Trading Dow Pattern the Triangle Pattern (Part 2)

The second triangle: the Descending Triangle

One of the most common patterns under the Dow Theory is the Triangle Pattern. In this write-up, we will look into the Descending Triangle pattern and see how traders use it to determine their trades, how you can do the same and more!

Why is it under Dow Theory?

The whole reason why this theory is considered under the Dow Theory is because it follows the rules under the Dow theory which are as follows:

Types of Triangle Patterns

There are three types of triangle patterns: Ascending, Descending, and Symmetrical. Previously, we’ve already looked into the Ascending Triangle. Now, we will look into the Descending Triangle.

Descending Triangle:

The descending triangle pattern in trading is a bearish chart formation that can be used to predict a potential downward movement in the price of an asset

This pattern is formed over time as an asset’s price makes lower highs (this forms the sloping top line — or “resistance”) but struggles to fall below a certain level, which creates a flat bottom line. This flat line is known as the “support level” because the price seems to be supported there and doesn’t drop below it.

The descending triangle pattern is generally considered a continuation pattern rather than a reversal pattern. Continuation patterns suggest that the existing trend is likely to continue after a period of consolidation. In the case of an ascending triangle:

Existing Downtrend: The ascending triangle typically forms during a downtrend, with lower highs indicating waning buying interest.

Consolidation Phase: The pattern represents a period of consolidation where the price encounters resistance while forming lower highs. This suggests a temporary balance between buyers and sellers, despite the shrink in the balance.

Breakout Confirmation: The pattern is confirmed when the price breaks out below the horizontal resistance line. This breakout is seen as a signal that the buying pressure has lost to the selling pressure, and the downtrend is likely to resume.

Key Characteristics

Downward Sloping Upper Trendline: This is formed by connecting a series of lower highs. It shows that sellers are gradually able to push the price lower, indicating increasing bearish sentiment.

Horizontal Lower Trendline (Support): This is a straight line that connects the series of lows that occur at a similar price level. The support line indicates a price level where buying interest is consistent and strong enough to prevent the price from declining further.

Converging Trendlines: The downward sloping upper trendline and the flat lower trendline converge as the pattern develops, creating a right-angled triangle that points to the right.

How many ‘valleys’: If you consider a pair of through and peak as a ‘mountain’, then you should wait for at least 2 to 3 valleys to appear as part of the patterns before proceeding to your next step.

Formation period: There is no specific minimum or maximum. Generally, the whole pattern would usually form between a lower limit of 7–10 weeks and could go at an upper limit of a few months.

Trading Volume: Typically, the trading volume diminishes as the pattern develops. A significant increase in volume is often seen when the price eventually breaks below the support level, confirming the pattern.

What happens during a descending triangle formation?

What happens during this pattern is that people are starting to sell this stock slowly, and once they realize that a trend is forming, they panic sell which causes the price to drop significantly.

Much like its ascending counterpart, this trend can go the other way around if the price breaks through its upper trend line.

How to trade?

Confirmation: Sometimes, after breaking out, the price may retest the support level, which now acts as resistance. A bounce off this level can serve as a confirmation of the bearish trend.

In the example above, it’s a 50–50 ish example of how the triangle trade was confirmed, because if you see, just two days after the breakout, the price went right above the breakout line and stays there for a while.

Some traders would place their short right away and wait until stop loss is hit before they pull out, some would wait further — whereby if we’re talking about the example above, they might not enter into this trade, which is okay as well.

Set a Price Target: Traders often set a price target by measuring the height of the back of the triangle and then subtracting that amount from the point of the breakout.

In our example above, we can see that the price difference at the back of the triangle is around 15%.

So, your appropriate target for profit-taking should be somewhere around 15%, lower than 15% if you’re more on the safe side, and more than 15% if you want to play it riskier.

In this case, we manage to reach 15% and even more at August 2nd, 2011.

Set stop loss: The stop loss for a short position is usually placed somewhere around the top part at the beginning of the triangle. In the example we had, it would be somewhere around $18.53.

If you’re playing it safe, you can place it a below $18.53. If you’re taking more risk, you can place it a bit higher than that. How much is “a bit”? That would depend on your personal preferences.

Bottom line

Do note that identifying these patterns in the wild wouldn’t be as easy, and even if you do, there will always be a chance that the pattern doesn’t turn out as you thought it should be. These patterns are essentially a collection of experiences of many traders which stumbled upon a usual trend. Try to look for more indicators to confirm your deductions.

To minimize your risk, you can also try to master your pattern identifying skills while keeping your head abreast on value investing method.

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