Hello friends and welcome to another informative podcast by Angel One.
Did you know that if you're outdoors in a fairly open space (like in the ocean), you can actually spot the rain approaching for miles? If you're not a fan of the rain and witness vertical lines forming between the sky and the ground over the horizon it's probably time for you to find shelter because these lines indicate a downpour.
Similarly, when traders are able to draw a very specific set of lines on a stock graph, they expect the stock price to decline. This specific set of lines is what traders refer to as a descending triangle pattern. This pattern is formed when the stock price high gets consistently lower (forming a diagonal, descending line) while the stock price low remains consistent, (forming a straight line). The two lines - referred to as the upper and lower trendlines respectively, together make a sort of triangle shape.
When traders notice a declining triangle pattern, they immediately look for the stock price to fall below the (straight) lower trendline. This movement of a stock price breaking out of its recent trajectory (on either side of either trendline) is referred to as a breakout.
Of course, specifically in the case of the descending triangle pattern, traders are looking for a breakout that occurs below the lower trendline. In other words, the prediction is set in motion when - amidst a descending triangle pattern - the stock price reaches a lower-than-seen-recently low.
They consider this breakout amidst a declining triangle pattern to be a sign that the stock price will continue to drop. The common assumption is that the stock price will continue to fall at the same rate, or alternatively, the pace might even pick up.
As a result, upon spotting this sign, traders tend to short their trades, that is, they tend to sell their trades with the hope of buying them back at a much lower rate. Since many traders are likely to react to a declining triangle pattern, this might serve to drive the prices down even further. The stock is now knee-deep in a bearish cycle.
Because prices are expected to continue declining, descending triangle patterns are categorized as continuation patterns, along with their counterpart, the ascending triangle pattern.
Besides being forewarned about a potential continued decline in the stock prices, traders use the descending triangle pattern to set their stop loss and target price. For instance, traders set their target price at the point on the graph which is equal to the entry price minus the distance between the two trend lines.
A few points that traders should consider while using the descending triangle pattern for technical analysis:
Consideration number 1:
The descending triangle pattern must be clearly differentiated from its counterpart, the ascending triangle pattern because while both patterns fall under the umbrella of continuation patterns, traders peg different predictions for each of them. When traders spot an ascending triangle pattern they predict a price movement in the direction of wherever the breakout occurs - in other words they don't necessarily predict that prices will decline.
Consideration number 2:
Like its counterpart, the higher the number of stock price highs and lows that line up to display a descending travel pattern, the higher the likelihood of the stock price declining when a breakout is spotted.
Consideration number 3:
If you see lines appearing between the sky on the ground over the horizon, it is a sign that a rain shower is approaching. But if the lines fade away or move away from you or stop entirely, you can safely assume that the shower is not coming your way after all. Similarly, if the price breakout moves in the opposite direction than anticipated, you can safely assume that the prediction of a continued or more pronounced downtrend, has proven faulty. (remember that traders anticipate that the price will break out below the lower trendline). In other words, another prediction based on other parameters will be required.
Consideration number 4:
Descending triangle patterns like all technical indicators, offer traders a snapshot based on which they can make an informed prediction and an informed decision based on the said prediction. They cannot however be treated as a definitive sign that the stock price will move as predicted. Traders should not assume that the appearance of a descending triangle pattern is a guarantee of anything.
On that cautionary note, we conclude our podcast but not before a one last note of caution: never rely on a single parameter while making a stock price prediction. Stock prices are influenced by a large variety of factors. Make sure to stay up to date with news related to the company linked to the said stock. Prices could have been in a state of decline … maybe because the company is found to be deep in debt…..but the stock price could do a complete about turn if the company announces some good news like a new investor or a merger or an acquisition. In fact a situation like this was witnessed very recently in the Indian stock market, in the case of a listed Ayurveda company.
To learn more about the various patterns and technical indicators out there listen to our podcasts and also try out our videos.