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Technical Analysis of Stock Trends
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Friday September 03, 2010 |
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.
Descending
Triangle for Enron Corp.
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.
ascending
triangle 
symmetrical
triangle
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