7# Descending Triangle (Continuation Pattern)

Ascending and descending triangles are also referred to as "right-angle" triangles.

Generally, a triangle pattern is considered to be a continuation or consolidation pattern. Sometimes, however, the formation marks a reversal of a trend.

Descending triangles are generally considered bearish. From a time perspective, triangles are usually considered to be intermediate patterns. Usually, it takes longer than a month to form a triangle. Seldom will a triangle last longer than three months.

What does a descending triangle look like?

In this "flat-bottom" triangle, the bottom trendline is horizontal and the top trendline slopes downward. The pattern illustrates lows occurring at a constant price level, with highs moving constantly lower.

The breakout, in other words, should occur well before the pattern reaches the apex of the triangle. To take the measurement, begin by drawing the two converging trendlines.

Measure the length of the triangle from its base to the apex. Next, plot the distance along the horizontal width of the pattern where the breakout should take place. If prices remain within the trendlines beyond the three-quarters point of the triangle, technical analysts will approach the triangle with caution. Typically if prices don't breakout of the trendlines before that point, the triangle "begins to lose its potency" and prices will simply drift out beyond the apex with no surge in either direction.

2. Price Action - With its "flat-bottomed" shape, the descending triangle indicates that sellers are more aggressive than buyers. The pattern typically emerges when buyers feel that the stock is overvalued and decide that the fair value is at a specific lower level. These buyers are prepared to purchase the stock if it hits that specific price level. The floor does not hold because demand wanes - possibly buyers have run out of money or interest in the stock. Once the downside breakout occurs, the stock price continues to fall.

3. Measuring the Triangle - To project the minimum short-term price objective of a triangle, an investor must wait until the price has broken through the trendline. When theprice breaks through the trendline, the investor then knows whether

the pattern is a consolidation or a reversal formation. To calculate the minimum price objective, calculate the "height" of the formation at its widest part - the "base" of the triangle. The height is equally determined by projecting a vertical line from the first point of contact with the trendline on the left of the chart to the next point of contact with the opposite trendline. In other words, measure from the highest high point on one trendline to the lowest low point on the opposite trendline. Both these points will be located on the far left of the formation. Next, locate the "apex" of the triangle (the point where the trendlines converge). Take the result of the measurement of the height of the triangle and add it to the price marked by the apex of the triangle if an upside breakout occurs and subtract it from the apex price if the triangle experiences a downside breakout.

4. Duration of the Triangle - As mentioned before, the triangle is a relatively short-term pattern. It may take up to one month to form and it usually forms in less than three months.

5. Forecasting Implications - The descending triangle is considered to be bearish. Bulkowski, however, warns that only 55% of developing descending triangles actually prove to be bearish. However, if investors wait for a valid breakout, then

the success rate increases to 96%. Statistics compiled by Bulkowski show that descending triangles are less likely to hit their target prices than ascending ones. According to Edwards and Magee, volume confirmation is more important for ascending triangles than descending ones.

6. Shape of Descending Triangle - Prices should rise to hit the upper trendline at least twice (two highs), then fall away. Prices should fall to the lower trendline at least twice (two lows), then rise. The horizontal bottom trendline need not be completely horizontal but it often is and, in any event, it should be close to horizontal.

7. Volume - The descending triangle, volume tends to be slightly higher on dips and lighter on bounces.11

8. Premature or False Breakouts - Triangles are among the patterns most susceptible to this phenomenon. Because the pattern can be either a reversal or continuation pattern, investors are particularly susceptible to false moves or, at the very

least, confused by them. In addition, because volume becomes so thin as the triangle formation progresses to the apex, it takes very little activity to bring about an erratic and false movement in price, taking the price outside of the trendlines.

Descending 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.

The technical target for a descending triangle is derived by measuring the vertical height of the triangle and applying this length to the new breakout level.

• 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.

Descending Triangle is a mirror image of the Ascending 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 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.

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