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Descending Triangle
Chart Patterns - Continuation - Descending Triangle
Technically speaking, an descending right angle triangle is a decline to a new low on news followed by a kick back rally to an intermediate resistance level, a second decline to test the recent low followed by a second rally toward but not through intermediate resistance and finally a decline to fresh new lows on strong volume.
Why Does it Happen?
As you might imagine, the descending right angle triangle is a mirror image of the ascending right angle triangle. Like the ascending triangle, the pattern consists of a right angle triangle formation that follows a lengthy trending period. In the case of the descending right angle triangle, the pattern takes shape after a period in which the stock in question has fallen from favor. This fall from grace may be the result of an earnings warning, product delay, lawsuit or negative guidance from management but it is fairly certain that the root of the price weakness is poorer fundamentals. For weeks the stock trends lower with no bottom in sight. Wall Street analysts become extremely bearish and the stock looks like a lost cause but as a fresh new low is created, buyers suddenly emerge. In most cases this initial buying will come from serious long term investors (smart money) that feel the stock is reasonably priced. These investors have strong hands and all things being equal, they will hold the stock but they are not willing to pay prices in excess of what they feel to be fair value. In short, they look at the position as a work in progress, since the near term fundamental outlook is poor they see no need to "chase" the stock higher. This initial round of buying by longer-term investors creates a short term bottom (bottom#1). As days pass some professional traders start to realize that there are strong bids for the stock at bottom#1 and the technical and emotional selling that had plagued the stock subsides. Slowly the stock begins to move higher. Although this advance may be aided by positive Wall Street analyst comments or more favorable news flows, volume remains exceptionally light. The stock continues to move higher until there is another negative fundamental development. At that point sellers return and a reaction high is established. As we will see, this point is vital in the classification of this pattern. The continued negative fundamental news and poor sentiment for the stock lead to more aggressive selling and once again the stock drifts back to the bottom#1 level. Given the negative sentiment a decline through that level seems assured but longer-term buyers renew their efforts, volume increases and the stock holds the most recent lows, establishing bottom#2. With two solid bottoms (support) now in place a new group of buyers enter the picture. Sensing that the buying is entrenched speculators begin to buy new positions in anticipation of a big move higher -- the only problem is the longer-term buyers are not willing to chase the stock. As the price rallies, volume slows significantly, in fact, so slow is volume that the stock fails to move beyond the reaction high. Buyers relent and price begins to falter. Within a few days the stock is trading back near the level of bottom #1 and #2. Speculators begin adding new long positions in anticipation of a rally but the selling continues. Just as longer-term buyers are getting ready to buy a new negative fundamental development occurs and the stock opens dramatically lower, falling well below the levels of bottom #1 and #2. This breakout leads speculators to panic and sell existing long positions for a loss. Longer-term investors are also forced to rethink their strategy in light of the news and some liquidation begins creating a huge imbalance between supply and demand. A new leg lower unfolds. Weeks later the stock trades significantly lower.
How are Technical Targets Derived?
The technical target for a descending right angle triangle is derived by measuring the vertical height of the triangle and applying this length to the new breakout level.
Vital Signs
Descending
triangles are among the most reliable of all technical
patterns because both supply and demand are easily defined.
The defining
characteristic of descending right angle triangles is the
pattern of declining highs and a series of equal lows.
This combination of points can be connected to form a right
angle triangle. If a stock violates any part of the triangle
during its formation the pattern it should be considered void
and trading positions should be abandoned.
Triangles are
about indecision and as such volume should slow noticeably as
the pattern is being constructed. It is most important that
volume surge as the stock declines through the reaction low.
This tells the technical trader that demand has been absorbed
and the next leg of the bear phase is about to begin.
Downside breakouts often lead to small 2-3% declines followed by an immediate test of the breakout level. If the stock closes above this level (now resistance) for any reason the pattern becomes invalid.
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