REVERSAL PATTERNS IN STOCK OR FOREX CHARTS
In stocks or forex charts, the Head and Shoulders Top formation is one of the most common and also one of the most reliable of all the major reversal patterns.
This pattern typically consists of a left shoulder, a head and a right shoulder.
The left shoulder is formed on the stock or forex chart or any traded instrument chart usually at the end of an extensive advance during which the volume is quite heavy.
At the end of the left shoulder, there is usually a small dip or recession which typically occurs on low volume.
The head then forms with heavy volume on the upside and with lesser volume accompanying the subsequent reaction.
At this point, in order to conform to proper form, prices must come down somewhere near the low of the left shoulder – somewhat lower perhaps or somewhat higher but, in any case, below the top of the left shoulder.
The right shoulder is then formed by a rally on usually less volume than any previous rallies in this formation.
On the stock or forex chart, a neckline can now be drawn across the bottoms of the left shoulder, the head and right shoulder.
A breaking of this neckline on a decline from the right shoulder is the final confirmation and completes the Head and Shoulders Top formation on the stock or forex chart.
This is, therefore, your signal to sell short.
The Head and Shoulders Bottom formation on the chart is the inverse of a Head and Shoulders Top and often indicates a trend reversal from down to top.
The volume pattern is somewhat different in a Head and Shoulders Bottom and should be watched carefully.
A high volume breakout would give us good reason to believe the Head and Shoulders Bottom formation is genuine.
The Double Top Formations pattern meanwhile appears as an “M” alphabet on a stock or forex chart.
This pattern could be misleading to anticipate on the chart and there are to be no confirmation of a Double Top until the valley or neckline has been broken.
Volume can offer a clue in the formation of this pattern on the chart.
If the volume on the rise of the second peak is less than on the first peak, you have an initial indication that prices may fail to go above the previous high.
High volume accompanying the second rise would minimize that possibility.
Another factor to determine the validity of a Double Top formation is the time element.
If two tops appear at the same level but quite close together in time, the chances are good that they are merely part of a consolidation area.
If, on the other hand, the peaks are separated by a deep and long reaction, this is more likely a true Double Top on the stock or forex chart and you should be more alert.
Double Bottoms are the inverse of Double Tops and appear on the charts as a “W” alphabet formation.
All rules associated with Double Top formations also apply to Double Bottoms.
The volume patterns are different.
A valid Double Bottom should show a marked increase in volume on the rally up from the second bottom on the chart.
Triple Tops are more rare than Double Tops.
Volume is usually less on the second advance, and still less on the third.
The highs need not be spaced as far apart as those which constitute a Double Top, and they need not be equally spaced.
Also, the intervening valleys need not bottom out at exactly the same level; either the first or the second may be deeper.
But the triple top is not confirmed until prices have broken through both valleys.
If prices continue to rally up to the level of the three previous peaks, they usually go higher; and if prices descend to the same level a fourth time, they usually go lower.
It is very rare to see four tops or bottoms at equal levels on the stock or forex chart at any point in time.
Triple Bottoms are simply Triple Tops turned upside down and all the rules can be applied in reverse.
The accompanying volume pattern, however, is different.
The third low should be on light volume and the ensuing rally from that bottom should show a considerable pickup in activity.
Rounding Tops and Bottoms. Rounding Tops are rare and the more common pattern is the Rounding Bottoms, commonly known as “Saucer Bottoms” that you can see on any stock or forex charts.
In Rounded Bottom, one will notice the volume decreasing as selling pressure eases.
The trend then becomes neutral with very little trading activity occurring. As prices start up, volume increases as well.
Finally, price and volume continue to accelerate, with prices often literally blasting out of this pattern and can be seen visually on the stock or forex chart instruments.
Broadening Formations pattern usually has bearish implications.
They appear much more frequently at tops than at bottoms in any stock or forex charts.
The theory is that five minor reversals are followed by a substantial decline.
The Broadening Top formation usually suggests a market that is lacking support from the “smart money” and is out of control.
Quite often, well informed selling is completed during the early stages of the formation; and in the later stages, the participation is from the less informed, more excitable public.
Volume is often very irregular and offers no clue as to the direction of the subsequent breakout.
The price swings themselves are very unpredictable so it is difficult to tell where each swing will end.
Broadening Tops are a difficult formation to trade and it is not easy to see it on any stock or forex charts as well.
However, one can usually be quite sure the trend has turned down after a break of the lower of the two valleys.
Wedge Formations pattern usually only reverse minor trend and, as a general rule of thumb, should typically take 3 weeks or so to complete.
It happens frequently in the trend of prices and can be seen easily on any stock for forex charts.
It is a chart formation in which price fluctuations are confined within converging straight lines.
These form a pattern which itself may have a rising or falling slant.
A Rising Wedge, both boundary lines slant up from left to right but the lower line rises at a steeper angle than the upper line.
After breaking the lower line boundary, prices usually decline in earnest.
Generally, each new price advance, or wave up, is feebler than last, indicating that investment demand is weakening at the higher price levels.
Rising Wedges are usually more reliable when found in a Bear Market.
In a Bull Market, what appears to be a Rising Wedge may actually be a continuation pattern known as a “Flag” or “Pennant”.
This is more likely to be true if the Wedge is less than three weeks in length.
In a Falling Wedge, both boundary lines slant down from left to right but the upper line descends at a steeper angle than the lower line.
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