Triangles in technical analysis come in different shapes and forms, but they all respect some basic rules. They have five segments, labeled with letters, and two essential trendlines (a-c and b-d).
But some triangles have distinctive interpretation. On top of the rules of trading a triangle, they have further implications over the price action to follow. Limiting triangles are such patterns.
What is a Limiting Triangle in Elliott Wave?
As the name suggests, such a triangle limits the price action to follow. Responsible for its discovery, Ralph Elliott found only two places where such a triangle appears: the 4th wave of an impulsive wave or the b-wave of a zigzag. In both cases, the price action is limited: the 5th wave completes the five-wave structure of an impulsive move, and the c-wave ends the a-b-c corresponding to the zigzag.
The limiting triangle forms after a bullish or bearish trend. And, always breaks in the direction of the underlying trend.
In other words, a limiting triangle acts as a continuation pattern. But the price action that follows has little power, no follow-through, and a correction starts. A limiting triangle formed on the EURUSD daily chart pictured below. The pair evolved in a horizontal pattern for almost three years, finishing it by the time the U.S. Presidential elections ended.
The market phases explained above show the power of the limiting triangle. First, there’s a bearish trend. No sign whatsoever that the dovishness ends soon. Next, the market consolidates for a long time, through important macro-events like the Brexit vote in June 2016. The triangle breaks lower on Trump’s election day, but there’s limited price action. While the market makes a new lower low, it soon bounces back, correcting the underlying bearish trend.
Finally, the bounce goes deeper into the bearish trend’s territory. This is the power of a limiting triangle, and the key is to interpret its formation correctly.
Labeling a Limiting Triangle
Elliott established clear rules for labeling a contracting triangle. All its five segments are corrective and, therefore, labeled with letters.
A typical triangular pattern travels between two trendlines: the a-c and b-d. However, some variations exist, like triangles on the c-e base or in a-e base too. Still, the most relevant trendline is the b-d one. By the time the price breaks it, it signals the end of the contracting pattern.
As it turns out, the limiting triangle on the EURUSD daily chart has a c-e baseline. The spike higher in the e-wave belongs to the uncertainty in the days before the last U.S. Presidential election.
When reality sat in, and the market participants realized Trump is going to win, they looked for protection in the U.S. Dollar’s safe-haven status. The USD surged across the FX dashboard.
In doing that, it broke the b-d trendline, ending almost three years of consolidation on the EURUSD pair. Here are some characteristics to consider when labeling a contracting triangle:
- the price should not pierce the two trendlines
- after the b-d trendline breaks, the focus shifts to the triangle’s apex
- find the apex by projecting the two trendlines further on the right side of the chart
- look for the apex to provide support and resistance
Using the rules from above, the apex of the EURUSD limiting triangle sits around 1.1030. By interpreting the price action that followed the triangle, we see that after the price got back above 1.1030, it didn’t return to it to this day.
The no piercing rule refers to the distance between the trendlines’ points. First, draw the trendlines to define the triangle. Next, check the price action between the two points that give the trendline. No parts of the two trendlines should be pierced by the price action in between.
Trading a Limiting Triangle
A limiting triangle has clear trading rules. To start with, the first thing to do is to place a pending order at the end of the d-wave. Using the same EURUSD example, it means placing a pending sell stop order by the time the price breaks below the d-wave. On such a move, the price also breaks the b-d trendline. Typically, the b-d trendline of a limiting triangle isn’t retested. Even in this case, the price doesn’t retest it. It just seems so, because the blue trendline is so thick. But a close look at the price action reveals no retesting.
The next thing is to place the stop-loss order. Always use the end of the e-wave for it. Finally, the take profit is the triangle’s measured move. That is seventy-five percent of the longest wave’s length. In this case, wave a seems to be the longest, so just calculate it and project it from the end of the e-wave.
Aggressive traders go long as soon as the price reaches the measured move. After all, if the price action to follow the limiting triangle is supposed to reverse, then going long makes sense. The chart from above shows how the limiting triangle fits into the overall Elliott Wave count. From left to right, there’s a five-wave structure corresponding to the impulsive move.
A small first wave followed by a running correction for the second wave. Next, the extended third wave formed, longer than 161.8% when compared with the first wave.
The limiting triangle appears as the fourth wave, just like Ralph Elliott stated in one of his numerous rules of the theory that bears his name. Finally, the triangle breaks lower, forming a terminal impulsive wave for the fifth wave. By the time it completes, the bouncing began.
When trading with the Elliott Waves theory, it is all about the overall structure to interpret. If you see that a triangle doesn’t pierce the two trendlines, think of the possibility that a limiting triangle may form. Next, remember that such triangles appear only as the fourth wave of an impulsive move or the b-wave of a zigzag. Check the structure to define which wave it is.
Finally, place the pending orders to trade the end of the triangle and the limited price action to follow. In doing that, you can trade the price action both ways: one in the direction of the underlying trend, and the other one in the opposite direction.