Head and Shoulders Top

A Head and Shoulders Top is a Classic Bearish Pattern and considered a bearish signal. It indicates a possible reversal of the current uptrend to a new downtrend.

The Head and Shoulders Top is an extremely popular pattern among investors because it's one of the most reliable of all formations. It also appears to be an easy one to spot. Novice investors often make the mistake of seeing Head and Shoulders everywhere. Seasoned technical analysts will tell you that it is tough to spot the real occurrences.

The classic Head and Shoulders Top looks like a human head with shoulders on either side of the head. A perfect example of the pattern has three sharp high points, created by three successive rallies in the price of the financial instrument.

The first point - the left shoulder - occurs as the price of the financial instrument in a rising market hits a high and then falls back. The second point - the head - happens when prices rise to an even higher high and then fall back again. The third point - the right shoulder - occurs when prices rise again but don't hit the high of the head. Prices then fall back again once they have hit the high of the right shoulder. The shoulders are definitely lower than the head and, in a classic formation, are often roughly equal to one another.

A key element of the pattern is the neckline. The neckline is formed by drawing a line connecting two low price points of the formation. The first low point occurs at the end of the left shoulder and the beginning of the uptrend to the head. The second marks the end of the head and the beginning of the upturn to the right shoulder. The neckline can be horizontal or it can slope up or down. The pattern is complete when the support provided by the neckline is "broken." This occurs when the price of the financial instrument, falling from the high point of the right shoulder, moves below the neckline. Technical analysts will often say that the pattern is not confirmed until the price closes below the neckline - it is not enough for it to trade below the neckline.

There are many variations, some of which are described here and can be just as valid as the classic formation. Other factors - including volume and the quality of the breakout - should be considered in conjunction with the pattern itself.

Variations of a Head and Shoulders Top

Following are some variations of the Head and Shoulder pattern that may occur.

The Drooping Shoulder
The drooping shoulder, where the neckline has a downward slope, is highly unusual and demonstrates extreme weakness. The droop happens because the price at the end of the head and the beginning of the right shoulder has dropped even lower than the previous low at the end of the left shoulder and the beginning of the head. Most experts agree that a downward slope has bearish implications for market weakness. When the right shoulder is drooping, the trader will have to wait longer than usual for a decisive neck break. It should also be noted that when that decisive break does occur much of the move will have already occurred.

Varying Width of Shoulders
The classic Head and Shoulders Top is symmetrical. However, if the shoulders don't match in width, don't discount the pattern.

Flat Shoulders
While the classic Head and Shoulders Top is made up of three sharp upward points, these need not be present for the pattern to be valid. Sometimes, shoulders can be rounded.

Multiple Head and Shoulders Patterns
Many valid Head and Shoulders patterns are not as well defined as the classical head with a shoulder on either side. It is not uncommon to see more than two shoulders and more than one head. A common version of a multiple Head and Shoulders pattern includes two left shoulders of more or less equal size, one head, and then two right shoulders that mimic the size and shape of the left shoulders.

Volume
Volume is extremely important for this pattern.

For a Head and Shoulders Top the volume pattern is as follows.

Volume is highest when the left shoulder is forming. In fact, volume is often expanding as the uptrend continues and more and more buyers want to get in.

Volume is lowest on the right shoulder as investors see a reversal happening. Experts say low volume levels on the right shoulder are a strong sign of a reversal.

In the head portion of the price pattern, volume falls somewhere between the strength of the left shoulder and weakness of the right shoulder. Volume often increases when the neckline is broken as the reversal is now complete and downside pressure begins in earnest. One of the key characteristics looked for in a Head and Shoulders Top by seasoned Technical Analysts is very high volume on the breakout.

Although volume is important, experts warn us not to get caught up in the precise number of shares being traded. What is more important are changes in the rate of trading.

Important Characteristics

Following are important characteristics for this pattern.

Symmetry
The right and left shoulders peak at approximately the same price level. In addition, the shoulders are often about the same distance from the head. In other words, there should be about the same amount of time between the development of the top of the left shoulder and the head as between the head and the top of the right shoulder. In the real world, the formation will seldom be perfectly symmetrical. Sometimes one shoulder will be higher than the other or take more time to develop.

Volume
Volume is highest on the left shoulder, lowest on the right shoulder and somewhere in between on the head.

Duration of the Pattern
Some experts say that an average pattern takes at least three months from start to the breakout point when the neckline is broken. It is not uncommon, however, for a pattern to last up to six months. The duration of the pattern is sometimes called the "width" or "length" of the pattern.

Need for an Uptrend
This is a reversal pattern which marks the transition from an uptrend in prices to a downtrend. This means that the pattern always begins during an uptrend of prices.

