Section 6:

Bearish Continuation Patterns

 

Bearish continuation patterns are best to apply in bearish markets, industries, or individual stocks. It sounds simple enough, but too many traders ignore this axiom. Don’t go looking for bearish continuation patterns in bullish markets or sectors.

A bear market is one that is at a minimum ten percent off of its highs. A more conservative definition is a market that is 20 percent off of its highs. Look for bearish continuation patterns in markets, sectors, or stocks that are at least ten percent from their highs and trending lower. Preferably only look for bear markets in sectors or stocks that are 20 percent, or more, off of their highs and trending lower.

Bearish continuation patterns predict the continuation of existing bearish trends. A prerequisite of bearish continuation patterns, therefore, is a historical bearish trend. Put another way, there needs to be a historical bearish trend before the formation of a bearish continuation pattern. As simple as this may sound, it’s often overlooked by traders new to price patterns.

The formation of a bearish continuation pattern doesn’t guarantee a continuation of a bearish trend. The probabilities favor as much, but it’s far from a guarantee. It’s vital to manage risk in the event that a bearish continuation pattern doesn’t play out as planned. Remember that short sellers are a fickle group of traders. They know that stocks can go a lot higher than they can go lower. It’s imperative to manage risk, maybe even erring on the side of being conservative, when trading bearish price patterns.

 

 

Bearish continuation patterns oftentimes require a catalyst, a piece of bad news or an event in the economy. The odds of making money when trading bearish continuation patterns greatly increase when there is a catalyst to motivate a move lower.

 

Bearish Triangle

 

Description:

A bearish triangle is a symmetrical triangle that forms in the context of a bearish trend. The triangle starts with a big downward move in the stock over a short period of time. The stock then proceeds to bounce higher, reverse lower, and continues to do so along converging support and resistance lines. The lines meet at the apex of the triangle, at which point the stock generally breaks lower.

A stock doesn’t necessarily need to reach the apex of a bearish triangle before breaking down from the pattern. In fact, a breakdown from a bearish triangle before the apex generally reveals aggressive selling, even fear in the marketplace. This can be a good sign that the stock will continue to trend lower.

Nuance:

The triangle itself is symmetrical and, in fact, neutral in terms of directional bias. It’s only a bearish triangle if it occurs in the context of a bearish trend. It’s very important to independently define the trend when coming across situations such as triangles.

Application:

A bearish triangle is confirmed once the stock breaks below the lower-end of the triangle, which is defined by the upward sloping support line. A bearish triangle is rejected if the stock breaks above the downward sloping resistance line. Such a rejection usually leads to sideways trading or occasionally the beginning of a bullish trend.

Figure 6.1

Example:

A long-term bearish triangle formed in shares of Alcatel-Lucent (ALU) over the course of about 16 months as shown in Figure 6.1. The bearish triangle was preceded by a lengthy bearish trend in the stock.

Notice how ALU bounced back and forth, between upward sloping support and downward sloping resistance. The stock broke down below the upward sloping support line at $12. It steadily dropped over the next several months.