Last Updated on 24 March, 2020 by Samuelsson
In technical analysis and trading there are many types of patterns and formations that try to predict the future movements of the markets. Some of the more popular patterns resemble different types of geometrical shapes, such as rectangles and triangles. In this guide, you’ll get to learn more about the “descending triangle”, which is one of the more popular price formations out there.
A descending triangle is a bearish price pattern that occurs in a downtrend, and signals that the bearish trend will persist. Still, in some cases, a descending triangle may appear as a reversal pattern at the end of a bullish trend. Nevertheless, it remains a bearish pattern regardless of the previous direction of the trend.
In this guide, we’re going to have a closer look at some of the more important aspects of the pattern. This includes:
- How to define a descending triangle
- How most traders use descending triangles
- Some techniques you can use to improve the performance of the pattern, in order to avoid false signals
How to Spot a Descending Triangle: Definition of the Pattern
Like we just mentioned, a descending triangle usually occurs in a negative trend, signaling that the bearish sentiment and direction are here to stay.
To make the definition easier to follow, here it comes in the form of a numbered list:
- There should be at least two lows that occur around the same level, which creates a horizontal line if they were to be connected with a line.
- There should be at least two highs, which form lower and lower, creating a downward sloping trend line when connecting with a line.
- It’s preferred that the volume contracts as the pattern forms, which suggests that market activity is low as market participants are waiting for a breakout below the base of the triangle.
Now, while these conditions apply to the descending triangle itself, you should also make sure that the market is coming from a negative trend that has been ongoing for some time.
Generally, the longer time period a trend has been on-going, the more likely it is that it will persist into the future. Market participants simply have become accustomed to seeing prices go in a certain direction, and therefore assume that they will continue to do so. In addition, there usually tends to be some fundamental factors at play that have supported the negative trend, and at least are more likely to do so going forward than not!
The stock market is a good example of a market that’s in a long term trend that’s backed by fundamentals. As you probably know, stocks always go up over time since the economy always will grow and improve over time. Therefore, we like to go long in stocks and equities, since our trades will be supported by the long term bias of the market.
What Does the Descending Triangle Mean – What Does it Tell Us About the Market?
As you probably have realized by now, descending triangles form as the market takes a short pause in an ongoing bearish trend, while gathering strength for the imminent breakout to the downside. In that regard, you could say that it’s a sort of consolidation pattern that’s reminiscent of the rectangle pattern.
Now, every pattern tells us something about the prevailing market forces and their impact on prices. And when it comes to the descending triangle pattern, there are a couple of things that are worth noting. Let’s look at them one by one!
- The lows of the triangle remain at the same level, which suggests that sellers try to push the market below that level to continue the bearish trend, but simply fail. The bullish resistance is too big.
- However, at the same time, the highs of the pattern get lower and lower, which shows that sellers remain strong and manage to keep prices from going higher.
- In the meanwhile, market volatility decreases as the market moves further into the tightening triangle. Typically, the lower the volatility of a market, the bigger moves you can expect as the market finally breaks out. Put in another way, extremely low volatility usually signals that market participants are unsure, and the more uncertainty there is, the higher the chance that a breakout will become explosive.
- The long term market trend is negative, which tells us that it’s very probable that the overall market sentiment is bearish, and should support a bearish breakout to the downside.
In conclusion, the main factors that make the descending triangle a bearish pattern could be said to be the long term falling trend, in combination with the lower highs.
How to Trade Descending Triangles
Having had a look at the definition of the descending triangle pattern, we’ll now move on to discussing some trading setups.
Just keep in mind that while all information about techniques and tactics that we share below show you how these patterns are used by most people, it doesn’t mean that they’re profitable approaches. The results you get are going to depend a lot on the timeframe and market you choose, and this is why we always recommend that you learn and make use of backtesting to ensure that the concepts and strategies you trade work well!
With that said, let’s go through this step by step!
Step 1: Identify the Descending Triangle
The first step is to identify the descending triangle in accordance with the definition that we laid forward earlier in the article. However, this isn’t as easy as it might seem, as it can be hard to identify patterns of different kinds before they have been finalized.
Normally we demand that there must be a minimum of two highs and two lows, which is what it takes to draw the two lines that mark the start of the pattern. Of course, the more points the lines connect the more certain you can be that the pattern indeed is forming.
Step 2: The Breakout
The next step is to wait for the breakout below the lower line of the triangle, which confirms that the market is headed downwards.
While this might seem simple, you’ll find that not all breakouts are worth following. On the contrary, many breakouts will prove to be false where the price reverses back into the body of the triangle.
On common technique to reduce the impact of these false breakouts is to add a distance to the breakout level. That way you won’t be fooled by those times when the market just slightly moves past the breakout level, and increase your chances of catching the real breakout.
Another technique that’s used by quite some traders is to not act on the initial breakout, but wait for the market to return to the breakout level. Then, as soon as it becomes apparent that the breakout level remains respected, they enter the market.
In the image below you see an example of this very setup. The market broke out and then revisited the breakout level, before it finally turned down in the anticipated direction.