Slope of the Neckline
The neckline can slope up or down. An upward sloping neckline is considered to be more bullish than a downward sloping one, which indicates a weaker situation with more drastic price declines. It is rather rare to have a downward sloping neckline for this pattern.

Trading Considerations

Duration of the Pattern
Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to move to the target price. The shorter the pattern the sooner the price move. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration.

Target Price
The target price provides an important indication about the potential price move that this pattern indicates. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern is considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.

Inbound Trend
The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least two times the duration of the pattern.

Criteria that Support

Support and Resistance
Look for a region of support or resistance around the target price. A region of price consolidation or a strong Support and Resistance Line at or around the target price is a strong indicator that the price will move to that point.

Location of Moving Average
The Head and Shoulders Top should be above the Moving Average. Compare the location of the pattern to a Moving Average of appropriate length. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Moving Average Trend
The Moving Average should change direction within the duration of the pattern and should head in the direction indicated by the pattern. Look at the direction of the Moving Average Trend. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Volume
Volume is highest when the left shoulder is forming.
Volume is lowest on the right shoulder.

In the head portion of the price pattern, volume falls somewhere between the strength of the left shoulder and weakness of the right shoulder.

A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern.

Other Patterns
Other reversal patterns (such as Bullish and Bearish Engulfing Lines and Islands) that occur at the peaks and valleys indicate strong resistance at those points. The presence of these patterns inside a Head and Shoulders is a strong indication in support of this pattern.

Criteria that Refute

No Volume Spike on Confirmation
The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable.

Location of Moving Average
If the Head and Shoulders Top is below the Moving Average then this pattern should be considered less reliable. Compare the location of the pattern to a Moving Average of appropriate length. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Moving Average Trend
A Moving Average that is trending in the opposite direction to that indicated by the pattern is an indication that this pattern is less reliable. Look at the direction of the Moving Average Trend. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Inbound Trend
An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.

Downside Breakout

A Downside Breakout is a Classic Bearish Pattern and considered a bearish signal, marking a breakout from a trading range to start a new downtrend.

A Downside Breakout occurs when prices break out through the bottom of a trading range and descend quickly as a new downtrend forms. It appears that the market is being flooded with sell orders. There are usually gaps throughout this activity. This pattern can last for a few days to a few weeks.

Criteria that Support

Duration of Trading Range
The duration of the trading range for which the breakout occurred can provide an indication of the strength of the breakout. The longer the duration of the trading range the more significant the breakout.

Narrowness of Trading Range
The "narrowness" of the trading range can also be used to gauge the breakout. To determine the narrowness of the trading range, compare the upper boundary with the lower boundary of the trading range. If the trading range has a small difference between the upper and lower boundary (making it narrow) then the breakout is considered stronger and more reliable.

Support and Resistance
Look for a region of support or resistance. A region of price consolidation or a strong Support and Resistance Line at or around the target price is a strong indicator that the price will move to that point.

Moving Average Trend
Look at the direction of the Moving Average Trend. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average. The Moving Average should change direction during the duration of the pattern and should head in the direction indicated by the pattern.

Volume
A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern. In addition, the volume during the duration of the pattern should be declining on average.

Criteria that Refute

Duration of Trading Range
The duration of the trading range for which the breakout occurred can provide an indication of the strength of the breakout. The shorter the duration of the trading range the less significant the breakout.

Narrowness of Trading Range
The "narrowness" of the trading range can also be used to gauge the breakout. To determine the narrowness of the trading range, compare the upper boundary with the lower boundary of the trading range. If the trading range has a large difference between the upper and lower boundary (making it wide) then the breakout is considered weaker and less reliable.

No Volume Spike on Confirmation
The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable.

Moving Average Trend
Look at the direction of the Moving Average Trend. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average. A Moving Average that is trending in the opposite direction to that indicated by the pattern is an indication that this pattern is less reliable.

Double Top

A Double Top is a Classic Bearish Pattern and considered a bearish signal, indicating a possible reversal of the current uptrend to a new downtrend.

Sometimes called an "M" formation because of the pattern it creates on the chart, the Double Top is one of the most frequently seen and common of the patterns.

The Double Top is a reversal pattern of an upward trend in a financial instrument's price. The Double Top marks an uptrend in the process of becoming a downtrend.

A Double Top consists of two well-defined, sharp peaks at approximately the same price level. The two tops are distinct and sharp. The pattern is complete when prices decline below the lowest low in the formation. The lowest low is called the "confirmation point".

