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The Descending Triangle

07/19/00 10:26:02 AM
by Han Kim

There are many reversal patterns and among them, the triangle pattern is one of the most significant. However, reversals do not always occur.

Security:   ORPH
Position:   N/A

The descending triangle can signal the reversal of an uptrend in the market being charted. It is formed when a runup in a security's price levels off and is followed by a series of lower highs and relatively equal lows. Figure 1, of Orphan Medical Inc. [ORPH], illustrates a descending triangle pattern. In the ORPH chart below, a trendline was drawn connecting the descending peaks, and another line connecting the valleys. These lines were extended to the right until they formed a descending triangle. Volume, typically heavier at the beginning of the pattern, decreases as price moves toward the apex and then increases during the breakout.

The minimum number of lows and highs required to form the descending triangle, or any triangle for that matter, is two of each, for a total of four. The descending triangle is referred to as a right-angle triangle because if a vertical line is drawn at the open end of the triangle, a right-angle triangle is formed. If this pattern is followed by a breakout to the downside from within the triangle formation, it would be a triangle top. Or if the price breaks out to the upside, it would become a continuation pattern rather than a reversal.

Figure 1. This descending triangle formation has a corresponding decline in volume. However, it is a continuation pattern since the breakout is to the upside.
Graphic provided by: Window.
 
The successive lower highs forming the descending side of the triangle indicates more aggressive selling than buying. Frequently, price will break out to the downside after a number of reversals (minimum of four) within the bounds of the two trendlines. Breakouts usually occur after moving about two-thirds to three-quarters of the distance between the start of the formation and the apex, but there are exceptions.

It is not uncommon for prices to retrace back to the trendline after breaking out of the triangle and then reverse again, continuing in the direction of the breakout. The breakout is considered to have failed if prices move significantly back into the triangle pattern, which does happen occasionally.

For this particular security, the breakout was to the upside and a continuation pattern occurred instead of a reversal. It is a good idea to keep an eye on descending triangles and make sure that the breakouts are in the direction that you choose.



Han Kim

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