Traders use the descending triangle chart pattern to help capture shorting opportunities.
While generally categorised as a bearish pattern, the descending triangle is typically a continuation formation, as a consolidation phase within a downward price trend. It can also be observed as a reversal pattern following a pronounced upward price trend.
Traders tend to use a downside breakout from a descending triangle pattern as good reason to hit the sell button.
A descending triangle is formed by two trend lines; one line is drawn horizontally intersecting previous price troughs that represent a support level, while the upper line of the triangle is a downward sloping line that is drawn through consecutive price peaks.
Traders tend to see a shorting opportunity when the price breaks out below the lower horizontal line as the price will often fall sharply once a meaningful move below this level takes place.
In general, a greater number of points along the lower trend line tends to make for the strongest descending triangle signal. It shows that this price level really has been a formidable point of support, so a breakout below it is likely to be all the more significant.
As a minimum requirement, the descending triangle formation requires at least two low points across the horizontal line and two points along a downwardly sloping upper line.
Trading volumes tend to diminish while the descending triangle pattern is maintained, defining it as a typical consolidation phase. It’s therefore crucial that a price breakout below the horizontal trend line is accompanied by higher trading volumes to ensure that it is a valid shorting signal.
A breakout below the support level could be an indication that big institutional investors are selling the asset, precluding an even sharper price fall.
On the other hand, if the price subsequently rises well above the horizontal support line then it could be an indication that a valid breakout from the descending triangle pattern has in fact not occurred. Instead, we could potentially witness a reversal of a long-term downward price trend.
Trading the ascending triangle
As an example, suppose bitcoin falls from $8000 to $7100. We then see a rise to $7700. The next downward price move sees bitcoin back at around $7100 again, while the next upward bounce sees bitcoin at $7500.
This pattern continues with bitcoin back at $7100, which we know to be the price point that denotes the lower horizontal line of the descending triangle. On the final upward price move in the pattern that forms the next point on the downwardly sloping upper line, bitcoin’s price is $7300.
When a breakout finally occurs, taking bitcoin down to $7000 on higher trading volumes, we take a short position. At the end of the trading day, bitcoin is priced at $6200 and we decide to close out our position, taking a large profit.
To obtain a price target for the trade, we can use the height of the triangle ($8000 − $7100) minus the breakout level. So, $900 - $7100 = $6200
We could choose to put on a stop loss to guard against a price recovery at the point of the last peak in the pattern. So, in this case, we could elect to implement a stop loss at $7300.
Following the breakout, the horizontal lower line of the original descending triangle pattern could be viewed as a key resistance level. In our bitcoin example, this is at $7100.