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Saturday, February 23, 2008

DESCENDING CHANNEL PATTERN

Descending Channel Pattern is a short-term bearish continuation pattern, whereby the price movement is contained within two parallel descending trend lines and the price is moving lower while bouncing off upper and lower down-trending lines.
Descending Channel pattern is also known as “Bearish Price Channel”.

The Formation of Descending Channel Pattern



Descending Channel Pattern has two parallel trend lines that are sloping downward.
In this case, the descending upper line acts as resistance, while the descending lower line as support.

In general, Price Channel pattern has Main Trend Line (or Primary Trend Line) and Channel Line (or Secondary Trend Line).
The Main Trend Line is the one that determine the trend and slope of the price channel, while the Channel Line is the line that is drawn parallel to the Main Trend Line.

For Descending Channel Pattern, the descending upper line serves as Main Trend Line, and the descending lower line as Channel Line.

To draw the Main Trend Line (descending upper line), there should be at least two consecutively lower peak (high) points to be connected. These two peaks should have some distance. In other words, prices should increase and hit the descending upper line then decline for at least twice (forming at least two peaks).

Likewise, to draw the Channel Line (descending lower line), there should be at least two consecutively lower trough (low) points to be connected. These two troughs should also have some distance. That means prices should drop and hit the descending lower line then bounce up for at least twice (forming at least two troughs).

These two down-trending lines should be parallel or close to parallel, and they can be extended down as well.

In Descending Channel pattern, the price should continue moving lower while bouncing off upper and lower trend lines, until a breakout occurs and either trend line is broken.

As such, one effective way to trade this pattern is by short selling the stock on the upper trend line (resistance level) for short-term trade.
Although it is possible to buy the stock on the lower trend line (support level), this trade may carry more risk because one would be trading against the trend. And trading against the trend will usually be much riskier. (Remember the well-known trading phrase: "The Trend is Your Friend").

Breakout
The breakout from Descending Channel pattern may happen to the upside (i.e. the price penetrates through the upper trend line) or to the downside (i.e. the price penetrates through the lower trend line).

As with the other patterns, the minimum penetration criteria for a breakout should be price closes outside either trend lines, not just an intraday penetration.

A breakout to the upside from Descending Channel that indicates the short-term downtrend might have come to an end, and it provides a technical “Buy” (Bullish) signal.

A breakout to the downside indicates that that a selling intensity has increased, resulting in accelerated price decrease. This provides a technical “Sell” (Bearish) signal.

To read about other chart patterns, go to: Learning Charts Patterns.

Related Topics:
* FREE Trading Videos from Famous Trading Gurus
* Understanding Candlestick Charts
* Options Trading Basic – Part 2
* Understanding Implied Volatility (IV)

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