Upcoming Trade Set-Up in Cotton: How Contracting Triangles Precede Dramatic Thrusts in Price
A lesson in forecasting dramatic price reversals in real time using contracting triangles

By Nico Isaac
Fri, 28 Dec 2012 16:00:00 ET

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 – and a developing trade set-up in cotton

First, there's the basic definition and diagram of the pattern:

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 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. This is where the two examples below come in.

1) The first example covers a long-term time frame and comes from the December 2010 Monthly Futures Junctures. There, Senior Commodities Analyst Jeffrey Kennedy, editor of EWI's Futures Junctures Service, presents 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% to a one-year low – fulfilling the expectations of a triangle's "thrust."

2) For the second example of a contracting triangle at work in real-time, we look to the Feb. 23, 2012, Daily Futures Junctures, where  Kennedy presents this chart of coffee on a near-term time frame.

Price action in coffee off the 197.80 low is clearly corrective. Specifically, on the smaller time frame charts, it appears the move up is a small contracting triangle. If correct, then we can expect the resumption of the larger down trend at any time.

Right away, the larger downtrend in coffee resumed and has continued unabated to the two-year lows we see today.

Now that we've covered the past in contracting triangle history, let's move on to the future.

On Dec. 27, Daily Futures Junctures presents a detailed price chart of cotton that shows a distinct, eight-month-long contracting triangle nearing completion. Kennedy says, "The stage is set" for a thrust in price to follow.

Read the Dec. 27 Daily Futures Junctures now to discover which direction cotton will thrust next.

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