The Role of Moving Averages
Moving averages can provide an additional layer of confirmation for triangle breakout trades. A 20-period and 50-period simple moving average (SMA) are commonly used on intraday charts. In a bullish scenario, a trader wants to see the 20-period SMA above the 50-period SMA. This indicates a short-term uptrend. A breakout from a triangle in the direction of the moving average alignment has a higher probability of success. For example, if NQ is in an uptrend with the 20-period SMA at 15,100 and the 50-period SMA at 15,050, a breakout from an ascending triangle at 15,120 is a high-probability long trade.
A crossover of the moving averages can also signal a shift in momentum that can precede a breakout. If the 20-period SMA crosses above the 50-period SMA while a symmetrical triangle is forming, it can be an early indication that the breakout will be to the upside. Conversely, a cross of the 20-period SMA below the 50-period SMA can foreshadow a downside break. A trader should not rely solely on moving average crossovers for entries, but use them as a confluence factor to support a trade decision based on the triangle pattern itself.
Measuring the Target: The Height Projection Method
The most common method for estimating the price target of a triangle breakout is the height projection method. A trader measures the vertical distance at the widest part of the triangle, from the upper trendline to the lower trendline. This height is then added to the breakout price for an upside breakout, or subtracted from the breakdown price for a downside breakdown. This provides a logical price target based on the energy stored within the pattern.
For instance, a descending triangle forms on a 1-hour chart of Gold (GC). The horizontal support is at $1,900. The falling upper trendline starts at $1,950. The height of the pattern is $50. A breakdown occurs at $1,899. The price target is calculated as $1,899 - $50 = $1,849. This method provides a clear target, which allows the trader to calculate the risk-to-reward ratio before entering the trade. If the stop loss is placed at $1,910, the risk is $11. The potential reward is $50. The R:R is $50 / $11 = 4.55, a very attractive trade.
Worked Example: SPY Descending Triangle
A descending triangle forms on the 15-minute chart of the SPDR S&P 500 ETF (SPY). The horizontal support is at $440. The falling upper trendline connects the highs of $445, $443, and $441.50.
- Entry: A breakdown occurs when a 15-minute candle closes below $440. The close is at $439.80. A trader shorts 100 shares at $439.80.
- Stop: The stop loss is placed above the falling upper trendline. The trendline is currently at $441. The stop is placed at $441.20, representing a risk of $1.40 per share, or $140 total risk.
- Target: The target is calculated by taking the height of the triangle at its widest point and subtracting it from the breakdown price. The height is $445 - $440 = $5. The target is $439.80 - $5 = $434.80.
- R:R: The potential reward is $439.80 - $434.80 = $5. The risk is $1.40. The R:R is $5 / $1.40 = 3.57. This is a favorable risk-to-reward ratio.
Adjusting Stops to Reduce Risk
Once a triangle breakout trade is profitable, a trader should look for opportunities to reduce risk. One method is to move the stop loss to the breakeven point once the price has moved in the trader’s favor by a distance equal to the initial risk. In the SPY example, the initial risk is $1.40. Once SPY reaches $438.40 ($439.80 - $1.40), the trader can move the stop loss from $441.20 to the entry price of $439.80. This creates a risk-free trade. The worst-case scenario is a scratch trade, with no loss except for commissions.
Another technique is a trailing stop. The stop loss is moved to lock in profits as the trade progresses. A trader could trail the stop below the low of the previous candle, or use a moving average as a trailing stop. For example, a trader could trail the stop below the 20-period SMA on the 15-minute chart. This allows the trade to capture a larger move if the breakout initiates a strong trend, while still protecting profits if the price reverses.
Key Takeaways:
- Moving averages can be used to confirm the direction of a triangle breakout.
- The height projection method provides a logical price target.
- A worked example on SPY shows a 3.57 R:R trade.
- Adjusting stops to breakeven or using a trailing stop can reduce risk and protect profits.
