DESCENDING TRIANGLE

One of the purposes of this book is to provide you with clear, use-ful, and important information as it relates to the One Shot – One Kill trading method. I want to couple this knowledge with insight as to how to adequately spot potential downturns in the market. Understanding certain high-probability chart forma-tions is key to doing so.

After the double top, another extremely bearish chart for-mation that should put you on alert is the descending triangle formation. The price action going on in this situation is akin to a dam fighting the pressure of an oncoming rush. As long as that dam is there, then all of the people who are long feel confident.

However, with each subsequent rush attack, the dam gets weaker until the floodgates break open. What tends to follow is an incredible amount of downward exertion behind the stock, caused by the panic brought about by the break in the support level. The precipitous drop in a stock is usually the continuation of a downward trend. The stock might have moved lower, then consolidated, and is now gathering steam for its next move to the downside (see Charts 3.7 and 3.8).

A mistake that many traders make is shorting a stock at precisely the wrong time by chasing breakdowns that have already made a sizeable move and are beginning to put in a nat-ural countertrend pullback. Understanding this natnat-ural ebb and flow of the markets is why we put the majority of our size on descending triangle patterns after the breakdown and come back up for a breath of fresh air. Unfortunately for the stock, this is the ideal opportunity for One Shot – One Kill traders to

66 Phase I: Basic Trading Tactics

CHART 3.7 A classic descending triangle pattern. As with the ascending triangle, the descending triangle usually sees the stock rally back to retest its breakdown point, which provides a low-risk short entry with a tight stop to get in on the trade. In the case of Loews Cineplex Corporation (LCP), this stock broke down and made a succession of lower highs, thereby giving traders multiple chances to reenter.

CHART 3.8 LCP continued to trade lower and ultimately went off the trading map.

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down to $40 (while you are on the sideline), is something I have experienced in the past and hope that you can avoid. This sce-nario is less likely to happen if you use the pullbacks within the underlying move.

As with every pattern in this book, what time frame you decide upon is up to you, the individual trader/investor. How-ever, a 13- and 60-minute intraday chart is particularly useful for day traders and swing traders, because it does a great job of filtering out a lot of noise. Longer-term investors can look at a daily or weekly chart to get a feel for a potential breakdown in the stock, the market, or both. Again, let me stress, just as with an ascending triangle, you need to have confirmation with a descending triangle before making a trade. Helping you deter-mine the likely chances for profit will be the same indicators used in determining an ascending triangle.

An important factor will be assessing whether or not any major Fibonacci areas could manifest as support. As you will see in Chapter 4, shorting stocks into a heavy area of Fibonacci sup-port can prove to be a costly mistake. It often leaves you with an undesirable risk-to-reward ratio in the trade. It does so because of where you would have to put your stop in order to give your-self a fair chance in the trade, compared to where your likely profit target would be.

The third area, which proves particularly adept, is paying attention to the amount of volume, which occurred when the stock broke through. If, during the downtrend, there is heavy volume relative to the stock’s daily average (for example, 25 per-cent greater than average), then there stands to be a better

at 11 and then, another lower high near 10. The stock had been using a base of support near 9 for some time to rally upward. Fol-lowing the initial breakdown of support, most of the time stocks will try to make an attempt to retest their breakdown point. It is when that subsequent breakdown point fails that traders using the One Shot – One Kill Method should become more aggressive with their trades and not be afraid to put the boxer to the mat—

that is, aggressively adding to a winning position and letting the position work for them. Following the failure of a retest, an increase in your position to the short side would be perfectly acceptable, because if you entered correctly, then you should already be profitable in the trade. You would thereby be allowed to enter a second position, fully knowing that if it goes against you, you should still be able to at least break even. However, if the formation follows through, which is what the trend suggests, then you should be rewarded for your proper money manage-ment, risk managemanage-ment, and trading ability.

The next example of a classic descending triangle occurred in August 2001, with the Nasdaq 100. The Nasdaq had been using 1600 as a support base and definitively cracked through it in the middle of August (see Chart 3.9).

It is okay to short here. However, it is not prudent to go in with size, until after a retest of that breakdown point fails, thereby giving a much better probability of having a successful trade. More importantly, it gives a better overall risk-to-reward ratio. After the Nasdaq failed its retest, it was time to short with size and watch it roll down. And roll down it did.

These textbook setups should have you take notice, because they are what put the odds in your favor. Once again, all you are trying to do is simply put yourself into trades with positive expected returns, based on logical price calculations. Over time, this kind of trading should allow you to bank bigger profits based on overall better performance.

Remember, however, that at all times you must wear the hat of a well-disciplined risk manager. So it’s important to have as many indications in your favor as possible, because each one helps add to the likelihood of a successful trade.

Micromanaging your positions can be one of the worst things you do as a trader. However, it is something, at one time

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CHART 3.9 The Nasdaq 100 broke down from a descending triangle base in the middle of August 2001. The retest of the original breakdown point provided a spot for a low-risk short entry to get in the market.

or another, we have probably all done. It results from convincing ourselves that somehow, with no real explanation, the trade we entered confidently, just a little while ago, has now changed. It can also result in a lack of confidence in the indicators, method, and/or plan being used. This is not to say the market is not prone to sudden reversals, or that you can’t be flexible, but over time, I have found that changing my plan as I go has brought with it more harm than good.