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The Traders Wheel
5/2/98 by Alan Farley

Hell’s Triangle

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 as 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.gif (4277 bytes) 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 Decline.
 
Article contributed by The HARD Right Edge, which presents highly original workshops, tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission, which presents highly original workshops, tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission.
 
 

 

 
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Last modified: April 02, 2001

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