Analysts vary in their specific definitions of a Double Top. According to some, after the first top is formed, a reaction of at least 10% should follow. That decline is measured from high to low. The second rally back to the previous high (plus or minus 3%) should be on lower volume than the first. Other analysts maintain that the decline registered between the two tops should be at least 20% and the peaks should be spaced at least a month apart.

The pattern is comprised of two distinct tops that appear near the same price level. Tops will have a significant amount of time between them - ranging from a few weeks to a year.

Generally, volume in a Double Top is usually higher on the left top than the right. Volume tends to be downward as the pattern forms. Volume does, however, pick up as the pattern hits its peaks. Volume increases again when the pattern completes, breaking through the confirmation point.

Important Characteristics

Following are important characteristics for a Double Top.

Uptrend Preceding Double Top
The Double Top is a reversal formation. It begins with prices in an uptrend. The trend upwards should be fairly long and healthy.

Time between Tops
Analysts pay close attention to the "size" of the pattern - the duration of the interval between the two tops. Generally, the longer the time between the two tops, the more important the pattern is as a good reversal signal. It is not unusual for a few months to pass between the dates of the two tops.

Decline from First Top
The deeper the trough between the two tops, the better the performance of the pattern.

Volume
Volume tends to be heaviest during the first peak and lighter on the second. It is common to see volume pick up again at the time of breakout.

Pullback after Breakout
A pullback after the breakout is usual for a Double Top. The higher the volume on the breakout, the higher the likelihood is for a pullback.

Two Peaks at Different Levels
Sometimes the two peaks comprising a Double Top are not at exactly the same price level. This does not necessarily render the pattern invalid. Some analysts point out that investors should be less concerned if the second peak does not hit the high of the first peak.

Trading Considerations

Pattern Duration
Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to move to its expected target. The shorter the pattern the sooner the price will move to its target. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration.

Target Price
The target price provides an important indication about the potential price move that this pattern suggests. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern should be considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.

Inbound Trend
The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least two times the duration of the pattern.

Criteria that Support

Support and Resistance Lines
Look for a region of support or resistance around the target price. A region of price consolidation or a strong Support and Resistance Line at or around the target price is a strong indicator that the price will move to that point.

Relationship of Pattern and Moving Average
The location of a Moving Average relative to the pattern can be a good indicator of the potential of the pattern. The Double Top should be above the Moving Average. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Moving Average Trend
The Moving Average should change direction within the pattern and should head in the direction indicated by the pattern. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Volume
Volume is important for a Double Top. Two characteristics regarding volume should be noted. A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern. In addition, the volume throughout the duration of the pattern should be declining on average.

Other Patterns Present
Reversal Patterns (such as Bullish and Bearish Engulfing Lines and Islands) that occur at the peaks and valleys indicate strong resistance at those points. The presence of these patterns inside a Double Top is a strong indication in support of this pattern.

Criteria that Refute

No Volume Spike on Confirmation
The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable.

Relationship of Pattern and Moving Average
If the Double Top is below the Moving Average then this pattern should be considered less reliable. Compare the location of the pattern to a Moving Average of appropriate length. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Moving Average Trend
A Moving Average that is trending in the opposite direction to that indicated by the pattern is an indication that this pattern is less reliable. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Short Inbound Trend
An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.

Underlying Behavior

A Double Top occurs when prices are in an uptrend. Prices rise to a resistance level, retreat, and then return to the resistance level again before declining. A Double Top often forms in active markets, experiencing heavy trading. A stock's price heads up rapidly on high volume. Demand falls off and price falls, often remaining in a trough for weeks or months. A second run-up in the price occurs taking the price back up to the level achieved by the first top. This time volume is heavy but not as heavy as during the first run-up. Prices fall back a second time, unable to pierce the resistance level. These two sharp advances with relatively heavy volume have exhausted the buying power in the stock. Without that power behind it, the instrument reverses its upward movement and falls into a downward trend.

A pullback after the breakout is usual for a Double Top. The higher the volume on the breakout, the higher the likelihood is for a pullback. When everyone sells their shares soon after a breakout, what is left is an imbalance of buying demand (since the sellers have all sold), so the price rises and pulls back to the confirmation point.

Diamond Top

A Diamond Top is a Classic Bearish Pattern and considered a bearish signal, indicating a possible reversal of the current uptrend to a new downtrend.

Diamond patterns usually form over several months in very active markets. Volume remains high during the formation of this pattern. The Diamond Top indicates a reversal to a downtrend.

The Diamond Top pattern occurs because prices create higher highs and lower lows in a broadening pattern. Then the trading range gradually narrows after the highs peak and the lows start trending upward.

Trading Considerations

Duration of Pattern
Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to move to its target. The shorter the pattern the sooner the price move. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration.

Target Price
The target price provides an important indication about the potential price move that this pattern indicates. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern should be considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.

