What's inside:

  • SIlver prices nearing a breakout following clean price contraction
  • Patiently awaiting indications for trade direction
  • Within days of a resolution, should lead to ~ $1 move

Early last week we examined the coiling price action in silver prices. The conclusion was drawn that if silver can continue along its narrowing path it would lead to a very well-defined symmetrical triangle.

After another week of trade, indeed it has, and is now on the verge of making a break for it.

I love these formations along with a couple of others, most notably the 'head-and-shoulders' pattern. Why? Because they are explainable and easy to understand. There is no real big mystery as to why they form, and while subjective, they don't require a good deal of interpretation like some of other forms of pattern recognition.

Take the triangle for example. As a natural function of markets, volatility oscillates between high and low periods like the rising and receeding of the tide. A triangle, or wedge pattern, is simply a contraction in market volatility. After some time has elapsed, whether a catalyst is involved or not, a breakout (expansion in volatility) occurs.

For a detailed explanation of the ‘head-and-shoulders’ pattern, you can read more here.

Simple stuff. Right?

Well, yes and no. Yes, in concept, but often times the contraction in volatility takes time off the clock before eventually maturing, making patience an utmost requirement. As we have recently seen in silver, had you bought and sold in anticipation of a breakout you would have found yourself getting 'chopped up' as the converging top and bottom-side trend-lines kept price neatly contained.

But once the top or bottom-side trend-line is cleanly broken, game on.

From a trend following perspective, a breakdown in line with the path of least resistance should offer a nice momentum breakout for short entries.

However, before momentum can kick in it will need to contend with a bottom-side trend line (2014) which helped forge a low in December.

Silver Daily: Jun '15 - Present

Silver Prices – Contraction in volatility nearing resolution

On this end, handling the bearish break will look something like this: Establish a partial position on a daily closing bar below the lower trend-line and then wait to see how it handles support at the 2014 t-line before becoming more aggressive. The end objective is set under $13, based on the potential measured move. This is calculated by the height of formation subtracted from the point of breakout. In this case approximately $1.

A bullish breakout against the prevailing downward trend could be a little trickier and probability of it failing to gain momentum is higher than the bearish continuation scenario. There is resistance in the $14.40/50 vicinity to contend with before a clearer path towards a measured move target over $15 can be achieved. The target also roughly coincides with a down-trend line extending back to 2013.

Personally, I tend to trade the countertrend breakouts with less size.

A potential tailwind for an upside breakout is if we see gold gain traction on the back of trader positioning still remaining near an extreme; in the past this has been a boon for gold. For further details on market positioning in gold, you can check out this piece. A swift dollar pullback would certainly help the bullish case, too.

On an ending note: We are within days of a resolution, and for those who have sat on the sidelines patiently, a nice reward could soon be store.

Want to learn more about how to manage trade set-ups like the one described today? I suggest checking out, 'Traits of Successful Traders'.

---Written by Paul Robinson, Market Analyst

You can follow Paul on Twitter at @PaulRobinsonFX or if you would like to email him personally with any questions or suggestions, you can reach him at instructor@dailyfx.com.