A triangle involves a market going sideways within a contracting range. By studying these formations, we can gain a lot of clues about future price action. Specifically, they can tell us the likely direction in which a market is to move next, the probable extent of the coming move, and when it might get under way.
GBPUSD's five-stage triangle
The triangle pattern can occur on pretty much any timeframe, such as a tiny one on a one-minute chart, to a massive one on a monthly chart that lasts for many years or more. The larger the formation, the more important the subsequent price move will generally be.
The accompanying chart shows the sterling/dollar exchange rate (GBPUSD). An enormous triangle pattern is in evidence beginning in early 2009. It’s important to understand the internal dynamics of a triangle, which generally break down into five stages, which I've labelled here from A to E. Think of it like an increasingly coiled spring that is ultimately destined to break out dramatically.
The fifth stage is what GBPUSD has clearly been in just lately. More often than not, the breakout from a triangle occurs in the direction of the prior trend, which in this instance was the down-move of 2007-09. Notice how it originally entered the triangle via a fall. And, sure enough, GBPUSD has lately dropped below the lower boundary of its huge triangle.
Sterling breakout
By measuring the base of the triangle on the left of the chart, we can derive a target for GBPUSD. The height of the triangle's base is around 30¢. We then project this figure downwards from the middle of the triangle at $1.60, giving a target of $1.30. This is now my officially-stated target over time for this exchange rate.
While triangles are very powerful set-ups, I still like to combine their messages with other technical evidence, such as the Elliott Wave Principle. My application of this theory to GBPUSD’s decline through the bottom of its triangle confirms that the breakdown was a main-trend development, rather than a counter-trend move.
Sterling's next move
So, what happens next? The typical development now would be a corrective rally in GBPUSD up to the triangle’s lower boundary at $1.5850. In fact, I wouldn’t be surprised if it overshot this level, before resuming its major downtrend. As long as this move continues to look corrective according to my criteria, I will be looking for short positions via spread bets and also by buying US dollars.
