Chart Pattern..

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123 Bottom

Definition:

The 123 bottom is the most common bullish reversal pattern. The requirements for the 123 bottom are rather common, causing the pattern to frequently appear in existing bearish trends. Many 123 bottoms reach the first two conditions, but never confirm. The 123 bottom, therefore, can be somewhat deceiving. That’s why it’s imperative that the pattern confirms before placing trades.

The 123 bottom starts when a stock sharply reverses higher after an extended bearish trend. This sharp rebound is the first requirement of the pattern, or part 1. The second requirement is for the stock to halt its rally attempt at short-term resistance, which is part 2 of the pattern. Part 3 of the pattern forms when the stock stages another sharp rebound, but from a relatively higher level than in part 1. The 123 bottom confirms when the stock breaks above short-term resistance as defined in part 2.

Nuance:

A basic definition of a bearish trend is lower lows. A basic definition of a bullish trend is higher lows. The 123 bottom seeks to identify when a pattern of lower lows ends and a new pattern of higher lows begins.

Another way to think of a 123 bottom is as a very short-term cup and handle, only the 123 bottom occurs at the end of a bearish trend.

The 123 bottom occurs in most bearish trends, but it rarely confirms. When it does confirm, it’s best to take a very short-term approach to trading the 123 bottom. Taking profits quickly is generally a good idea after entering a 123 bottom.

Application:

A 123 bottom is confirmed once the stock breaks above the horizontal resistance level as defined in part 2 of the definition. An entry can be taken as soon as the stock crosses its short-term resistance. This resistance will often act as support in the days following a breakout.

A 123 bottom is rejected if the stock fails to break above resistance or falls below the relative low traced in part 3. A drop below the relative low in part 3 reveals a very short-term pattern of lower lows, which is a bearish indication.

Example:

Shares of Goldman Sachs (GS) traced a 123 bottom over the course of three weeks as shown in Figure 7.1. The pattern began when the stock rebounded from $160, tracing part 1. The pattern continued to unfold when GS reached up to but rolled over from the $180 level. This was part 2 of the pattern and served as short-term resistance. Part 3 of the pattern was formed when GS pulled back to near $170, which was $10 higher than the low in part 1. The pattern was confirmed one week later when GS broke above resistance at $180, and aggressively trended higher.

 

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Double Bottom

Definition:

A double bottom occurs within the context of an existing bearish trend. It starts when a stock reaches a low from which it sharply rebounds. The stock then hits a high from which it rolls over. The stock then falls back down to the previous low and rebounds for a second time, forming two equal lows. These lows are connected to form a horizontal support level. The resistance level is defined by the high formed after the initial rebound.

Nuance:

Double bottoms occur frequently within the context of bearish trends; therefore, it’s important to wait for confirmation before acting on a double bottom. Like 123 bottoms, double bottoms are ubiquitous. Many will form but ultimately fail over the course of a bearish trend. Anticipating confirmation is possible, but doing so requires acute risk management.

Double bottoms can form over very short periods and long periods of time.

Application:

A double bottom is confirmed once a stock breaks above the horizontal resistance level. Entry points can be taken upon the breakout or after waiting for a retest of previous resistance and then buying on the bounce. A double bottom is rejected once a stock breaks down below horizontal support.

Example:

Shares of Intel (INTC) traced a double bottom by first staging a sharp rebound from $16.50 as shown in Figure 7.2. The stock bolted up to near $18.50 in a couple of weeks, but the rally leveled off and the stock returned to the $16.50 level for the second time. INTC sharply rebounded once more, and broke above the $18.50 horizontal resistance several weeks later.

Notice how INTC used previous resistance at $18.50 as support for about one month before ultimately heading much higher.

Example:

Shares of American Air (AMR) offer an example of how double bottoms can be deceiving as shown in Figure 7.3. Note the formation of several double bottoms over the course of nine months. One double bottom after another failed as the stock continued along its existing bearish trend.

 

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Triple Bottom

Definition:

A triple bottom occurs within the context of an existing bearish trend. It starts when a stock reaches a low from which it sharply rebounds. The stock then hits a high from which it rolls over. The stock falls back down to the previous low and rebounds for a second time, forming two equal lows. The stock then rebounds to its recent highs and rolls over once more. The pattern concludes after the stock falls to its lows and stops going down for a third time. These three lows are connected to form a horizontal support level. The resistance level is defined by the two highs formed after the rebound attempts.

Nuance:

Triple bottoms occur less frequently than double bottoms. But when triple bottoms do form, they provide very precise entry points and risk management levels. Triple bottoms can form over very short and long periods of time.

Triple bottoms can go on and become quadruple bottoms if the same horizontal support level is retested. The patterns can continue indefinitely, but the more often a support level is tested the weaker it becomes. Keep as much in mind when trading triple bottoms that don’t immediately reverse higher.

Application:

A triple bottom is confirmed once the stock breaks above the horizontal resistance level. Entry points can be taken upon the breakout or after waiting for a retest or previous resistance and then buying on the bounce. A triple bottom is rejected if the stock falls below horizontal support.

