The 50% Line

Contracting triangles are one of the most common forms of consolidation and they are coming in two forms: continuation and reversal pattern.

            Under the Elliott Waves Theory, a contracting triangle that acts as a reversal pattern (price exits the triangle in the opposite direction than the one it initially entered) can only be found in corrective patterns/counts/waves, and they can be: b waves in flats, part of a leg of a contracting triangle of a higher degree, b waves in elongated flats, the end of a complex correction like a double or even a triple combination, etc.

            Same theory states that a contracting triangle is most likely to be found as a continuation pattern, and in this case it can only be found as a b wave in a correction or, most likely, as a fourth wave, in an impulsive move or an ending diagonal/terminal impulse.

            While both statements above are true, what is valid for both of them is the fact that a contracting triangle is formed out of five different legs, and each and every one of this legs are coming in the form of threes (meaning corrective, not impulsive waves of a lower degree). Each leg of a contracting triangle is supposed to be smaller than the previous one, (the name contracting suggests that), but it is not mandatory that the first wave (wave a) to be the longest one.

            It is typically for wave a to be the longest wave and this is the situation I would like to take into consideration as it is most likely to happen. However, even if the b wave is the longest wave between the five waves a contracting triangle has (a-b-c-d-e), the principle I will describe below is still valid for both cases, as you can see from the chart attached below.

            The image below is a contracting triangle on the usdcad weekly chart and the contracting triangle that you are seeing is most likely part of a complex form of correction, a double combination in this case and it is acting as a reversal pattern. The chart shows the moment the contracting triangle forms, and, in order to have an educated guess about the possible end of the triangle (basically to try to identify the end of the e wave) is to measure he length of the longest wave in the triangle (in this case wave a) and look for the 50% line as this is the most likely place for he contracting triangle to end. The 50% line should also act as a pivotal level for price action withing the triangle, so it should be taken into consideration as early as possible by the time we have confirmation we are looking at a contracting triangle (look for elongated flats to be part of a leg of a triangle or even the entire leg of a triangle). 

There are situations though when the a wave in a contracting triangle is not the longest wave, and many traders are confused and do not know what to look for next. Well, the principle is the same, in the sense that the 50% line should be drawn still by measuring the longest wave in the triangle (and this time the b wave, as this is the only other possibility) and look for the 50% retracement level, as this is the most likely value for the triangle to end. However, in this case, the 50% line should be interpreted more as having an arbitrary value, in the sense that the e wave is tricky when price consolidates in such a triangle, like is the example below. Here, on the eurusd daily chart, this contracting triangle, while still actual and valid, seems to be a continuation pattern in which the b wave is the longest wave withing the triangle’s waves and the whole triangle to be part of a B wave of a larger degree.

 

            In conclusion, whenever you are seeing price is consolidating in a contracting triangle, regardless the time frame, and want to have an educated guess about the level it may break, all one needs to do is to measure the length of the longest wave within the legs of the triangle, look for the 50% level related to that leg, and draw a horizontal line. That level is the so called 50% line of the contracting triangle and represents the ideal place for the triangle to end.

This article is a contribution by John from Forex Brokers Hub