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Elliott Waves Theory – Trading the Apex of a Contracting Triangle

apex of contracting triangle1Contracting triangles are corrective waves that form either as simple corrections or as part of complex corrections. According to Elliott, they are very common, as complex corrections form most of the time when the market is consolidating. Treating a contracting triangle is subject to a lot of factors that a trader needs to consider: internal Fibonacci relations between the legs of the triangle, the requirements of the a–c and b–d trendlines, as well as the apex of the contracting triangle. All of them are equally important in the overall analysis, and a proper interpretation will lead to finding the right pattern that will follow the contracting triangle. However, the apex of a contracting triangle requires special attention.

Three Ways to Use the Apex of a Contracting Triangle

Just to be sure we’re on the same page, the apex of a contracting triangle represents the intersection point of the two trendlines that make the triangle: the a–c and b–d ones. It can be used for identifying future support and resistance levels, just like in the case of an expanding triangle, but also to find out the measured move when the price breaks, as well as the time when that target should be reached.

Support and Resistance Levels

apex of contracting triangle2Perhaps the most important way to use the apex is to find out future support and resistance levels that the market will form. This is only valid, though,  when the apex can be identified relatively close to the actual triangle. Otherwise, if the two trendlines are almost parallel, the apex is of no use for the overall market interpretation. After the a–c and b–d trendlines have been drawn, the thing to do is to project them onto the right side of the chart in order to find out the apex. Once that is in place, a horizontal line should be drawn. This line represents the overall support and resistance level for future prices, and gives a pretty good idea of what to do when future prices reach the apex level. In other words, if the price breaks higher out of a contracting triangle and then reaches the apex level, it is not wise to stay on the short side any longer. I’m not saying one should go long, but at least shorts should be closed on such a move, as it is most likely that a bounce is about to come.

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Find the Measured Move of a Triangle

A triangle, like other patterns, can be either a continuation or a reversal pattern. If it is a continuation pattern, the contracting triangle can be a pennant or part of a complex correction that will eventually break in the same direction as the direction prior to the triangular formation.

On the other hand, when contracting triangles form as part of complex corrections, they usually form at the end of the correction, and are therefore reversal patterns. In both cases, a measured move can be calculated based on the type of the triangle. This measured move is strongly related to the longest leg of the contracting triangle. In such a triangle, the longest leg can be either the a-wave or the b-wave.

apex of contracting triangle3 If the a-wave is the longest leg of the contracting triangle, the triangle is called a horizontal one. If the b-wave is the longest one, the triangle is irregular. The measured move is a Fibonacci ratio based on the longest leg, and it varies from 75% in the case of a horizontal triangle, all the way to more than 161.8% if the b-wave is the longest of the five waves that make up the triangle. Such a measured move is in some cases strongly related with the apex, but in a way that has nothing to do with price, and rather with time. It is very common for the measured move to come in the timezone of the apex, and this brings an extremely important characteristic to the overall trading concept: price and time in the same place.

Price and Time with the Apex

As a continuation of the previous paragraphs, the apex gives the time element for a trade to come to fruition. Time is an extremely important element in trading, and Elliott found a great way to integrate it into the overall theory.

apex of contracting triangle4 For years, the interplay between price and time was (and it still is) the holy grail in trading. Knowing how to put a time on a price forecast is as important as, if not even more important than, the actual forecast. Time can be used as a stop loss tool as well, in the sense that if the market does not make a specific move in a set period of time, the forecast or the analysis is considered to be incorrect, and the trade should be closed. This doesn’t mean that a profit wasn’t made; it only means that the time expired and so the overall picture needs to be re-interpreted. This is exactly what the apex of a contracting triangle is showing. This apex is used most of the time as a support and resistance level, so it is referring to the actual price; however, it shows the time element as well. The thing to do is to take a vertical line this time and to place it exactly on the intersection point of the a–c and b–d trendlines, or at the apex point. This is the time that price has to reach the measured move of the triangle. If the measured move does not come in approximately the timezone of the apex, the contracting triangle should be interpreted in a different way. To be more exact, when a contracting triangle is part of a complex correction, the measured move usually comes well before the timezone of the apex. However, when the measured move is reached within the timezone of the apex, the next thing to do is to look for a sharp reversal into the support and resistance area given by the apex. This means that the price will turn to the horizontal line that marks the apex point.

Trading with the apex of a contracting triangle is a rewarding way to identify both reversals and continuation patterns in the Forex market. While some may look at the apex as not being that important, a correct analysis and interpretation of a contracting triangle can only be made by taking its apex into account. The next article here on our Forex Trading Academy will deal with different types of contracting triangles, and one should consider all the ways the apex of these triangles can be used. Only in this way can a complete technical analysis of a contracting triangle be carried out.

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Apex in Contracting Triangles
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