascending triangle offers no guarantee about the traders prediction panning out positively.
To be more sure of the likelihood that an ascending triangle pattern will deliver as predicted, traders usually watch for a corresponding reaction in volume. If there is no corresponding shift in volume it is likely that the price will revert to where it was before, rather than a new trend forming. If the price reverts to its original trajectory (or does something else altogether), a false breakout has occurred and the traders prediction has proven faulty.
That's why it is better for traders to peg their predictions on multiple factors and extensive research. Traders are best off using various tools for technical analysis to reconfirm their predictions. Beginner traders might also do well to hire experts to give them advice on potential stock price movements.
Trade in small sums to begin with and definitely consider your risk appetite before you invest. It's okay to sacrifice that holiday in Bali so you could try your hand at the stock market but you must not take risks with capital that is required to pay basic monthly expenses.
Learn about various patterns and how to use them to make calculated predictions in our other podcast episodes. Happy trading!