Inverted Triangle Wave Strategy

Introduction

The strategy to be discussed is a variety of the Elliot wave pattern known as the inverted triangular wave strategy. This pattern is very rare but when it occurs, it can be deployed for profits. They resemble a symmetrical triangle in behaviour, but the trend lines which border this shape are divergent and not convergent.

Indicators

This strategy is not dependent on indicators. However, the coloured MACD indicator can be used to confirm the entries for any trade made with this strategy. This strategy can be executed on any time frame, but it is advised that the trader should not use any time frame lower than one hour for the trade analysis and setup.

 The Strategy

This strategy is hinged on the complete adherence to all rules regarding the Elliot wave patterns. The price action must form an ABCDE wave pattern. The direction wave A follows is what will determine if the pattern will end up bullish or bearish. All waves must be contained within the trend lines that border the divergent triangles. Some of the waves may be single, while others may be zigzag in nature.

The direction of the Wave A determines how the pattern ends. Usually, an initial wave creeps into the inverted triangle, then heads towards point A from where wave A forms (see snapshots below). Wave A also has the smallest move of all waves in terms of price range.

a) Long Trade

It is very difficult to distinguish the bullish inverted triangle from the bearish one, since both triangles basically move in the same direction. What sets the two apart is the direction of the wave A. Wave A usually moves in the direction of the expected breakout price move.

 bull_angle

So for a long trade, we are looking for an initial wave which creeps into the inverted triangle  from below, followed by a downward wave that ends at point A on the lower trend line, from which Wave A takes off to the upper trend line. The first example we shall examine is that of a divergent wave triangle pattern which shows a bullish price pattern.

bull_angle2

 This chart is a GBPUSD hourly chart which shows the following:

  1. The ABCDE Elliot wave pattern forming an inverted triangle.
  2. The initial wave (in red to the left of the chart), which hits the upper trend line, then heads down to point A from where wave A starts. So we expect price to eventually breakout to the upside.

There are two possible ways to trade this move.

  • Completion of the ABCDE Elliot wave to point E confirms that the long trade is good to go. Long trade entry can be made at point E to follow the wave to the upper trend line, and possibly beyond as price breaks out of the upper trend line.
  • The trader can decide to wait until the breakout from the upper trend line is confirmed, then a Buy Limit order can be used for the trade entry as price attempts a pullback to the broken upper trend line which is now acting as a price support.

Stop Loss and Take Profit Settings

For the first trade scenario (long entry at point E), the stop loss is set a few pips below the lower trend line. The Take Profit is set at the upper trend line as the 1st target and if price breaks the trend line, a trailing stop can be used to follow the trade to its logical conclusion.

For the second trade scenario (Buy Limit after breakout), the stop loss is set below the upper trend line as shown in the snapshot, and the Take Profit could be set at either double or triple the stop loss, or using any other technically sound criteria for taking profits.

b) Short Trade

The next example is that of a short trade, which is a reverse of the long trade setup.

bear_angle

This chart is a GBPUSD hourly chart which shows the following:

  1. The ABCDE Elliot wave pattern forming an inverted triangle.
  2. We see wave A starting from the upper trend line. So we expect price to eventually breakout to the downside.

There are two possible ways to trade this move.

  • Completion of the ABCDE Elliot wave to point E confirms that the short trade can be made at point E to follow the wave to the lower trend line, and possibly beyond as price breaks out of the lower trend line.
  • The trader can decide to wait until the breakout from the lower trend line is confirmed, then a Sell Limit order can be used for the trade entry as price attempts a pullback to the broken lower trend line which is now acting as a price resistance.

 bear_angle2

 

Stop Loss

The stop loss for the first trade setup is set above the upper trend line, with the Take Profit set at the lower trend line for the first target and if price breaks to the downside, a trailing stop can be used to keep chasing more profit while protecting profit already made.

The second trade will kick off from the broken lower trend line. Stop loss is therefore set above this line, with Take Profit left to the trader’s discretion.

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