Inbound Trend
The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least 2 times the duration of the pattern.

Criteria that Support

Support and Resistance
Support can be found at the turning point of the lows and resistance at the top peak of the Diamond.

Moving Average
Watch for the 200-day Moving Average to flatten out. Then watch for the 50-day Moving Average to cross below the 200-day Moving Average. This should signal the breakout.

Criteria that Refute

No Volume
A lack of a volume throughout the pattern is an indication that this pattern may not be reliable.

Short Inbound Trend
An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.

Continuation Diamond : Bearish Pattern

A Continuation Diamond (Bearish) is a Classic Bearish Pattern and considered a bearish signal, indicating that the current downtrend may continue.

Diamond patterns usually form over several months in very active markets. Volume remains high during the formation of this pattern. The Continuation Diamond (Bearish) indicates a possible continuation of a downtrend.

The Continuation Diamond (Bearish) pattern occurs because prices create higher highs and lower lows in a broadening pattern. Then the trading range gradually narrows after the highs peak and the lows start trending upward.

Trading Considerations

Duration of Pattern
Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to move to its target. The shorter the pattern the sooner the price move. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration.

Target Price
The target price provides an important indication about the potential price move that this pattern indicates. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern should be considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.

Inbound Trend
The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least 2 times the duration of the pattern.

Criteria that Support

Support and Resistance
Support can be found at the turning point of the lows and resistance at the top peak of the Diamond.

Criteria that Refute

No Volume
A lack of a volume throughout the pattern is an indication that this pattern may not be reliable.

Short Inbound Trend
An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.

Symmetrical Continuation Triangle (Bullish)

A Symmetrical Continuation Triangle (Bullish) is a Classic Pattern and considered a bullish signal, indicating that the current uptrend may continue.


A Symmetrical Continuation Triangle (Bullish) shows two converging trendlines, the lower one is ascending, the upper one is descending. The formation occurs because prices are reaching both lower highs and higher lows. The pattern will display two highs touching the upper (descending) trendline and two lows touching the lower (ascending) trendline.

This pattern is confirmed when the price breaks out of the triangle formation to close above the upper (descending) trendline.

Volume is an important factor to consider. Typically, volume follows a reliable pattern: volume should diminish as the price swings back and forth between an increasingly narrow range of highs and lows. However, when the breakout occurs, there should be a noticeable increase in volume. If this volume picture is not clear, investors should be cautious about decisions based on this triangle.

Important Characteristics

Following are important characteristics for this pattern.

Occurrence of a Breakout
Technical analysts pay close attention to how long the Triangle takes to develop to its apex. The general rule is that prices should break out - clearly penetrate the upper trendline - somewhere between three-quarters and two-thirds of the horizontal width of the formation. The break out, in other words, should occur well before the pattern reaches the apex of the Triangle. The closer the breakout occurs to the apex the less reliable the formation.

Duration of the Triangle
The Triangle is a relatively short-term pattern. While long-term triangles do form, the most reliable triangles take between one and three months.

Volume
Investors should see volume decreasing as the pattern progresses toward the apex of the Triangle. At breakout, however, there should be a noticeable increase in volume.

Trading Considerations

Duration of the Pattern
Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to reach its target. The shorter the pattern the sooner the price move. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration.

Target Price
The target price provides an important indication about the potential price move that this pattern indicates. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern should be considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.

Inbound Trend
The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least two times the duration of the pattern.

Confirm the Breakout
To avoid taking an inadvisable position in a stock, some investors advise waiting a few days to determine whether the breakout signals that the price is ready to move. A key sign of a possible false move is low volume. If there's no pick up in volume around the breakout, investors should be wary. Typically, a good breakout from a Triangle formation will be accompanied by a definite surge in volume.

Criteria that Support

Support and Resistance
Look for a region of support or resistance around the target price. A region of price consolidation or a strong Support and Resistance Line at or around the target price is a strong indicator that the price will move to that point.

Price moves above Resistance Level
You can also check that the prices following the pattern have crossed above a key resistance level such as the 200 day moving average. This would provide extra confirmation that the trend is poised to continue upward.

Volume
A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern. In addition, the volume during the duration of the pattern should be declining on average.

Criteria that Refute

No Volume Spike on Breakout
The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable.

Short Inbound Trend
An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.

Price moves below Support Level
If post pattern prices have dropped below a key support level such as a 200 day moving average, this could be a temporary pullback (which is common) or perhaps a sign that the previous bullish signal was actually a false signal - sometimes called a bull trap. When such a pullback is encountered, one helpful clue is to look at volume. If pricing pulled back on high volume this may signify a failure of the original bullish pattern - sometimes leading to a potentially profitable bearish play. If there is not much volume, then it could simply be a temporary pullback to the breakout level and prices may change direction and continue upward after all.

