This week we explore and breakdown the different reversal patterns.
Head and Shoulders
The "head and shoulders" pattern is created by a peak (a shoulder) followed by a higher peak (the head), and then another lower peak (another shoulder). A "neckline" is drawn by linking the lowest points of the two troughs. This neckline's slope may either be up or down,
This suggests a reversal of an increasing market trend if the price line breaks below the neckline, which will be a "bearish signal," i.e. an indicator to either sell a long position or enter a short position. In the other hand, this implies a reversal of a falling price trend if the price line breaks above the neckline which will be a "bullish signal," i.e. an indicator to either close a short position or join a long position. Volume is a confirmatory measure of a future head and shoulders, as declining volume follows each successive peak/trough.
Describing how a head and shoulders are produced helps recognize the rational psychology of the crowd that shapes this pattern. As supply and demand forces become balanced, a significant upward trend begins to lose traction and level off for a while. An initial dip generates the left shoulder and is seen by market investors who are accustomed to the ongoing bull run as a renewed buying opportunity. Consequently, the market is being propelled to new levels. At this point, maturing market circumstances and a lack of apparent demand lead to another downward shift towards the neckline, forming the head. A final attempt at recovery fails, and the correct shoulder is formed. As a turnaround, the resulting downward split of the neckline activates the development of the head and shoulders, and the sector reverses into a bear trend. For an inverse head and shoulders, the opposite statement is true.
- A central peak that rises over the peaks of the lower left and right shoulder.
- The neckline traced over the left shoulder and head low points.
- The neckline is similar to horizontal but may have a slight up or downslope. A break below the neckline that indicates a trend's reversal.
- Target move: Deduct the neckline's value from the high. Subtract from the neckline this value.
Source: Head And Shoulders Pattern
Double Tops and Bottoms
Double tops and bottoms are common and easily recognizable technical occurrences. A double top' follows a growing market and displays two peaks. There is no need for the two peaks to be the same height. If the price subsequently falls below the mid-low point, this means that the trend is complete and that the market will continue to fall toward the price target. A double bottom' reveals the same in reverse, showing that growing demand has become a previously falling market. As some variation is appropriate, the tops or bottoms do not need to be precisely at the same level.
- A first peak that is accompanied by a price decrease-the pullback between the two peaks.
- A price increase back up to form a second peak at a pace comparable to the first.
- A later reversal of the trend.
- Target move: Deduct the value from the first peak of the low pullback. Subtract this from the pullback low for the goal downside.
Source: Double Top and Bottom
Triple Tops and Bottoms
A triple top/bottom can be seen as a minor variation of the shape of the head and shoulder. The critical difference is that the peaks are approximately at the same level (or troughs). In that each top should be followed by decreasing height, the volume confirmation is also comparable. When both troughs have been cracked, the pattern is complete.
Triple tops and bottoms are systems that are both rarer and weaker than double tops and head and shoulders. The underlying explanation for this is that the market has more of a bias against the previous pattern than the other categories.
A V-shaped and sharp pattern reversal occurs very quickly and is easy to recognize. The spike reversal usually terminates a bull or bear pattern that is exponential and emotionally charged.
Often a fast-moving market results in responses from emotional market participants. Over a brief period, desperate buying or selling exhausts interest, and an equally volatile reversal offsets the sharp trending move. This shakes the previously overriding assumption that only in the trending direction can the market shift. Over the intervening cycle, an inability to regain lost ground alters greed to fear, and a pattern reversal occurs. Spikes are similar to a head and shoulders, but like a head and small shoulders, with a short spike length.
- Sharp blow off in price accompanied by an equally rapid decline to where blowoff began.
- Should not trade back into spike ideally.
- Usually traces a minimum of the original V form.
Ending Diagonal or Wedge Formations
Ending diagonal or wedge formations is a reasonably unusual, but relevant, pattern of a trend reversal that originates in the theory of the Elliott Wave. In a rising wedge formation, a significant trend often terminates. On a definite break below the bottom trend line, this formation is triggered. With the minimum target of retracing the entire rising wedge shape, a sharp and elongated reverse trend can be expected.
When a share price consolidates between an upward-moving wedge-type trend, a rising wedge occurs. A dropping wedge is when the resistance line slope is (negatively) steeper than the line of support. A pattern reversal can be predicted in both situations. If the breakout is above the resistance line, i.e. upwards, then on a rising wedge shape, this is seen to be quite bullish and vice versa.
- Two rising (or falling) trend lines converge to form a directional triangular pattern.
- A sudden vertical breakout that brings the market back to at least the beginning of the pattern to wipe out the entire move within the wedge.
- A full retracement of the wedge pattern.
- The most effective of all chart trends is the minimum target move.
Thank you for reading and hope you have a good rest of the day!
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