The most elusive and unrealistic goal of trading is to buy at the bottom or sell at the top. Prices rarely stop where you expect. The only way to
see a top or bottom is after they occur. In this chapter we will look at the most popular top and bottom formations and see which ones are the best candidates for trading, and when they can be used.
We have already seen some of the top and bottom patterns, although they may have occurred at different places in the price move. Spikes and
reversal days, island reversals, and “V”tops and bottoms are simple formation.Rounded tops and Bottoms and head-andshoulders formations take longer to develop but are very reliable.
“V”TOPS
The classic topis an inverted “V”although it is called a “V”top.It is a sharp run up with a single day marking the high, and then an equally fast price drop. It is always accompanied by high volatility and usually high volume. The final peak may also be an upward spike. There is a classic “V” Top in Amazon during January 1999,Show in fig.and another potentia,smaller formation in April that looked as though it was a “V” top two days after, which quickly disappeared into a broader formation of no particular pattern.You can’t tell a “V” top,after one day down. The final peak in late April 1999 is broader than a classic “V”top but may still go under the same name.
“V” Top in crude oil
The top in January 1999 is a classic “V”top the highest top in late April is slightly broader, the result of a three-day price pattern. Just before the last top, in early April, was a potential “V” top that disappeared after three days.
The Blow – Off
A “V” top with an extended spike at the top is thought of as a blow-off.High volatility, high volume, and a pattern of accelerating upward prices must reach a point where the momentum can’t be sustained.The range on the last day is wider than previous days, and the following day opens much lower and day is wider than previous days, and the following day opens much lower and remains lower. The market thinks about whether it can muster enough energy to continue the run-up, decides that it cannot, and collapses. Every-one changes their opinion from bull to bear on the same day, and each wants out before the others. Prices drop faster than they rose during the last part of the bull market.
“V” Bottoms
“V” bottoms are much less common that their upside counterparts.They occur more often in futures, where supply and demand can change dramat-basically and leverage causes surges of buying and selling. Both “V” tops and bottoms should be read as a sign that prices have gone too far, too fast. Both buyers and sellers need time to reevaluate the fundamentals to decide where prices should be. “V”bottons are followed by a rebound and then a period of sideways movement.
DOUBLE TOPS AND BOTTOMS
A double top is just what you would expect, one price peak followed a few days or weeks by another peak, stopping very close to the same level. A dou-ble bottom , more common than a double top, is the occurrence of two price valleys with the lowest prices at nearly the same level. Because prices are more likely to settle for a while at a lower price than a high one, prices often test a previous support level, causing a double bottom.
Double Tops
Tops and bottoms occur at the same level because traders believe that the same reason prices failed to go higher the first time will be the reason they fail the second time. At extreme tops and bottoms this is true. The very high or low prices are not supported by the fundamentals of the business or by the supply and demand numbers. They are pushed to extremes by crowd psychology without regard to reason. Traders, looking for a place to sell at an unreasonably high price, target the previous point where prices failed. As prices move higher to test that level, increased speculative selling causes the buyers to realize that something is wrong, and they back away from the mar-
ket, causing prices to drop and forming a double top.Although a classic double top is thought to peak at exactly the same price, selling in anticipation of that test of the top may cause the second peak to be lower than the first.shows one type of double top in
crude oil. Although some double tops are two sharp peaks, this one looks as though it was gathering energy yet still failed to make new highs.
The double top, formed at the beginning of 1990, turned into a rounded top. Prices have been created by back-adjusting individual futures contracts; therefore, the scale on the right doesn’t show the actual prices in 1990. The pattern,however, show is identical.
In this double bottom pattern there are four failed attempts to move lower, followed by a faster break upward. When prices penetrate the highs between the two bottom patterns, we have a confirmation of the bottom. Our first profit target would be an equal distance above the confirmation, at about $7.50.
Double Bottoms
Bottoms are more orderly than tops. They should be quiet rather than normal investor to recognize that there is little additional downside potential.Economists might call this the point of equilibrium.Neither buyers nor sellers are convinced that prices will continue to move. They wait for fur-thernews.
Double bottoms will often test the same price level because large posi-tion traders accumulate more stock, or increase their futures position, each time the price falls to their target level. Once prices are low, there is less chance of absolute loss. Selling a double top can be very risky. The greatest risk when buying a double bottom is that your timing is wrong. If prices don’t rally soon, you’ve used your capital poorly.
Cisco shows a double bottom in Figure 11.4, although it lacks the clear decline in volatility that we would like to see. The small spikes down show four attempts to go lower, followed by a faster move up. When prices cross above the highs formed between the two bottom patterns, we have a com-vpletion, or confirmation , of the double bottom.
TRIPLE TOPS AND BOTTOMS
Triple tops and bottoms are considerably less common than double tops and bottoms, and much less likely to turn at exactly the same price. Figure 11.5 shows a classic triple top in natural gas. There are many other patterns that comprise this top, including an island reversal as the first peak, a spike as the second, and finally a lower, wider peak that ends the move.If you look at the days following the first two peaks, each looked as though it marked the top. After the first island reversal, prices dropped $2; after the second peak there was another large gap down and a one-day loss of more than $1. We can say only that investors were very nervous at $10. A triple bottom that can be traded is most likely to occur at low prices and low volatility, much the same as a double bottom. Prices show an inabil-ity to go lower because investors are willing to accumulate a position at a good value.
