of a reversal, with a head and shoulders
top (Figure 4). Note the middle peak
(head), with two lower peaks on either
side (left and right shoulders).
In the classic head and shoulders pattern, the head isn’t spiky. But now that
more traders have access to the markets,
the head forms quickly as retail and institutional traders jump in and fuel the rally.
Meanwhile, the bigger traders may take
advantage of the price peak and sell o;
Head and shoulders patterns have what’s
called a “neckline,” which is the clear support
(or resistance for an inverse pattern). Price
THE REVERSAL EFFECT
Has the market topped or bottomed? Here
are a couple patterns that typically appear at
tops, and in reverse formation, at bottoms.
4 HEAD AND SHOULDERS
These patterns can occur at the top of an
uptrend, or the bottom of a downtrend.
Remember Figure 1, where we weren’t
sure if the trend was going to reverse
or continue? It wasn’t until about nine
months later that the trend showed signs
needs to break out from the neckline on high
volume to increase the likelihood of a true
reversal. In Figure 4, the last four down bars
show increasing volume—bears are taking
over, and the trend is likely to reverse.
5 TRIPLE TOPS
When you have three somewhat equal price
peaks after an uptrend, it may be an indication of the trend’s end and the beginning
of a reversal. While the triple top is playing
out, you may sense indecision among traders. It could become a double top, a rectangle, or some other continuation pattern,
depending on where price bounces occur,
and with how much volume. After the third
peak, if volume increases during sello;s (a
sign the bears are winning the battle), it’s
likely the trend will reverse.
In Figure 5, after the third peak, you see
a consolidation. Then price heads back
toward the top, but doesn’t make it. The
catalyst for the turnaround was one sello;
day with huge volume. After that it was all
downhill—price continued to drop, with
high volume on down days. There were
times when bulls attempted to push prices
higher, but without success. The bears had
the upper hand.
WHEN LOOKING FOR MOMENTUM,
acknowledge the strength and power of
crowds. There are two things crowds do:
buy and sell. And while it’s never a sure
thing, their behavior tends to be repetitive.
Resist being drawn to the trend’s external appearance. Instead, try to recognize
what’s going on behind those price bars to
gauge your potential entry and exit points.
Jayanthi Gopalakrishnan is not a representative of
TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the
author and may not be reflective of those held by
TD Ameritrade, Inc.
For more on the risks of trading and trading
options, see page 37, #1– 2.
FIGURE 4: Head and shoulders. As reversals, these patterns could appear at the top or bottom of a trend, but
don’t let them fool you. Wait for a breakout below the “neckline” before putting on positions. Source: thinkorswim®
from TD Ameritrade. For illustrative purposes only.
FIGURE 5: Triple tops for a reversal. There can be a lot of momentum as a triple top plays out because of the
indecision among traders. Keep an eye on volume as the peaks form. Source: thinkorswim® from TD Ameritrade. For illustrative
Strong sello; day