The classic Descending Triangle illustrates
the painful rollover from bull to bear market better than any other pattern.
But why does it work with such deadly accuracy? Most traders don't understand
how or why patterns predict outcomes. Some even believe these important
tools rely on mysticism or convenient curve fitting. The simple truth is
more powerful: congestion patterns in technical analysis reflect
the impact of crowd psychology on changes in price and momentum.
Shock and fear quickly follow the first reversal
marking a triangle's major top. But many shareholders remain
true believers and expect their profits will return when selling dissipates.
They continue to hold positions as hope slowly replaces better judgement.
The selloff then carries further than anticipated and their discomfort
increases. Just as pain begins to escalate, the correction suddenly ends
and the stock firmly bounces.
For many longs, this late buying reinforces
a dangerous bias that they were right all along. Renewed confidence
even prompts some to add to positions. But smarter players have a change
of heart and view this new rally as a chance to get out. As they quietly
exit, the strong bounce loses momentum and the stock once again turns and
fails. Those still riding the issue now watch the low of the first reversal
with much apprehension.
Prior countertrend lows present trading opportunities
to those familiar with double bottom behavior. As price descends
a second time toward the emotional barrier of the last low, short-term
traders step in looking for a good DB play. Price again stabilizes near
that prior value, encouraging new investors (with very bad timing) to enter
final long positions.
By this time, the stock's bullish momentum
has slowly drained through the criss-cross price swings. Relative
strength indicators now signal sharp negative divergence but price continues
to hold up well through this sideways development. Momentum indicators
roll over and Bollinger Bands contract as price range narrows.
This double bottom appears to hold as a weak
rally draws a third high. But this final bounce fades and traders
exit quickly. Shorts now smell blood and enter initial positions. Fear
increases and stops build just under the double low shelf. Price returns
for one final test as negative sentiment expands sharply. Often, price
and volatility then contract right at the break point.
The bulls must hold this line. However,
odds have now shifted firmly against them. Recognizing the imminent breakdown,
short-term traders use all upticks to enter new short sales and easily
counter any weak bull response. Finally, the last positive sentiment dies
and horizontal support violates, triggering the stops. Price spirals downward
in a substantial price decline.
|SEEK sketches a perfect Descending Triangle
reversal and breakdown following a 1998 rally. Sharp, parabolic rallies
often set the stage for dramatic topping formations. Note how the triangle
is also a variation of the Adam and Eve pattern AND a 5-Wave