Underlying Behavior

This pattern is a result of converging trendlines of support and resistance which give this Triangle pattern its distinctive shape. This occurs because the trading action gets tighter and tighter until the market breaks out with great force. Buyers and sellers find themselves in a period where they are not sure where the market is headed. Their uncertainty is marked by their actions of buying and selling sooner, making the range of the price movements increasingly tight. As the range between the peaks and troughs marking the progression of price narrows, the trendlines meet at the "apex" located at the right of the chart.

The narrowing of the trading action and the decreasing volume of trade reflect the indecision in the market. Finally consensus or decision in the market is reached and this is reflected as the price breaks out of the triangle. A spike in volume on this breakout date reflects stronger consensus that the stock should move in that direction.

Rounded Bottom

A Rounded Bottom is a Classic Pattern, which is considered a bullish signal, indicating a possible reversal of the current downtrend to a new uptrend.

Rounded Bottoms are elongated and U-shaped, and are sometimes referred to as rounding turns, bowls or saucers. The pattern is confirmed when the price breaks out above its moving average.
Important Characteristics

Following are important characteristic to look for in a Rounded Bottom.

Shape

The price pattern forms a gradual bowl shape. There should be an obvious bottom to the bowl. Price can fluctuate or be linear; however, the overall curve should be smooth and regular, without obvious spikes. For example, a V-shaped turn would not be considered a rounded bottom.

Volume

Volume tends to mirror the price pattern. Consequently, as the rounded bottom begins to descend, volume tends to decrease as bearishness wanes and investors become indecisive. Following a period of relative inactivity, at the bottom of the bowl, the price pattern starts its upward turn. As sentiment becomes more decisively bullish, volume tends to increase. When looking at volume in a rounded bottom pattern, Robert D. Edwards and John Magee note that "volume accelerates with the [price] trend until often it reaches a sort of climactic peak in a few days of almost 'vertical' price movement on the chart."

Duration of the Rounded Bottom

Rounded Bottoms are long-term patterns. Martin J. Pring identifies that the pattern can occur over a period of about 3 weeks, but can also be observed over several years.

Trading Considerations

Duration of the Pattern

The duration of the pattern indicates the significance of the price movement. John J. Murphy writes that rounded bottoms "are usually spotted on weekly or monthly charts that span several years. The longer they last, the more significant they become."

Target Price

Understandably, investors like to buy at the lowest possible price. However, even the most promising-looking rounded bottoms patterns can fail. To determine whether a downturn has bearish potential, watch the price at the bottom of the downturn. For a rounded bottom, the price tends to hover and bounce between an upper and lower price limit. You may observe this behavior for weeks or even years, as knowledgeable investors accumulate stock at the lowest possible price.

Clifford Pistolese advises that, "If well-informed, long-term investors are buying within the trading range, the eventual breakout will probably be to the upside." To manage risk, both Pistolese and Thomas N. Bulkowski suggest that investors buy stock when the breakout actually occurs.

Price may end higher or lower than it was at the beginning of the formation. After an upside breakout, technical analysts may use the starting price at the left side of the bowl to determine where the price may head. However, you will want to monitor the stock with interest.

Criteria that Support

Volume

Volume should parallel the price formation, dropping off as the pattern reaches the bottom, then increasing as the new uptrend is established.

Moving Average

Moving averages help to determine whether the rounded bottom has the potential for an upside breakout. For a rounded bottom, the price should cross the moving average when it begins to ascend. When this crossover occurs, the pattern is "confirmed".

There is an abundance of literature about moving averages if you are interested in understanding how they operate. In simple terms, the moving average can be used to detect a possible pattern success or failure. Typically, a moving average represents the closing price of a stock over a specified number of days, and can be used to predict the general direction of a stock. Depending on the type of stock, investors may decide to use a long, medium or short term moving average. For example, short duration patterns generally use a 50-day moving average, and longer patterns generally use a 200-day moving average.

Criteria that Refute

Shape

A formation is not a true rounded bottom when it does not involve a period of consolidation. Consolidation occurs following the descent when the price at the bottom of the pattern seems to bounce between an upper and lower limit. While, there are V-shaped patterns that yield successful returns, the rounded bottoms are a more reliable and predictable formation.

Underlying Behavior

A Rounded Bottom forms as investor sentiment shifts gradually from bearishness to bullishness. As the sentiment turns down toward the bottom, there is a drop off in trading volume due to the indecisiveness in the market. There is a period of consolidation at the bottom as trading bounces within a certain range, and then finally there is a gradual upturn marking the shift to bullishness. As investors become more decisive about the bullishness, there is an increase in trading volume.

