What Is a Descending Channel?
A descending channel is a chart pattern that indicates a downward trend in a security's price. Visually, a descending channel angles downward, from a high point to a lower point.
A descending channel is one of three basic trend channels. The other two are the ascending channel and the horizontal channel (which is also called a trading range).
Key Takeaways
- A descending channel is a chart pattern that indicates a downward trend in prices.
- It is drawn by connecting the lower highs and lower lows of a security's price with parallel trendlines.
- Traders who believe that a security's price is likely to remain within its descending channel can initiate trades when the price fluctuates back and forth within the channel boundaries.
- A more potent trade signal may occur with a breakout, which is when a security's price breaches an established channel's boundaries, either on the upper or lower side.
Understanding Descending Channels
Channels are used broadly by technical traders to identify and follow the price trends of securities over time. In particular, a descending channel is used by technical analysts to evaluate a downward trend.
Ascending channels indicate a price trend that moves upward. Horizontal channels show a price trend that moves neither up nor down, but in a level formation across the chart. Both ascending and descending channels are primary channels followed by technical analysts.
A descending channel is established by drawing two trendlines. The top trendline connects the resistance points (lower highs) in a series of prices for a security. The bottom trendline connects the points of support (lower lows). These lines run parallel to each other. The space between the trendlines is the channel. Prices remain inside the channel.
For traders, the idea behind the descending channel is that once established, it may signify a continuation of lower high and low prices. Therefore, they may use it to identify potential entry and exit points for trades at optimal support and resistance levels.
Trading Strategies
1. Traders who believe a security is likely to remain within its descending channel can initiate trades when the price fluctuates within the channel's boundaries. Typically, trendlines are extended to provide a visual of the expected path for the security to traverse, should its current trend hold.
So, a trader might place an order to go long (buy) at an expected upcoming lower low. Then they'd plan on taking a profit by placing an order to sell at an expected upcoming lower high, as indicated by the chart.
2. Alternatively, a trader might place an order to short (or sell) the security when its price meets the next lower high. Then they'd place an order to cover their short (or buy) at the expected upcoming lower low.
3. A more potent signal occurs with a breakout, which is when a security's price breaches the descending channel's boundaries, either on the upper or lower side.
If this breakout occurs across the lower trendline (in the set direction of the existing downward trend), the descending channel would show a continuation pattern. If the breakout occurs to the upside across the upper trendline, the move may indicate that the descending channel has been a prelude to a reversal.
A security's price can move quickly and sharply in the direction of that breakout. So a trader has some choices:
- If the price breaks out of the descending channel to the upside, the trader can buy the security if they believe, perhaps in conjunction with other indicators, that a reversal has begun.
- If the price breaks out of the descending channel to the downside, the trader can sell the security if they believe the security is in a continuation pattern. They can then buy it when the price reaches a lower level in the channel.
4. Look for a security with low to moderate volatility that keeps its price action constrained. In such a case, buying and selling within an established descending channel can be especially fruitful.
5. Trading a descending channel can also be profitable after a security’s price shows a reversal and breakout, which is usually followed by a series of runaway gaps and an exhaustion gap all in the same direction.
The more points where a trendline connects, the better developed the descending channel, and the better an indicator of a trend it may be.
Envelope Channels
Envelope channels are another popular channel formation that can incorporate both descending and ascending channel patterns.
An envelope channel involves upper and lower trendlines, or bands, that enclose a security's price movements. These bands are established with a combination of moving averages plus a set distance above the upper band and below the lower band.
Envelope channels can use trading strategies similar to those used with descending channels. Their trade analysis typically is based on a security's price movement over an extended period of time.
How Does a Descending Channel Help Traders?
A descending channel helps traders and investors who want to trade an established pattern of price movements. Once the trendlines are solid and extended, traders can get a sense of points of price support and resistance. That, along with other technical indicators that may confirm the continuation of the downward trend, can equip them to take and exit positions with confidence.
How Does a Descending Channel Differ From a Horizontal Channel?
If you look at a descending channel on a chart, you'll see that it has a downward sloping shape. This indicates that a security's prices are moving down. A horizontal channel will move across the chart, rather than downward. That indicates that the security's prices are not trending up or down but are staying within more static upper and lower boundaries over a period of time.
Are Descending Channels Bullish or Bearish?
A descending channel is a bearish sign, indicating lower high prices and lower low prices for a security.
The Bottom Line
A descending channel is a chart pattern that indicates a downward trend in the prices of a security. Traders who follow channels as part of their technical analysis can trade descending channels by buying a security when its price hits levels of support and selling when its price reaches levels of resistance.
