Three Mountains and Three Rivers - Head and Shoulder Pattern Trading Strategy

THREE MOUNTAINS AND THREE RIVERS

There is a group of longer-term topping and bottoming patterns that includes

ü  The three mountains

ü  The three rivers

ü  The three Buddha tops

ü  Inverted three Buddha

ü  Dumpling tops

ü  Fry- pan bottoms

ü  Tower tops and bottoms.

Similar to the Western triple top, the Japanese have a three mountain top (see Exhibit 4.35). It is supposed to represent a major top. If the market backs off from a high three times or makes three attempts at a high, it is deemed a three-mountain top. The high point of the final mountain ideally should be confirmed with a bearish candle indicator (for example, a doji or dark-cloud cover). If the central mountain of a three mountain top is the highest mountain, it is a special type of three mountain called a three Buddha top (see Exhibit 4.36). The reason for this name is because, in Buddhist temples, there is a large central Buddha with smaller Buddhas (that is, saints) on both sides. This is the same pattern as the West's head and shoulders top.

Exhibit 4.35. Three Mountain Top

Exhibit 4.36. Three Buddha Top

Exhibit 4.37. Three River Top

Exhibit 4.38. Inverted Three Buddha

Although the three Buddha top is analogous to the Western head and shoulders pattern, the theory about the Japanese three Buddha pattern was used over a hundred years before the head and shoulders was known in America. (The earliest I have seen a reference to a head and shoulders pattern in the United States was by Richard Schabacker in the 1930s. For those who are familiar with the Edwards and Magee classic book, Technical Analysis of Stock Trends, much of the material in that book is based on Schabacker's work. Schabacker was Edwards's father-in-law.)

It is intriguing how market observers from both the West and the East have come up with this same pattern. Market psychology is the same around the world, or, as a Japanese proverb expresses, "The tone of a bird's song is the same everywhere." The three river bottom pattern (see Exhibit 4.37) is the opposite of the three mountain top. This occurs when the market tests a bottom level three times. The peak of the troughs should be exceeded to confirm a bottom. The equivalent of the Western inverted head and shoulders bottom is called, not surprisingly, an inverted three Buddha (see Exhibit 4.38).

Area A in Exhibit 4.39 shows hesitation near $124, especially with the bearish engulfing pattern made in the last two weeks in November. The retreat from this bearish engulfing pattern

Exhibit 4.39. Yen/Dollar-Weekly (Three Mountain Top)

found stabilization at a bullish engulfing pattern. The ascent from this bullish engulfing pattern stopped, not surprisingly at the aforementioned bearish engulfing pattern's resistance near $124 at B. B was another bearish engulfing pattern. The next rally in mid May and the subsequent bearish engulfing pattern at C put a three mountain top in place.

In Exhibit 4.39, the peaks of each mountain were almost the same. This is not necessary. It is still considered a three mountain top if the three price peaks are not exactly at the same highs. In Exhibit 4.40, price crested at A, B, and C, with B and C at slightly higher levels. This would still be considered a three mountain top. During the last two sessions at C, Intel was rising with two very small real bodies. This was a symptom of uneasiness. The price peak came at $76, a shooting star. The real turning signal, and the confirmation of the three Buddha top, came with the gap down after the late August shooting star.

While a three mountain top has nearly the same highs, the three Buddha top has the middle portion as the highest high. Again we can think of the three Buddha top as comparable to

Exhibit 4.40. Intel-Weekly

the head and shoulders top. In Exhibit 4.41 we see a three Buddha, a.k.a head and shoulders top, with the price peaks at 1, 2, and 3 defining the pattern. The rising line shown on the chart in Western terms would be called the neckline of the head and shoulders top. Classically, the neckline of the head and shoulders top once broken should become resistance. This is what unfolded with the break of the neckline on August 19 and then a little rebound on August 21 (and three sessions after that), stopping at the neckline's new resistance as confirmed by the bearish upper shadows.

Exhibit 4.42 is another example of the three Buddha top. Since this pattern is the same as the head and shoulders top, we can shift into the Western technical based on the concept of the head and shoulders neckline discussed in the previous exhibit.

Specifically, once the neckline was broken, it became resistance. The market tried to stabilize with a little bullish engulfing pattern around 13:00, but the failure to push this index above the neckline resistant kept the bears in control. This reflects how critical it is to think about where a candle pattern 

Exhibit 4.41 Yen/Dollar-Daily (Three Buddha Top)

is formed. In this instance the bullish engulfing pattern is a potential bottoming signal, but wouldn't it make sense to let the market close over the neckline's resistance before buying— even with the bullish engulfing pattern? It does pay to wait, since such a close over the neckline would help reinforce that the bulls have more control.

Our Western inverted head and shoulders is the same as the Japanese inverted three Buddha. That is, there are three lows made with the middle low as the lowest. This is shown in Exhibit 4.43 at lows at A, B, and C. Since the low at B was under the low at A or C, it formed an inverted three Buddha. Note how once the bulls pushed the pound above 163 with the tall white candle in early January, that prior resistance around 163 became support. This concept of a former resistance area being converted into new support is a powerful trading technique that is discussed in Chapter 9.

Exhibit 4.44 has an inverted three Buddha. Notice once again how a former resistance area from March near $52 to $52.50 once penetrated became a support zone for most of April.

Exhibit 4.42. NASDAQ-100 Trust-15 Minutes (Three Buddha Top)

Exhibit 4.43. British Pound/Dollar (Inverted Three Buddha)

Exhibit 4.44. Sealed Air-Daily (Inverted Three Buddha)