Pennant (Bullish)

A Pennant (Bullish) a Classic Pattern, is considered a bullish signal, indicating that the current uptrend may continue.

A Pennant (Bullish) follows a steep or nearly vertical rise in price, and consists of two converging trendlines that form a narrow, tapering flag shape. The Pennant shape generally appears as a horizontal shape, rather than one with a downtrend or uptrend.

Apart from its shape, the Pennant is similar in all respects to the Flag. The Pennant is also similar to the Symmetrical Triangle or Wedge continuation patterns however; the Pennant is typically shorter in duration and flies horizontally.

Important Characteristics

Following are important characteristics for this pattern.

Trendlines

For Pennants, the price trendlines tend to converge. At the start of the Pennant, the price spikes, perhaps in response to a favorable product or earnings announcement. Following the price spike, the price fluctuations continue until they taper out and become decreasingly less volatile. This behavior appears on a price chart with the initial price spike forming what technical analysts refer to as the "mast" of the Pennant, followed by a triangular pennant shape.

Volume

As the Pennant develops, the volume tends to decrease. Martin Pring notes in his book, Technical Analysis Explained, "a pennant is in effect a very small triangle. If anything, volume tends to contract even more during the formation of a pennant than during that of a flag." However, as with Flags, when the Pennant completes you will often observe a sharp spike in volume.

Duration of the Pattern

In his book, Technical Analysis of the Financial Markets, John J. Murphy identifies that Pennants and Flags are relatively short-term and should be completed within one to three weeks. He also notes that by comparison, the bullish patterns take longer to develop than the related bearish patterns.

Trading Considerations

Possibility of Price Reversal

In some rare cases, the price will break against the original price movement, and create a reversal trend. The pattern reversal may be signaled during the Pennant formation by an increase in volume, as opposed to the more typical decrease.

Duration of the Pattern

The duration of the pattern depends on the extent of the price fluctuations (consolidation). The greater the fluctuations, the longer a pattern will take to develop.

Target Price

It is commonly held that the length of the mast indicates the potential price increase. Like the Flag, the Pennant is considered to be a pause in an uptrend. Following the Pennant, the price typically jumps to replicate the height of the mast, while continuing in the direction of the inbound trend.

Criteria that Support

Volume

Volume should diminish noticeably as the pattern forms.

A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern. In addition, the volume over the course of the pattern should be declining on average.

Criteria that Refute

Duration of the Pattern

According to Martin Pring, a pattern that exceeds "4 weeks to develop should ... be treated with caution". After 4 weeks, interest in the stock is likely to decrease to point that it is unlikely to continue in a strong uptrend.

No Volume Spike on Breakout

The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable and may actually reverse.

Underlying Behavior

This pattern is effectively a pause in an uptrend. The price has moved ahead of itself with a steep rise; therefore market activity takes a break before continuing the uptrend. This pause is reflected in the decreasing trading volume. Similarly, a spike in volume marks the resumption of the uptrend.

Megaphone Bottom

A Megaphone Bottom also known as a Broadening Bottom is a Classic Pattern and considered a bullish signal, indicating that the current downtrend may reverse to form a new uptrend.

This rare formation can be recognized by the successively higher highs and lower lows, which form after a downward move. Usually, two higher highs between three lower lows form the pattern, which is completed when prices break above the second higher high and do not fall below it.

The pattern is completed when, usually on the third upswing within the pattern, prices break above the prior high but fail to fall below this level again.

Head and Shoulders Bottom

A Head and Shoulders Bottom is a Classic Pattern which is considered a bullish signal. It indicates a possible reversal of the current downtrend into a new uptrend.

The Head and Shoulders bottom is a popular pattern with investors. This pattern marks a reversal of a downward trend in a financial instrument's price.

Volume is absolutely crucial to a Head and Shoulders Bottom. An investor will be looking for increasing volumes at the point of breakout. This increased volume definitively marks the end of the pattern and the reversal of a downward trend in the price of a stock.

A perfect example of the Head and Shoulders Bottom has three sharp low points created by three successive reactions in the price of the financial instrument. It is essential that this pattern form following a major downtrend in the financial instrument's price.

The first point - the left shoulder - occurs as the price of the financial instrument in a falling market hits a new low and then rises in a minor recovery. The second point - the head happens when prices fall from the high of the left shoulder to an even lower level and then rise again. The third point - the right shoulder - occurs when prices fall again but don't hit the low of the head. Prices then rise again once they have hit the low of the right shoulder. The lows of the shoulders are definitely higher than that of the head and, in a classic formation, are often roughly equal to one another.