Triple tops can contain other patterns. In this chart, the first peak is an island reversal and the second is a spike. The third peak fails to reach the highest price, making it easier for traders to sell.
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see a top or bottom is after they occur. In this chapter we will look at the most popular top and bottom formations and see which ones are the best candidates for trading, and when they can be used.
We have already seen some of the top and bottom patterns, although they may have occurred at different places in the price move. Spikes and
reversal days, island reversals, and “V”tops and bottoms are simple formation.Rounded tops and Bottoms and head-andshoulders formations take longer to develop but are very reliable.
“V”TOPS
The classic topis an inverted “V”although it is called a “V”top.It is a sharp run up with a single day marking the high, and then an equally fast price drop. It is always accompanied by high volatility and usually high volume. The final peak may also be an upward spike. There is a classic “V” Top in Amazon during January 1999,Show in fig.and another potentia,smaller formation in April that looked as though it was a “V” top two days after, which quickly disappeared into a broader formation of no particular pattern.You can’t tell a “V” top,after one day down. The final peak in late April 1999 is broader than a classic “V”top but may still go under the same name.
“V” Top in crude oil
The Blow – Off
A “V” top with an extended spike at the top is thought of as a blow-off.High volatility, high volume, and a pattern of accelerating upward prices must reach a point where the momentum can’t be sustained.The range on the last day is wider than previous days, and the following day opens much lower and day is wider than previous days, and the following day opens much lower and remains lower. The market thinks about whether it can muster enough energy to continue the run-up, decides that it cannot, and collapses. Every-one changes their opinion from bull to bear on the same day, and each wants out before the others. Prices drop faster than they rose during the last part of the bull market.
“V” Bottoms
“V” bottoms are much less common that their upside counterparts.They occur more often in futures, where supply and demand can change dramat-basically and leverage causes surges of buying and selling. Both “V” tops and bottoms should be read as a sign that prices have gone too far, too fast. Both buyers and sellers need time to reevaluate the fundamentals to decide where prices should be. “V”bottons are followed by a rebound and then a period of sideways movement.
DOUBLE TOPS AND BOTTOMS
A double top is just what you would expect, one price peak followed a few days or weeks by another peak, stopping very close to the same level. A dou-ble bottom , more common than a double top, is the occurrence of two price valleys with the lowest prices at nearly the same level. Because prices are more likely to settle for a while at a lower price than a high one, prices often test a previous support level, causing a double bottom.
Double Tops
Tops and bottoms occur at the same level because traders believe that the same reason prices failed to go higher the first time will be the reason they fail the second time. At extreme tops and bottoms this is true. The very high or low prices are not supported by the fundamentals of the business or by the supply and demand numbers. They are pushed to extremes by crowd psychology without regard to reason. Traders, looking for a place to sell at an unreasonably high price, target the previous point where prices failed. As prices move higher to test that level, increased speculative selling causes the buyers to realize that something is wrong, and they back away from the mar-
ket, causing prices to drop and forming a double top.Although a classic double top is thought to peak at exactly the same price, selling in anticipation of that test of the top may cause the second peak to be lower than the first.shows one type of double top in
crude oil. Although some double tops are two sharp peaks, this one looks as though it was gathering energy yet still failed to make new highs.
Double Top in crude oil
A double bottom in Cisco.
Double Bottoms
Bottoms are more orderly than tops. They should be quiet rather than normal investor to recognize that there is little additional downside potential.Economists might call this the point of equilibrium.Neither buyers nor sellers are convinced that prices will continue to move. They wait for fur-thernews.
Double bottoms will often test the same price level because large posi-tion traders accumulate more stock, or increase their futures position, each time the price falls to their target level. Once prices are low, there is less chance of absolute loss. Selling a double top can be very risky. The greatest risk when buying a double bottom is that your timing is wrong. If prices don’t rally soon, you’ve used your capital poorly.
Cisco shows a double bottom in Figure 11.4, although it lacks the clear decline in volatility that we would like to see. The small spikes down show four attempts to go lower, followed by a faster move up. When prices cross above the highs formed between the two bottom patterns, we have a com-vpletion, or confirmation , of the double bottom.
TRIPLE TOPS AND BOTTOMS
Triple tops and bottoms are considerably less common than double tops and bottoms, and much less likely to turn at exactly the same price. Figure 11.5 shows a classic triple top in natural gas. There are many other patterns that comprise this top, including an island reversal as the first peak, a spike as the second, and finally a lower, wider peak that ends the move.If you look at the days following the first two peaks, each looked as though it marked the top. After the first island reversal, prices dropped $2; after the second peak there was another large gap down and a one-day loss of more than $1. We can say only that investors were very nervous at $10. A triple bottom that can be traded is most likely to occur at low prices and low volatility, much the same as a double bottom. Prices show an inabil-ity to go lower because investors are willing to accumulate a position at a good value.
Natural gas shows a classic triple top.
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