Step 3: Stop Loss and profit target placement
Many price patterns have some estimated price targets inbuilt, and the descending triangle is no exception.
- Once the market breaks out of the triangle, it’s expected to move a distance equivalent of the widest distance of the triangle pattern. Therefore many traders choose to take profits once the market has moved that far.
- The stop loss is usually placed just slightly under the breakout level, which gives the market some room to breathe, while it still will cut off your trades if the breakout proves false.
Below you see an example of the stop loss and profit target placements.
Now, do remember that these rules are by no means final. You may try other approaches that you think work better with the markets and timeframes you work with. However, as a general rule of thumb, try to keep the risk-reward ratio at 2:1 or more. This means that any potential loss would only be half the size of any potential winner.
How to Improve the Triangle Pattern
Now that we have had a look at some of the methods traders use to trade the triangle pattern, it’s time to go on to some techniques you could employ to increase the likelihood that you only trade those triangle patterns that have the best odds of success.
We’ll present some of the methods that we have found useful in our own trading strategies, and that we believe could be successfully applied to the triangle pattern, during the right circumstances.
Please do remember that you always should validate everything before you decide to trade it. Our article on backtesting goes into more depth on this topic!
With that said, here are three methods you could use to decrease the chances of acting on false breakouts!
The original definition of a triangle does involve volume, but that doesn’t mean that you can’t impose additional conditions.
One approach you could use is to look at the volume of negative days relative to negative days as the triangle is forming. That way you might get a better sense of the market sentiment, which in turn could have an impact on the likelihood of a negative breakout.
The general view is that the more volume there is on down days, the more bearish is the market sentiment. In other words, that’s what we might want to demand.
2. The Length of trend
We did discuss this briefly earlier in the article, but it’s worth mentioning again.
If the bearish trend that precedes the triangle is long and consistent, it’s much more likely that we’ll see a breakout to the downside. Again, market participants are expecting prices to fall as they have done so for a long time, and there usually are some fundamental reasons for the bearish trend that are likely to hold true going forward as well.
Gaps occur a lot when the market turns volatile like is often the case once it breaks out from a triangle pattern. Sometimes the market will gap right past the breakout level, which makes it impossible to enter at that level.
Now, gaps may also occur inside the triangle, and their direction may tell us quite a lot about the prevailing market sentiment. For example, if most gaps occur downwards, it tells us that bears are in control, whereas positive gaps would indicate that bulls are in charge at the moment.
Descending Triangle VS Pennant
If you have heard about the pennant pattern, you may wonder that differentiates the descending triangle from most pennants.
Well, both patterns are quite similar, but there are some differences. Here are the main two:
- While the lower line of the descending triangle is horizontal, the pennant pattern has two sloping lines that converge.
- The other difference is the time it takes for both patterns to form. A pennant is usually just a few bars/days long, whereas the descending triangle should take at least a week or longer to form.
You’ll find that many people refer to triangle patterns and pennants interchangeably. It gets especially hard to identify the difference when the length of the pattern resides around the 1-week mark, which is generally when a pennant turns into more of a triangle.
Descending Triangle VS Symmetrical Triangle
In addition to the descending triangle, there are two other types of triangles you might want to know about. Those are:
- Ascending Triangles
- Neutral triangles
As it sounds, the ascending triangle is the inverse version of the ascending triangle, and is a bullish continuation pattern.
The symmetrical triangle is a triangle that is made up of lower highs and higher lows, which leads to that both lines are sloping and converging. The meaning of the pattern is then decided by the direction of the following breakout.
What’s the Success Rate of Descending Triangles?
Even though you may find statistics about the profitability and hit ratio of patterns like the descending triangle, they should be taken with a big grain of salt. The reason is that there are so many variables that go into identifying these somewhat arbitrary patterns, which means that the result you get will vary a lot depending on the definition.
Here are some other factors to consider:
- Historical Patterns are clear with hindsight: When looking at a chart of historical price movements it’s always easy to identify price patterns. However, in the heat of the moment, that’s not nearly as easy. If you review historical price data the chances are that you’ll choose to skip some triangles that formed due to reasons that seem obvious with hindsight, but were very unclear as the pattern was forming.
- The Timeframe: There are very few patterns and strategies that work well on most timeframes. Thus, the performance metrics you manage to get might not pertain to the timeframe you trade yourself.
- The market: Just as in the case with the timeframe, all markets aren’t equal. For instance, the types of strategies that work well on crude oil will be vastly different from those on the S&P500, just to name one example.
With all these factors at play, you should never take any number you find for granted. Perform your own backtests instead, to get verifiable numbers that you can trust!
We hope that this guide to the descending triangle pattern has provided answers to your questions about the pattern, and how you could approach it trading wise.
Now, before ending there is one critically important aspect we’d like to stress once again:
Always test the strategies you’re going to trade before you put any real money on the line. There are so many traders that lose most of their money, simply because they didn’t validate their strategies. We’ve mentioned it several times, but our guide to backtesting and how to build a trading strategy are excellent resources that will help combat this issue.