The neckline is a key element of this pattern. The neckline is formed by drawing a line connecting the two high price points of the formation. The first high point occurs at the end of the left shoulder and beginning of the downtrend to the head. The second marks the end of the head and the beginning of the downturn to the right shoulder. The neckline usually points down in a Head and Shoulders Bottom, but on rare occasions can slope up.

The pattern is complete when the resistance marked by the neckline is "broken". This occurs when the price of the stock, rising from the low point of the right shoulder moves up through the neckline. Many technical analysts only consider the neckline "broken" if the stock closes above the neckline.

The volume sequence should progress beginning with relatively heavy volume as prices descend to form the low point of the left shoulder. Once again, volume spikes as the stock hits a new low to form the point of the head. It is possible that volume at the head may be slightly lower than at the left shoulder. When the right shoulder is forming, however, volume should be markedly lighter as the price of the stock once again moves lower.

It is most important to watch volume at the point where the neckline is broken. For a true reversal, experts agree that heavy volume is essential.
Variations of the Head and Shoulders Bottom

There are a few notable variations for this pattern.

Multiple Head and Shoulders Patterns

Many valid Head and Shoulders patterns are not as well defined as the classical head with a shoulder on either side. It is not uncommon to see more than two shoulders and more than one head. A common version of a multiple Head and Shoulders pattern includes two left shoulders of more or less equal size, one head, and then two right shoulders that mimic the size and shape of the left shoulders.

Flat Shoulders

The classic Head and Shoulders pattern is made up of three sharply pointed components - the head and two shoulders. This is not always the case. Sometimes, the shoulders can lack sharp low points and instead be quite rounded. This does not affect the validity of the pattern.


Important Characteristics

Following are important characteristics for this pattern.

Symmetry

In a classic Head and Shoulders Bottom, the left and right shoulders hit their relative low points at approximately the same price and level. In addition, the shoulders are usually about the same distance from the head. Experts like to see symmetry but variations are not lethal to the validity of the pattern.

Volume

It is critical to watch the volume sequence as this pattern develops. Volume will usually be highest on the left shoulder and lowest on the right. Investors, looking to ensure that volume increases in the direction of the trend, should ensure that a "burst" in volume occurs at the time the neckline is broken.

Duration of Pattern

It is not unusual for a Head and Shoulders bottom to take several months to develop. Volume activity in stocks is characteristically less after a period of declining prices than after a bull market. Because of this lower volume, bottoms take longer to form and tend to be smaller than tops

Need for a Downtrend

This is a reversal pattern which marks the transition from a downtrend to an uptrend.

Slope of the Neckline

In a well-formed pattern, the slope will not be too steep, but don't automatically discount a formation with a steep neckline. Some experts believe an upward sloping neckline is more bullish than a downward sloping one. Others say slope has little to do with the stock's degree of bullishness.

Trading Considerations

Duration of the Pattern

Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to reach the Target Price. The shorter the pattern the sooner the price move. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration. The duration of the pattern is sometimes called the "width" or "length" of the pattern.

Target Price

The target price provides an important indication about the potential price move that this pattern indicates. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern should be considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.

Inbound Trend

The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least two times the duration of the pattern.

Criteria that Support

Support and Resistance

Look for a region of support or resistance around the target price. A region of price consolidation or a strong Support and Resistance Line at or around the target price is a strong indicator that the price will move to that point.

Location of Moving Average

The Head and Shoulders Bottom should be below the Moving Average. Compare the location of the pattern to a Moving Average of appropriate length. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Moving Average Trend

The Moving Average should change direction within the duration of the pattern and should head in the direction indicated by the pattern. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Volume

Volume will usually be highest on the left shoulder and lowest on the right.

A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern.

Other Patterns

Other reversal patterns (such as Bullish and Bearish Engulfing Lines and Islands) that occur at the peaks and valleys indicate strong resistance at those points. The presence of these patterns inside a Head and Shoulders is a strong indication in support of this pattern.


Criteria that Refute

No Volume Spike on Confirmation

The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable.

Location of Moving Average

If the Head and Shoulders Bottom is above the Moving Average then this pattern should be considered less reliable. Compare the location of the pattern to a Moving Average of appropriate length. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Moving Average Trend

Look at the direction of the Moving Average Trend. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average. A Moving Average that is trending in the opposite direction to that indicated by the pattern is an indication that this pattern is less reliable.

Short Inbound Trend

An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.

Flag (Bullish)

A Flag (Bullish) is a Classic Pattern and considered a bullish signal, indicating that the current uptrend may continue.

A Flag (Bullish) follows a steep or nearly vertical rise in price, and consists of two parallel trendlines that form a rectangular flag shape. The Flag can be horizontal (as though the wind is blowing it), although it often has a slight downtrend.

