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 dont 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
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.