Before I get started, I would just like to thank Davis Martin one last time—yesterday he announced his retirement from the service.
I’ve been working alongside Davis for the last two months, but I’m now ready to take over full-time.
That said, let’s get on with today’s trading lesson…
Ever notice that some patterns seem to work more than others?
I can say I have.
And that is why I love to trade the Descending Triangle chart pattern.
It really does have logic behind it… Unlike most chart patterns out there.
If this pattern is traded correctly – you will be making it rain. I’m talking about explosive breakouts traders drool over.
Want to learn the secrets to this pattern?
What is a Descending Triangle
A Descending Triangle is a set of lower highs that are approaching an area of support.
Here is how it looks.
This is an extremely bearish chart pattern that shows the sellers are in complete control.
For 2 reasons:
- Strong selling pressure
- Sell stop orders
Strong Selling Pressure
Why does this happen?
This is due to stronger than average selling pressure and a lack of buying pressure throughout the day.
Usually, as the price drops lower there is more demand that comes in to push the stock price back higher.
But this is not the case for the Descending Triangle.
From the price dropping and the lack of buyers, sellers continue to push the price even lower.
Sell Stop Orders
There is one order type that is the equivalent of an accelerant to a fire, and that is a stop order in the stock markets.
Textbooks will instruct many traders (who are long this stock) to place their stop levels right below the support.
And this is the problem.
As more and more traders start to see the same pattern the stop losses accumulate over time.
Then the price heads lower from sellers being in control of the stock.
Which triggers more selling pressure from the stop losses being executed.
And in turn, brings in more sellers…
The cycle repeats until all the stop orders are taken out and the buyers step in again.
This can turn into a feeding frenzy in the markets.
Let’s see how we can take advantage of this natural phenomenon..
How to catch the move before it happens
The most common way to trade this pattern is to look for an opportunity to go short when the price breaks below Support.
But this is not so easy…
Let me explain the 3 rules to ride this ride.
- Trade well defined patterns only
- The bigger the support the better the breakout
- Use target exits and trailing stops to your advantage
1. The breakdown should occur in a well-defined Descending Triangle
The reason you want to go short a well-defined pattern is to remove any “false positives” that may come up.
I mean…the last thing a trader wants is to be getting into a bearish pattern when a bullish pattern is actually setting up.
Since you are placing shorts near other long stop orders, you can get in right as volatility explodes and selling pressure is overpowering the buyers.
Here’s an example…
2. The more support is tested, the better
When prices test support levels in a stock, it does 2 things:
- Naturally attract more buyers
- Significantly increase the number of stop orders that are below this support line.
This is great news for a breakout trader!
Once the price breaks below support, this cluster of stop orders will dramatically increase the selling pressure to the downside.
…Like an accelerant to a flame. Volatility should explode.
3. How to time your entry and set a stop order
The problem with waiting for a confirmation signal is that the market can make a dramatic move and you could end up chasing the stock lower.
This is why I prefer to use a sell stop order and enter the trade once the price breaks below my support.
And for my stop loss?
I recommend looking at the most recent pivot (lower high price) to set your stops at.
If price reaches this level, it has confirmed a false Descending Triangle chart pattern.
In other words, GTFO.
Here is what I mean…
In the image above, the Descending Triangle was not “strong enough” for many reasons.
In turn, price traded higher on a breakout and once the pattern was invalidated it continued higher.
By placing a stop loss right at the high of the prior lower high, a trader would have been given the “most likely” opportunity to trade this pattern.
What if I don’t like to trade breakouts? Is there an alternative setup?
Just like most patterns, there are alternatives to their basic structure.
And Descending Triangles are not different.
3 Steps To Entering Late:
- Wait for price to re-test breakout
- Let price confirm direction
- Place stops at or above prior highs, not support level
Here’s what I mean…
In this image above, you can see the 3 steps well defined.
- Price broke out of the lower support but the trade was missed by the trader. The price then came back and re-tested the support level.
- Price confirmed direction by having a strong bearish candle appear at trend line support (ie. Bearish Engulfing Pattern)
- Stops placed at or above prior highs ( not support level) will guarantee that you remain in the trade as the price will continue lower
Descending Triangle: How to find your target price
There are two main ways to exit winnings trades
- Price targets
- Trailing stops
This is a technique where a chart pattern is completed after moving a measured amount in your favor.
For a Descending Triangle, this distance is defined as the difference between the highest high and the support line of the triangle body.
This works in 3 key steps:
- Calculate distance between highest high and support level of Descending Triangle
- Take distance and project it from the breakout point
- The “future” price is where you exit your trade
Unlike the target price, where a trader will take himself out of the markets…
This idea is to let the markets take you out of the trade instead.
Trailing stops are the key to riding massive winners.
Here’s what I mean…
There are 3 steps to remember for how it works…
- Decide on the trend duration (short, medium, long)
- Trail stop with appropriate moving average (20 EMA, 50 EMA, 100+ EMA)
- Exit when price crosses moving average
So one thing to remember…
There is no right way to approach trading this strategy.
But when you time breakouts correctly you can see explosive profits.
For some, a breakout is best and for others, waiting for a re-test is more their style.
It all depends what you feel comfortable trading at the end of the day.
There is no such thing as a “best” trading strategy, indicator setting, or whatever. The idea is to find what fits your trading style and tailor the theory to fit your needs.
- Descending Triangle shows that buyers are not in control and price is likely to move lower with sellers taking control of the stock for the near-term momentum.
- You can trade a breakout or re-test of the support level of the triangle
- The more times the support is hit, the weaker it becomes
- You can exit winners using profit targets or profit trailing stops