The vertical uptrend, that precedes a Flag, may occur because of buyers' reactions to a favorable company earnings announcement, or a new product launch. The sharp price increase is sometimes referred to as the "flagpole" or "mast".

The rectangular flag shape is the product of what technical analysts refer to as consolidation. Consolidation occurs when the price seems to bounce between an upper and lower price limit. This might occur, for example, in the days following a positive product announcement, when the excitement is starting to subside, and fewer buyers are willing to pay the high price that was commanded just a few days before. But, at the same time, sellers are unwilling to sell below a lower support limit.

A bullish signal occurs when the price rebounds beyond the upper trendline of the Flag formation, and continues the original upward price movement. This is considered a pattern confirmation.

When speaking about Flags, technical analysts may use jargon and refer to the flag as "flying at half-mast". Visually, this reference is nothing like a flag at half-mast, such as on a day of national mourning. Instead, this term refers to the location of the flag - at the mid-point of what would otherwise be a continuous uptrend.


Important characteristics


Trendlines

Flags are very similar to Pennants. However, with a Flag, the price trendlines tend to run parallel, whereas with a Pennant, the price trendlines tend to converge.

Volume

As the Flag develops, the volume tends to decrease. Following a positive product announcement, the price may have reached an unexpected high, and fewer buyers will be willing to buy. Interest in the stock may resume, however, as prices drop, and sellers begin to lower their price. The increased activity explains why you will often notice a sharp spike in volume at the end of a Flag.

Duration of the Pattern

Martin Pring notes in his book, Technical Analysis Explained that "Flags can form in a period as short as 5 days or as longs as 3 to 5 weeks." John J. Murphy identifies that Flags "often last no longer than one or two weeks."

Trading Considerations

Possibility of Price Reversal

In some rare cases, the price will break against the original price movement, and create a reversal trend. The pattern reversal may be signaled during the Flag formation by a sharp increase in volume, as opposed to the more typical decrease.

Duration of the Pattern

The duration of the pattern depends on the extent of the price fluctuations (consolidation). The greater the fluctuations, the longer a pattern will take to develop.

Target Price

It is commonly held that the length of the flagpole indicates the potential price increase. When the Flag completes, the price typically jumps to replicate the height of the original flagpole, while continuing in the direction of the inbound trend.

Criteria that Support


Volume should diminish noticeably as the pattern forms.

A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern. In addition, the volume over the course of the pattern should be declining on average.

Criteria that Refute

Duration of the Pattern

According to Martin Pring, a pattern that exceeds "4 weeks to develop should ... be treated with caution". After 4 weeks, interest in the stock is likely to decrease to point that it is unlikely to continue in a strong uptrend.

No Volume Spike on Breakout

The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable and may actually reverse.

Long Inbound Trend

Shabacker writes that, "When a mast is long ... and it's Flag relatively small, we should naturally expect the movement to be pretty well exhausted when its indicated objective is reached." He suggests that when you observe this formation, and a price continuation occurs, it is best to use the flagpole as a "yard-stick" to indicate the level at which to "take profits, step aside, and watch for further chart developments."

Underlying Behavior

This pattern is effectively a pause in an uptrend. The price has gotten ahead of itself with a steep rise; therefore market activity takes a break before continuing the uptrend. This pause is reflected in the decreasing trading volume. Similarly, a spike in volume marks the resumption of the uptrend.

Classic Patterns

Classic is a term used to refer to a group of patterns that typically have a longer-term horizon (greater than 12 days) and which have distinct price swings such that the price swings form distinctive patterns. The names of classic patterns often reflect the shape of the formation such as the Double Top, Double Bottom, Head and Shoulders Top, Ascending Triangle and so on.

Classic Bullish Patterns:

• Ascending Continuation Triangle
• Bottom Triangle
• Continuation Diamond (Bullish)
• Continuation Wedge (Bullish)
• Diamond Bottom
• Double Bottom
• Flag (Bullish)
• Head and Shoulders Bottom
• Megaphone Bottom
• Pennant (Bullish)
• Rounded Bottom
• Symmetrical Continuation Triangle (Bullish)
• Triple Bottom
• Upside Breakout

Classic Bearish Patterns:

• Continuation Diamond (Bearish)
• Continuation Wedge (Bearish)
• Descending Continuation Triangle
• Diamond Top
• Double Top
• Downside Breakout
• Flag (Bearish)
• Head and Shoulders Top
• Megaphone Top
• Pennant (Bearish)
• Rounded Top
• Symmetrical Continuation Triangle (Bearish)
• Top Triangle
• Triple Top