Traders know they shouldn’t go long when this classic trading pattern comes up

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Buying an asset in a downtrend can be a risky maneuver as most investors struggle to spot reversals, and when the trend deepens, traders face heavy losses. In such cases, identifying descending channel patterns can help traders avoid buying in a bearish trend.

A “descending channel”, also known as a “bearish price channel,” is formed by drawing two parallel downtrend lines that limit the price movement of the asset.

Descending channel bases

In a downtrend, price action makes a series of lower highs and lower lows. A descending channel is drawn by connecting the lower highs and lower lows using parallel trend lines. The main trend line is drawn first where two or more lower highs are connected. Then a parallel line, also called a channel line, is drawn connecting the lower lows.

Price action within a descending channel continues to move south as the bears sell to the main trend line on every recovery rally.

Descending channel pattern. Source: TradingView

The asset in the graph above is in a downtrend, making lower highs and lower lows. The main trend line is drawn by connecting two lower highs (labeled as ellipses), while the parallel channel line is drawn by connecting the two reaction lows.

When price hits the channel line, the bulls believe the price has gotten attractive and buy, but the bears are in no mood to let the bull do their thing. You sell when the price hits the main trend line and the trend remains down.

Trading within the channel is usually random but tied between the two parallel lines. A break below the channel suggests that bearish momentum has increased and this could lead to a downtrend.

Conversely, a break in the descending channel indicates a possible trend reversal. Sometimes these breakouts create a new uptrend, but on other occasions the price action spreads out before the downtrend resumes.

Descending canal eruptions

THETA / USDT daily chart. Source: TradingView

The graph above shows THETA tokens in a descending channel where the main trendline is formed by connecting the two lower highs of April 16 and May 9. The parallel line drawn by the April 18 reaction low forms the channel line.

As can be seen above, price action is largely trapped between these two lines. The bulls pushed the price above the channel on June 17th but failed to hold higher levels. The bears quickly pulled the price back into the channel and held the aggressive bulls captive.

There were some peaks below the canal line, but the long tails of the candles show that the cops took advantage of these dips to buy. This shows how the lines act as strong support and resistance.

Eventually the price broke the channel on July 24th and after a slight consolidation the rebound continued. This confirmed a legitimate breakout, suggesting a possible turnaround.

XMR / USDT daily chart. Source: TradingView

Monero (XMR) peaked on June 23, 2019 and then began a downward trend. The channel’s main trend line was formed by connecting the lower highs on July 8, 2019 and August 8, 2019 while the channel line was drawn from the July 16, 2019 low. The XMR / USDT pair continued to trade inside the channel through January 4, 2020.

The bulls pushed and closed the price across the channel on Jan 5th, 2020. This signaled a possible turnaround. The target goal can be achieved by adding the height of the channel to the breakout level.

In the above case, the depth of the channel was $ 31.50. Add that to the breakout level at $ 51.80 and you get a target of $ 83.30. The pair slightly exceeded the pattern target, falling from $ 96.90 on February 15, 2020.

This suggests that traders should use the target as a guide, but should decide to close the position after analyzing other supporting indicators and patterns.

Descending channel divisions

LUNA / USDT daily chart. Source: TradingView

Terra’s LUNA token peaked at $ 22.40 on March 21. Thereafter, trading began within a descending channel pattern. The bears pulled the price below the channel line on April 18th but failed to hold the lower levels. The bulls pushed price back into the channel on April 23rd, capturing the aggressive bears.

The sellers broke the canal line again on May 19. Attempts by the bulls to push the price back into the channel failed on May 20th and 21st, confirming a valid breakthrough. The model collapse target was $ 5.10 and the LUNA / USDT pair bottomed at $ 3.91.

Be careful not to confuse bull flags and descending channels

BTC / USDT daily chart. Source: TradingView

Bitcoin (BTC) rebounded sharply from $ 17,572.33 on December 11, 2020 to $ 41,950 on January 8, 2021. Subsequently, the price corrected within two parallel lines, which was a bullish flag pattern but could easily have been mistaken for a descending channel could.

Thomas Bulkowski, author of the Encyclopedia of Chart Patterns, says if a pattern is less than three weeks in length, it’s a flag, but longer than a channel.

In the example above, the correction took a little over three weeks and the price resumed its upward movement after breaking out of the flag.

The views and opinions expressed are those of the author only and do not necessarily reflect the views of Cointelegraph.com. Every step of investing and trading involves risk, so you should do your own research when making a decision.