Example:

Shares of Home Depot (HD) traced a perfect triple bottom, starting with a reversal from the $32 level as shown in Figure 7.4. The stock quickly found resistance at the $34 level, and bounced back and forth between these two levels twice more. The stock ultimately broke out in spectacular fashion and trended higher.

 

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Head and Shoulders Bottom

Definition:

A head and shoulders bottom is very similar to a triple bottom. The only difference is that the second rebound from support is at a relatively lower level than the first and third rebounds from support.

A head and shoulders bottom occurs within the context of a bearish trend. It starts when a stock rebounds sharply from a low known as the left shoulder, but then rolls over from a relative high. The pair proceeds to fall to a lower low known as the head before rebounding for a second time to the same high. These two equal highs form horizontal resistance. The pair rolls over once more and falls to the third low known as the right shoulder which is equal to the first low. It rebounds once more to near the relative highs, which are connected to form a horizontal resistance level known as the neckline.

Nuance:

Head and shoulders bottoms are rare, but one of the most popular bullish reversal patterns among traders. They are extremely powerful indicators of a reversal of a downward trend. The patterns are usually very actionable and profitable.

Head and shoulders bottoms sometimes appear diagonally, with a downward or upward sloping neckline, rather than horizontally.

Application:

A head and shoulders bottom is confirmed once the stock breaks above the neckline. An entry can be taken upon the breakout or after waiting for a retest of the neckline, which is a highly effective way of trading head and shoulders bottoms.

Example:

Shares of Mobil Telesystems (MBT) traced a head and shoulders bottom after a steady bearish trend as shown in Figure 7.5. The stock first reversed from the $28 level, but found resistance near $32. This first low at $28 was the left shoulder. It fell lower to $26, creating the head of the pattern. MBT traded up to $32 for a second time, but reversed lower for a second time. This reversal created the neckline of the pattern. The stock completed the head and shoulders bottom with a rebound from the $28 level for a second time. This rebound formed the right shoulder. The pattern confirmed when the stock broke above the neckline.

 

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Bearish Reversal Patterns

Bearish reversal patterns predict the reversal of an existing bullish trend and the beginning of a new bearish trend. Like bullish reversal patterns, bearish reversal patterns go against the grain of an existing trend. This makes bearish reversal patterns a bit more difficult in their application. Furthermore, bearish reversal patterns go against the long-term upward trend in stock prices.

Bearish reversal patterns emerge when existing bullish trends grow old, when the fundamental drivers of the trends have run their course, or when extreme levels of optimism or greed have taken hold. The bearish reversal patterns reveal equaling levels of demand for or supply of a stock; buyers complete all of their buying and sellers begin to see an overvaluation in prices.

The bearish reversal patterns point to an end of a bullish trend and the beginning of an opposite bearish trend. The reversal patterns provide entry points, offer price targets, and even suggest the time horizon in which the price target might be achieved.

It’s incredibly important to carefully measure and manage your risk when trading bearish reversal patterns because of the long-term upward trend in stock prices and the skewed risk to reward of bearish positions. The formation of a bearish reversal pattern doesn’t guarantee a new bearish trend.

The probabilities of bearish reversal patterns playing out as expected are less than the probabilities associated with trading bearish continuation patterns.

 

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123 Top

Definition:

The 123 top is the most common bearish reversal pattern. The requirements for the 123 top are rather common, causing the pattern to frequently appear in existing bearish trends. Many 123 top reach the first two conditions, but never confirm. The 123 top, therefore, can be somewhat deceiving. That’s why it’s imperative that the pattern confirms before placing trades.

The 123 top starts when a stock sharply pulls back after an extended bullish trend. This sharp reversal is the first requirement of the pattern, or part 1. The second requirement is for the stock to rebound from short-term support, which is part 2 of the pattern. Part 3 of the pattern forms when the stock stages another sharp pullback, but from a relatively lower level than in part 1. The 123 top confirms when the stock breaks below short-term support as defined in part 2.

Nuance:

A basic definition of a bullish trend is higher highs. A basic definition of a bearish trend is lower highs. The 123 top seeks to identify when a pattern of higher highs ends and a new pattern of lower highs begins.

Another way to think of a 123 top is as a very short-term double distribution, only the 123 top occurs at the end of a bullish trend.

The 123 top occurs in most bullish trends, but it rarely confirms. When it does confirm, it’s best to take a very short-term approach to trading the 123 top. Taking profits quickly is generally a good idea after entering a 123 top. Aside from the nature of the pattern, it’s also a good idea to take profits quickly so as to mitigate the risks that bearish traders face in the form of the long-term upward trend in stock prices.

Application:

A 123 top is confirmed once the stock breaks below the horizontal support level as defined in part 2 of the definition. An entry can be taken as soon as the stock drops below its short-term support. This support level will often act as resistance in the days following a breakdown.

A 123 top is rejected if the stock fails to break down below support or rallies above the relative high traced in part 3. A rally above the relative high in part 3 reveals a very short-term pattern of higher highs, which is a bullish indication.

