Triple Tops and Bottoms

TRIPLE TOPS AND BOTTOMS

Most of the points covered in the treatment of the head and shoulders pattern are also applicable to other types of reversal pat­terns. (See Figures 5.4a-c.) The triple top or bottom, which is much rarer in occurrence, is just a slight variation of that pattern. The main difference is that the three peaks or troughs in the triple top or bottom are at about the same level. (See Figure 5.4a.) Chartists often disagree as to whether a reversal pattern is a head and shoul­ders or a triple top. The argument is academic, because both pat­terns imply the exact same thing.

The volume tends to decline with each successive peak at the top and should increase at the breakdown point. The triple top is not complete until support levels along both of the inter­vening lows have been broken. Conversely, prices must close through the two intervening peaks at the bottom to complete a triple bottom. (As an alternate strategy, the breaking of the nearest peak or trough can also be used as a reversal signal.) Heavy upside volume on the completion of the bottom is also essential.

Figure 5.4a A triple top. Similar to the head and shoulders except that all peaks are at the same level. Each rally peak should be lighter volume. The patterns is complete when both troughs have been broken on heavier volume. The measuring technique is the height of the pattern projected downward from the breakdown point. Return moves back to the lower line are not unusual.

Figure 5.4b A triple bottom. Similar to a head and shoulders bottom except that each low is at the same level. A mirror image of the triple top except that volume is more important on the upside breakout.

Figure 5.4c A triple bottom reversal pattern. Prices found support just below 12 three on this chart before launching a major advance. The bottom formation on this weekly chart lasted two full years, thereby giving it major significance.

The measuring implication is also similar to the head and shoulders, and is based on the height of the pattern. Prices will usually move a minimum distance from the breakout point at least equal to the height of the pattern. Once the breakout occurs, a return move to the breakout point is not unusual. Because the triple top or bottom represents only a minor variation of the head and shoulders pattern, we won't say much more about it here.

DOUBLE TOPS AND BOTTOMS

A much more common reversal pattern is the double top or bottom. Next to the head and shoulders, it is the most frequently seen and the most easily recognized. (See Figures 5.5a-e.) Figures 5.5a and

Figure 5.5a Example of a double top. This pattern has two peaks (A and C) at about the same level. The pattern is complete when the middle trough at point B is broken on a closing basis. Volume is usually lighter on the sec­ond peak (C) and picks up on the breakdown (D). A return move back to the lower line is not unusual. The minimum measuring target is the height of the top projected downward from the breakdown point.

Figure 5.5b Example of a double bottom. A mirror image of the double top. Volume is more important on the upside breakout. Return moves back to the breakout point are more common at bottoms.

Figure 5.5c Example of a double bottom. This stock bounced sharply off the 68 level twice over a span of three months. Note that the second bottom was also an upside reversal day. The breaking of resistance at 80 completed the bottom.

Figure 5.5b show both the top and bottom variety. For obvious reasons, the top is often referred to as an "M" and the bottom as a "W." The general characteristics of a double top are similar to that of the head and shoulders and triple top except that only two peaks appear instead of three. The volume pattern is similar as is the measuring rule.

In an uptrend (as shown in Figure 5.5a), the market sets a new high at point A, usually on increased volume, and then declines to point B on declining volume. So far, everything is pro­ceeding as expected in a normal uptrend. The next rally to point C, however, is unable to penetrate the previous peak at A on a closing basis and begins to fall back again. A potential double top has been set up. I use the word "potential" because, as is the case with all reversal patterns, the reversal is not complete until the

Figure 5.5d Example of a double top. Sometimes the second peak doesn’t quite reach the first peak as in this example. This two month double top signaled a major decline. The actual signal was the breaking of support near 46 (see box).

previous support point at B is violated on a closing basis. Until that happens, prices could be in just a sideways consolidation phase, preparing for a resumption of the original uptrend.

The ideal top has two prominent peaks at about the same price level. Volume tends to be heavier during the first peak and lighter on the second. A decisive close under the middle trough at point B on heavier volume completes the pattern and signals a reversal of trend to the downside. A return move to the breakout point is not unusual prior to resumption of the downtrend.

Measuring Technique for the Double Top

The measuring technique for the double top is the height of the pattern projected from the breakdown point (the point where the

Figure 5.5e Price patterns show up regularly on the charts of major stock averages. On this chart, the Nasdaq Composite Index formed a double bottom near the 1470 level before turning nigher. The break of the down trendline (see box) confirmed the upturn.

middle trough at point B is broken). As an alternative, measure the height of the first downleg (points A to B) and project that length downward from the middle trough at point B. Measurements at the bottom are the same, but in the other direction.

VARIATIONS FROM THE IDEAL PATTERN

As in most other areas of market analysis, real-life examples are usually some variation of the ideal. For one thing, sometimes the two peaks are not at exactly the same price level. On occasion, the second peak will not quite reach the level of the first peak, which is not too problematical. What does cause some problems is when the second peak actually exceeds the first peak by a slight margin. What at first may appear to be a valid upside breakout and resumption of the uptrend may turn out to be part of the topping process. To help resolve this dilemma, some of the filtering crite­ria already mentioned may come in handy.

