Chapter 5 Major reversal patterns

Price patterns Types of price patterns Five major reversal patterns: Continuation Sideways Five major reversal patterns: Head and shoulder (most reliable) Double tops and bottoms (also reliable, p128) Triple tops and bottoms Spike (V) tops and bottoms Rounding (saucer)

Points common to all reversal patterns The first signal of an impending trend reversal is often the breaking of an important trendline. (see Line 1 in Figure 5.1a) The larger the pattern, the greater the subsequent move. The height measures the volatility of the pattern. *It is usually easier to identifying trade bottom than to catch market tops. Topping patterns are usually shorter in duration and more volatile than bottoms. Price swings within the tops are wider and more violent. Tops are usually takes less time to form. Prices tend to decline faster than they go. Bottoms usually have smaller price ranges and take longer to build. Volume confirmation is more important on the upside.

The head and shoulder pattern (see Figures 5.1a) It is the most reliable pattern, but on occasion, act as a consolidation (a pause, still in the trend) rather than a reversal. The shoulders (A and E) are at about the same high. The head is higher than shoulders. The lighter volume on each peak. The volume of point A is a bit lighter than on the previous rally. The pattern is completed on a close under the neckline (line 2 ). Near point D, the line 1 support is broken in a uptrend. (see Page 107, summary 4), The minimum price objective is the vertical distance from the head to the neckline projected downward from the breaking of the neckline. The return move will often occur back to the neckline, which should not re-cross the neckline once it has been broken.

Head and shoulder

The breaking of the neckline and the return move The deciding factor in the resolution of the head and shoulder top is a decisive closing violation of the neckline. A return move is a bounce back to the bottom of the neckline or to the previous reaction low at point D. * If the initial breaking of the neckline is on very heavy trading, the odds for a return move are diminished because the increased activity reflects greater down side pressure. Lighter volume on the initial break of the neckline increase the likelihood of a return move.

Head and shoulder top summary using Figure 5.1a A prior uptrend. A left shoulder on heavier volume (point A) followed by a corrective dip to point B. (heavier at A: comparing to C and E) A rally into new highs but on lighter volume(point C). A decline that moves below the previous peak (at A) and approaches the previous reaction low (point D). A third rally (point E) on noticeably light volume that fails to reach the top of the head. A close below the neckline. A return move back to the neckline (point G) followed by new lows.

Head and shoulder top Evident, decisively broken, and added confirmation 3 well defined tops The middle peak (head) is slighter higher than either of the two shoulders Confirmation The pattern is not complete until the neckline is decisively broken on a closing basis. Added confirmation 1-3% penetration criteria 2 successive close below the neckline (the 2 day rule)

Head and shoulder top Volume The head should take place lighter volume than the left shoulder. (not a requirement) [Volume signal] The volume of the right shoulder should be noticeably lighter than on the previous two peaks. Volume should then expand on the breaking of the neckline, decline during the return move, and then expand again once the return move is over.

Finding a price objective The minimum objective methods: *One method is based on the height of the pattern. For downside price objective, take the vertical distance from the head to the neckline. Then project that distance from the point where the neckline is broken. Another method is to measure the length of the first wave of the decline (C to D ?), and then double it. p108 The maximum objective is the size (100% retracement) of the prior move. ** [Rule] When a discrepancy exists between a projected price target and a clear-cut support or resistance level, it is safe to adjust the price target to that support or resistance level.

The inverse head and shoulders also called, head and shoulder bottom, basing pattern *Lack of demand of buying is often enough to push a market lower; but a market dose not go up on inertia. *The critical point occurs at the rally through the neckline. The signal must be accomplished by a sharp burst of trading volume if the breakout is real. One slight difference at bottom is the greater tendency for the return move back to the neckline to occur after the bullish breakout. *(For a real inverse head and shoulder) The return move is more common at bottoms than at tops and should occur on lighter volume. (difference again)

The inverse head and shoulders

The inverse head and shoulders (Head and shoulders bottom)

The slope of the neckline: 騙線 * The neckline at the top usually slopes slightly upward. (騙線)To initiate a short position, the downward slope neckline (a sign of market weakness) would need to wait a bit longer. (because the signal from the down sloping neckline occurs much later and only after much of the move has already taken place.) * For basing patterns (neckline at the bottom), most neckline have a slight downward tilt. (騙線) A rising neckline has a sign of greater market strength, but with the same drawback of giving a later signal.

[*Aggressive trading tactics] Initiate long position during the formation of the right shoulder (see Figure 5.3) The initial long probe One-half to two-thirds pullback of the rally from points C to D A decline to the same level as the left shoulder at point A The breaking of a short term down trendline (line 1) Additional positions can be added on the actual breakout of the neckline.

*Tactics for a head and shoulders bottom

Complex head and shoulder patterns Complex patterns: two heads, double left and right shoulders A helpful hint: symmetry Failed head and shoulder: price re-cross the neckline The head and shoulder as a consolidation pattern, an exception. Triple top (*Figure 5.4a) All peaks are at the same level Each peak should be on light volume The pattern is completed when both troughs are broken on heavier volume. Measuring: the height of the pattern is projected downward from the breakdown point Return move is common.

Triple tops and bottoms

Triple bottoms

Double tops and bottoms Double tops (*Figure 5.5a): commonly seen Two peaks are about the same level The pattern is completed when the middle trough at B is broken on a closing basis. Volume is usually lighter at the second peak C and pick up on the breakdown. Minimum measuring: the height of the pattern is projected downward from the breakdown point Return move is usual.

Double tops and bottoms

A double bottom

A double top

A double bottom on Nasdaq

Variations from the ideal “double top” pattern (validation using “>1 month”) (Filter) Use time and volume to verify double tops and bottoms Remember that, at a top, prices must actually violate (lower) the previous reaction low before the double top exists. *In general, most valid double tops or bottoms should have at least 1 month between the two peaks or troughs. The longer the time period between the two peaks and the greater the height of the pattern, the greater the potential impending reversal.

Variations from the ideal “double top” pattern: Bull trap, C is a little bot higher than A

Variations from the ideal “double top” pattern: Bull trap, 假突破在右

Variations from the ideal pattern: not double tops or bottoms, normal pullback and bounce

Saucers and spikes(碗碟型與V型反轉) Figure 5.8, Figure 5.9 Saucer bottoms are usually spotted on weekly or monthly charts that span several years. It is difficult to tell when the saucer is completed or to measure how far prices will travel in the opposite position. Spikes happen very quickly with little or no transition period. Spikes usually take place in a market that has gotten so over extended in one direction, that a sudden piece of adverse news causes the market to reverse direction very abruptly. (spike) A daily or weekly reversal, on very heavy volume, is sometimes the only warning they give us.

Saucer

V-Reversal