Descending Channel: Definition and Trading Strategies

What Is a Descending Channel?

A descending channel is drawn by connecting the lower highs and lower lows of a security's price with parallel trendlines to show a downward trend. Officially, the space between the trendlines is the descending channel, which falls under the broad category of trend channels.

Understanding Descending Channels

Overall, channels are used broadly by technical traders to identify and follow the trends of securities over time. A descending channel is one such charting pattern that technical analysts will use to evaluate the trend of a security. A channel is drawn from trendlines charted along the support and resistance levels of a security’s price series. In general, channels can be used to pinpoint optimal support and resistance levels to buy or sell securities.

Traders who believe a security is likely to remain within its descending channel can initiate trades when the price fluctuates within its channel trendline boundaries. The descending channel trendlines can be extended to provide an expected path for the security to traverse, should its current trend hold.

A more potent signal occurs with a breakout, which is when a security's price breaches an established channel's boundaries, either on the upper or lower side. When this happens, a security's price can move quickly and sharply in the direction of that breakout. If this move is in the direction of the prior trend, the descending channel would have been a continuation pattern. If the move is counter to the prior trend, the descending channel would have been a prelude to a reversal.

Within a descending channel, a trader could make selling bets when the security price reaches its resistance trendline. Conversely, long buying trades could be entered into when a security begins to reach its support trendline. These trading strategies can be beneficial when a security has low to moderate volatility that keeps its price action constrained. Trading on channel analysis 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.

An ascending channel is the opposite of a descending channel. Both ascending and descending channels are primary channels followed by technical analysts.

Envelope Channels

Envelope channels are another popular channel formation that can incorporate both descending and ascending channel patterns. Envelope channels are typically used to chart and analyze a security’s price movement over a longer period of time. Trendlines can be based on moving averages or highs and lows over specified intervals. Envelope channels can use trading strategies similar to both descending and ascending channels. This analysis will typically be based on a security's price movement over an extended period of time, while ascending and descending channels can be beneficial for charting a security’s price immediately after a reversal.