Lately been observing chart patterns of the listed stocks in the Philippine Stock Exchange.
We have observed that the PSEi has been going up towards the 5,500 level and we can't help but guess until where would this be, meaning when are we expecting a correction.
A correction is good time for the stock's price to "correct" meaning the prices we see now might not be the real price valuation of each stock due to the agitated forces that affect prices thus such time is good in order to revalue and really see the true prices of stocks.
When such situation occur we might experience an extended flattening of stock movements which we call consolidation. Getting caught in this is kinda frustrating thus we have to carefully plan buys and sells of our stocks. In a period of consolidation stock prices seem to just bounce up and down only on a particular price range, meaning every time the stock's resistance level is reached it bounces downward and when it hits the support level it bounces upward. This action repeats until a breakout occurs.
There is a special situation which we call a symmetrical triangle formation.
What is a symmetrical triangle formation?
Let me quote Stockcharts.com's definition of a Symmetrical triangle:
Let me quote Stockcharts.com's definition of a Symmetrical triangle:
The symmetrical triangle, which can also be referred to as a coil, usually forms during a trend as a continuation pattern. The pattern contains at least two lower highs and two higher lows. When these points are connected, the lines converge as they are extended and the symmetrical triangle takes shape. You could also think of it as a contracting wedge, wide at the beginning and narrowing over time.
Symmetrical Triangle patterns are mostly indicator of a continuation of a prior trend but at times t could be a signal of a reversal. Thus careful analysis should be taken.
Stockcharts.com provide these pointers to determine a continuation:
- Trend: In order to qualify as a continuation pattern, an established trend should exist. The trend should be at least a few months old and the symmetrical triangle marks a consolidation period before continuing after the breakout.Explanation - we should view the stock's chart in around 6 months - 1 year in order to determine what is its actual trend. Locate the forming symmetrical triangle and add about 6 - 12 months backward to see to which trend is the stock really going.
- Four (4) Points: At least 2 points are required to form a trend line and 2 trend lines are required to form a symmetrical triangle. Therefore, a minimum of 4 points are required to begin considering a formation as a symmetrical triangle. The second high (2) should be lower than the first (1) and the upper line should slope down. The second low (2) should be higher than the first (1) and the lower line should slope up. Ideally, the pattern will form with 6 points (3 on each side) before a breakout occurs.Explanation - it is easy to spot a triangle formation but it should be in accordance to the above formation to really consider it a symmetrical triangle. There should be a resistance level that is going down, that is the highs are actually lower than the previous high while the lows are actually higher than the previous low.
- Volume: As the symmetrical triangle extends and the trading range contracts, volume should start to diminish. This refers to the quiet before the storm, or the tightening consolidation before the breakout.Explanation - To confirm such consolidation, the volume should be contracting meaning as it progress it starts to go down.
- Duration: The symmetrical triangle can extend for a few weeks or many months. If the pattern is less than 3 weeks, it is usually considered a pennant. Typically, the time duration is about 3 months.Explanation - this chart formation should form from more than 3 weeks to 3 months to be considered as a symmetrical triangle.
- Breakout Time Frame: The ideal breakout point occurs 1/2 to 3/4 of the way through the pattern's development or time-span. The time-span of the pattern can be measured from the apex (convergence of upper and lower lines) back to the beginning of the lower trend line (base). A break before the 1/2 way point might be premature and a break too close to the apex may be insignificant. After all, as the apex approaches, a breakout must occur sometime.Explanation - the expected breakout, that is the continuation of the previous trend, should be from the middle of the chart pattern to near the converging point. At this time frame you should see the continuation that we are expecting if not then we might consider this as a reversal pattern.
- Breakout Direction: The future direction of the breakout can only be determined after the break has occurred. Sounds obvious enough, but attempting to guess the direction of the breakout can be dangerous. Even though a continuation pattern is supposed to breakout in the direction of the long-term trend, this is not always the case.Explanation - make your buy or sell decisions only when such continuation is confirmed which is only validated at the breakout point.
- Breakout Confirmation: For a break to be considered valid, it should be on a closing basis. Some traders apply a price (3% break) or time (sustained for 3 days) filter to confirm validity. The breakout should occur with an expansion in volume, especially on upside breakouts.Explanation - an obvious breakout confirmation or validation would be a sudden surge in volume.
- Return to Apex: After the breakout (up or down), the apex can turn into future support or resistance. The price sometimes returns to the apex or a support/resistance level around the breakout before resuming in the direction of the breakout.Explanation - the apex, the point where the downward resistance level and upward support level meet, will sometime become the new resistance/support level. Use this point for the next direction of the stock's price.
- Price Target: There are two methods to estimate the extent of the move after the breakout. First, the widest distance of the symmetrical triangle can be measured and applied to the breakout point. Second, a trend line can be drawn parallel to the pattern's trend line that slopes (up or down) in the direction of the break. The extension of this line will mark a potential breakout target.Explanation - establishing the target price could be measured using the two methods define. Of the two methods, the first one where the target price is determined by adding to the breakout point the widest distance of the pattern is commonly use.
A reminder to newbie stock traders or investors:
1. Always understand first any pattern before assuming that the chart you are seeing is making that pattern. As mentioned the symmetrical triangle pattern is not always a continuation pattern thus always check confirming signals like the volume and also if you know how to read candlesticks have a feel of the general sentiment of traders or investors.
2. In times of correction and consolidation buying stocks at dips is always an advantage. Remember that the stock's price may just bounce up and down within a price range thus buying every time price touches the support level is wiser. If you are sure that such will breakout soon, accumulate only as much as your risk tolerance can accomodate. If you need the money don't put everything in the said stock. Reserved some for any other purposes that you might be needing.