Filters

Most chartists require a close beyond a previous resistance peak instead of just an intraday penetration. Second, a price filter of some type might be used. One such example is a percentage pene­tration criterion (such as 1% or 3%). Third, the two day penetration rule could be used as an example of a time filter. In other words, prices would have to close beyond the top of the first peak for two consecutive days to signal a valid penetration. Another time filter could be a Friday close beyond the previous peak. The volume on the upside breakout might also provide a clue to its reliability.

These filters are certainly not infallible, but do serve to reduce the number of false signals (or whipsaws) that often occur. Sometimes these filters are helpful, and sometimes they're not. The analyst must face the realization that he or she is dealing with percentages and probabilities, and that there will be times when bad signals occur. That's simply a fact of trading life.

It's not that unusual for the final leg or wave of a bull mar­ket to set a new high before reversing direction. In such a case, the final upside breakout would become a "bull trap." (See Figures 5.6a and b.) We'll show you some indicators later on that may help you spot these false breakouts.

The Term "Double Top" Greatly Overused

The terms "double top and bottom" are greatly overused in the financial markets. Most potential double tops or bottoms wind up being something else. The reason for this is that prices have a strong tendency to back off from a previous peak or bounce off a previous low. These price changes are a natural reaction and do not in themselves constitute a reversal pattern. Remember that, at a top, prices must actually violate the previous reaction low before the double top exists.

Figure 5.6a Example of a false breakout, usually called a bull trap. Sometimes near the end of a major uptrend, prices will exceed a previous peak before failing. Chartists use vari­ous time and price filters to reduce such whipsaws. This top­ping pattern would probably qualify as a double top.

Figure 5.6b Example of a false breakout. Notice that the upside breakout was on light volume and the subsequent decline on heavy volume a negative chart combination. Watching the volume helps avoid some false breakouts, but not all.

Notice in Figure 5.7a that the price at point C backs off from the previous peak at point A. This is perfectly normal action in an uptrend. Many traders, however, will immediately label this pattern as a double top as soon as prices fail to clear the first peak on the first attempt. Figure 5.7b shows the same situation in a downtrend. It is very difficult for the chartist to determine whether the pullback from the previous peak or the bounce from the previous low is just a temporary setback in the existing trend or the start of a double top or bottom reversal pattern. Because the technical odds usually favor continuation of the present trend, it is usually wise to await completion of the pattern before taking action.

Figure 5.7a Example of a normal pullback from a previous peak before resumption of uptrend. This is normal market action and not to be confused with a double top. The double top only occurs when support at point B is broken.

Figure 5.7b Example of a nor­mal bounce off a previous low. This is normal market action and not to be confused with a double bottom. Prices will normally bounce off a previous low at least once, causing premature calls for a double bottom.

Time Between Peaks or Troughs Is Important

Finally, the size of the pattern is always important. The longer the time period between the two peaks and the greater the height of the pattern, the greater the potential impending reversal. This is true of all chart patterns. In general, most valid double tops or bottoms should have at least a month between the two peaks or troughs. Some will even be two or three months apart. (On longer range monthly and weekly charts, these patterns can span sever­al years.) Most of the examples used in this discussion have described market tops. The reader should be aware by now that bottoming patterns are mirror images of tops except for some of the general differences already touched upon at the beginning of the chapter.

SAUCERS AND SPIKES

Although not seen as frequently, reversal patterns sometimes take the shape of saucers or rounding bottoms. The saucer bottom shows a very slow and very gradual turn from down to sideways to up. It is difficult to tell exactly when the saucer has been com­pleted or to measure how far prices will travel in the opposite direction. Saucer bottoms are usually spotted on weekly or monthly charts that span several years. The longer they last, the more significant they become. (See Figure 5.8.)

Spikes are the hardest market turns to deal with because the spike (or V pattern) happens very quickly with little or no transi­tion period. They usually take place in a market that has gotten so overextended in one direction, that a sudden piece of adverse news causes the market to reverse direction very abruptly. A daily or weekly reversal, on very heavy volume, is sometimes the only warning they give us. That being the case, there's not much more we can say about them except that we hope you don't run into too many of them. Some technical indicators we discuss in later chapters will help you determine when markets have gotten dan­gerously over-extended. (See Figure 5.9.)

Figure 5.8 This chart shows what a saucer (or routing) bottom looks like. They’re very slow and gradual, but usually mark major turns. This bottom lasted four years.

Figure 5.9 Example of a v reversal pattern. These sudden reversal take place with little or no warning. A sudden price drop on heavy volume is usually the only telltale sign. Unfortunately, these sudden turns are hard to spot in advance.

CONCLUSION

We've discussed the five most commonly used major reversal pat­terns—the head and shoulders, double and triple tops and bot­toms, the saucer, and the V, or spike. Of those, the most common are the head and shoulders, and double tops and bottoms. These patterns usually signal important trend reversals in progress and are classified as major reversal patterns. There is another class of patterns, however, which are shorter term in nature and usually suggest trend consolidations rather than reversals. They are aptly called continuation patterns. Let's look at this other type of pattern in Chapter 6.