The Trouble with Triangles

I know I lured in some unsuspecting geometry haters but this week’s blog post has to do with the chart pattern rather than the geometric shape.

The chart below is a 5 year weekly look at the Chinese Stock market ETF, FXI.  You can see while price has swung up and down as much as 30% from its mean, it really has gone nowhere over the entire 5 year period. Also, you can see since the 2010 high, price has traded within a triangle bounded by the blue trend lines. Triangles are consolidation patterns and while we try and avoid consolidation zones they should not be ignored because eventually they lead to a breakout.

Breakouts are what every investor dreams to find because they can be the start of a new trend. And trends are where investors make money, not areas of consolidation.  All patterns in technical analysis have probabilities associated with their outcome. Technicians look for the patterns with the highest probability as that logically improves investing success. The higher the probability the higher the success. Now, here is the trouble with triangles they have no edge.  They provide no statistical probability greater than flipping a coin. Because of their 50% probability of breaking either up or down, you should wait for the breakout before entering a position.  To make things even worse, if you buy the breakout, there is an equal  probability it will reverse back in the other direction.

My chart of FXI is a perfect example of what I tried to explain above and why I hate triangles.  Price broke out to the upside (bullish breakout) which pulled in new investors thinking this was the start of a new bullish trend. After a 10% rise, almost up to the prior late 2010 high, price immediately reversed and fell right back into the triangle where it sits today. Those who bought the breakout and were not prepared with an exit strategy are likely now sitting with a loss. Those who were familiar with triangles could have entered with a tight leash and may have been skillful enough to have eeked out a small gain or better yet, have avoided this investment altogether.

Now you know the troubles with triangles