Example:

Shares of Freeport McMoran (FCX) traced a 123 top by first reversing from a high at $120 as shown in Figure 8.1. The stock fell to a short-term low at $105, and then sharply rebounded higher. But the stock fell just short of its previous high, and reversed lower at about $117.50. The 123 top was completed when the stock broke down below horizontal support at the $105 level. FCX proceeded to fall to a low near $85.

Notice the violent drop in FCX once it confirmed the 123 top. But the stock didn’t continue trending lower. In fact, it rebounded back to above the breakdown point of the 123 top several weeks later. This example illustrates why it’s a good idea to take profits quickly in bearish positions when trading 123 tops

 

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Double Top

Definition:

A double top occurs within the context of an existing bullish trend. It starts when a stock reaches a high from which it sharply reverses lower. The stock then hits a lower from which it bounces higher. The stock rebounds up to the previous high and reverses lower for a second time, forming two equal highs. These highs are connected to form a horizontal resistance level. The support level is defined by the low formed after the initial reversal lower.

Nuance:

Double tops occur frequently within the context of upward trends; therefore, it’s important to wait for confirmation before acting on a double top. Anticipating confirmation is possible, but doing so requires acute risk management. Double tops can form over very short and long periods of time.

Application:

A double top is confirmed once the stock breaks below the horizontal support level. Entry points can be taken upon the breakdown or after waiting for a retest of previous support and then waiting for a rollover. A double top is rejected if a stock breaks out above the horizontal resistance line.

Example:

Shares of Boyd Gaming (BYD) traced a perfect double top at $54 as shown in Figure 8.2. .Not all double tops are as precise as the double that formed in BYD.

The stock traded up to $54 on two separate occasions, which were separated by about six weeks. In between this time, the stock created horizontal support at the $48 level. The stock broke down below $48 without any hesitation, leading to a dramatic bearish trend.

 

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Triple Top

Definition:

A triple top occurs within the context of an existing bullish trend. It starts when a stock reaches a high from which it sharply reverses lower. The stock then reaches a low from which it rebounds. The stock rises up to the previous high and reverses lower for a second time, forming two equal highs. The stock then reverses back down to its recent low and bounces once more back up to its recent highs. The pattern concludes after the stock rolls over for a third time from its highs. These three highs are connected to form a horizontal resistance level. The support level is defined by the lows formed after the rebound attempts.

Nuance:

Triple tops occur less frequently than double tops. But when triple tops do form, they provide very precise entry points and risk management levels. Triple tops can form over very short and long periods of time.

Triple tops can go on and become quadruple top if the same horizontal support level is retested. The patterns can continue indefinitely, but the more often a resistance level is tested the weaker it becomes. Keep as much in mind when trading triple tops that don’t immediately reverse lower.

Application:

A triple top is confirmed once the currency pair breaks below the horizontal support level. Entry points can be taken upon the breakdown or after waiting for a retest or previous support and then taking action on the reversal. A triple top is rejected if the stock breaks above horizontal resistance

Example:

Shares of Chicos Fashion (CHS) formed a triple top in a relatively short period of time as shown in Figure 8.3. The stock traded up to but rolled over from $27.75 on three separate occasions over the course of two months. Meanwhile, horizontal support formed at the $24 level. After rolling over from the $24 horizontal resistance level for the third time, CHS broke below the $24 level and embarked on a new bearish trend.

 

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Head and Shoulders Top

Definition:

A head and shoulders top is very similar to a triple top. The only difference is that the second rollover from resistance is at a relatively higher level than the first and third reversals from resistance.

A head and shoulders top occurs within the context of an existing bullish trend. It starts when a stock reverses sharply lower from a high known as the left shoulder, but then rebounds from a relative low. The stock then proceeds to rise to a higher high known as the head before reversing lower for a second time to the same relative low. Next, the stock rebounds once more and rises to the third high known as the right shoulder which is equal to the first high. It rolls over once more to near the relative lows, which are connected to form a horizontal support level known as the neckline.

Nuance:

Head and shoulders tops are rare, but one of the most popular bearish reversal patterns among traders. They are extremely powerful indicators of a reversal of a bullish trend. The patterns are usually very actionable and profitable.

Head and shoulders tops sometimes appear diagonally, with a downward or upward sloping neckline, rather than horizontally.

Application:

A head and shoulders top is confirmed once the stock breaks below horizontal support known as the neckline. An entry can be taken upon the breakdown or after waiting for a retest of the neckline, which is a highly effective way of trading head and shoulders tops.

Example:

Shares of American Airlines (AMR) traced a head and shoulders top by first pulling back from the $34 level, creating the left shoulder as shown in Figure 8.4. The stock then aggressively rebounded from the $30 level and made its way up to above $40. But the stock reversed again, this time creating the head of the pattern. The stock rebounded from the $30 support level, forming two equal lows. These lows formed the neckline of the pattern. The head and shoulders top was completed when the stock rolled over from the $34 for a second time, creating the right shoulder. The pattern was confirmed when the stock broke down below horizontal support at $30.

 

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