by Nico Isaac
Updated: December 20, 2016
Schoolchildren may be out for the winter break, but class is always in session here at Elliott Wave International.
On the syllabus for today is the Elliott wave pattern known as the contracting triangle. This pattern, like all 13 Elliott wave configurations, can occur in any financial market at any given time frame -- from equities to ETFs, currencies to commodities.
First, there's the basic definition and diagram of the pattern in a bull and bear market:
A contracting triangle is a 5-wave, corrective move labeled A through E marked by converging trendlines and sideways price action. Each wave subdivides into 3 smaller waves. Contracting triangles can form by themselves only in the wave 4, B or X positions. In other words, part of the importance of a triangle is that it introduces the final wave of a sequence.
Also, after the pattern is finished compressing, it then expands in a powerful move known as a post-triangle "thrust."
It goes without saying that, because contracting triangles precede the final wave of a sequence, they make for ideal trade set-ups to position for the powerful thrusts that follow. This reliable trait of triangles makes them a favorite among technical traders. (Some technicians call the pattern a "wedge.")
But it's one thing to say how invaluable contracting triangles are; it's another thing entirely to show it.
Here, we go back to the December 2010 Monthly Commodity Junctures. There, our Senior Commodity Analyst, Jeffrey Kennedy (also the editor of EWI's Commodity Junctures Service) presented the following price chart of sugar that showed a complete, multi-year contracting triangle:
What is noteworthy about this price chart is the apparent fourth wave contracting triangle. ... This pattern is significant because triangles ... introduce the final wave of a sequence. Put simply, sugar has more to go as we move into 2011. Even so, the recent formation of the contracting triangle strongly suggests that sugar is forming its final wave up.
From there, sugar prices did, in fact, have "more to go." The market continued to rally until hitting a 30-year high in early February 2011. From there, sugar prices melted more than 40 -- fulfilling the expectations of a post-triangle "thrust" and a reversal that follows.
Now that we've covered the past in contracting triangle history, let's move on to the future -- the future of a major global currency exchange rate.
On December 20, our Currency Pro Service published the following chart of this popular U.S. dollar pair:
You've probably guessed what forex market we're talking about. If not, here's a hint: It rhymes with "schmeuro."
As you can see, here too our forex analysis identified the end of a massive, multi-year long contracting triangle -- with a post-triangle thrust already well underway.
The implication? One simple (and bearish) scenario that's hard to sugar-coat and whose name rhymes with "schmarity."