Technical Analysis I

Reversal Patterns 3 : The Wedges

The wedge pattern is more like a symmetrical triangle pattern, the only difference is that it has converging trendlines which slat in either upwards or downward direction. There are two main types of wedges – falling and rising. A falling wedge slopes downward-it is a bullish pattern. In a falling wedge, the upper (or resistance) trendline will have a sharper slope than the support level in the wedge construction. The lower (or support) trendline will be clearly flatter as you can see in the figure given below. The stock prices tend to move between the resistance and support lines formed with a downward bias. The price movement in the wedge should at minimum test both the support trendline and the resistance trendline twice during the life of the wedge. The more times it tests each level, especially on the resistance end, the higher quality the wedge pattern is thought to be. The buy signal is formed when the price breaks through the upper resistance line. This breakout move should be on heavier volume, but due to the longer-term nature of this pattern, it’s important that the price has successive closes above the resistance line.

Example of falling wedge:

Conversely, a rising wedge is a bearish pattern. A rising wedge slopes upward. The upper (or resistance) trendline will have a flatter slope than the support level in the wedge construction. The lower (or support) trendline will clearly slop sharp as you can see in the figure given below. The stock prices tend to move between the resistance and support lines formed with a upward bias. The price movement in the wedge should at minimum test both the support trendline and the resistance trendline twice during the life of the wedge. The more times it tests each level, especially on the support end, the higher quality the wedge pattern is thought to be.

Example of a Rising wedge:

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Reversal Patterns 2 : Head and Shoulders

The head-and-shoulders pattern is one of the most popular and reliable chart patterns in technical analysis. And as one might imagine from the name, the pattern looks like a head with two shoulders. A Head and Shoulders pattern forms when one peak, followed by a higher peak, which is then followed by a lower peak, and finally a break below the support level established by the two troughs formed by the pattern. The head-and-shoulders is a signal that a share price is set to fall..

As the Head and Shoulders pattern unfolds, volume plays an important role in confirmation. Ideally, but not always, volume during the advance of the left shoulder should be higher than during the advance of the head. This decrease in volume and the new high of the head, together, serve as a warning sign. The next warning sign comes when volume increases on the decline from the peak of the head. Final confirmation comes when volume further increases during the decline of the right shoulder

Inverse Head and shoulders Pattern:

The second version, the inverse head and shoulders, signals that a share price is set to rise and usually forms during a downward trend. As the name indicates, it is a mirror image of the head and shoulders pattern signaling that the price is set to raise .Needless to say, volume plays an important role here too. Without the proper expansion of volume, the validity of any breakout becomes suspect.

Head and Shoulder

Inverse Head and Shoulder

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Reversal Patterns 1 : Double tops and double bottoms

Introduction

Reversal implies a ‘change in direction’. Thus, reversal patterns are chart formations that tend to reverse the direction of the trend. These patterns can be spotted on the daily, weekly or monthly charts. The Existence of a prior trend is the most important prerequisites in analyzing trend reversal patterns. Many a time, a pattern that appears on the chart resembles a reversal pattern. However, if there were no major prior trends before the occurrence of this pattern, it becomes suspect. If on the other hand, one finds that a downward reversal pattern is being formed on the chart when the market has appreciated considerably, that reversal pattern is of significance and should be studied carefully. The second point to be studied carefully is the volume. Volume can provide insights in trend reversals. It should be used as a corroborative evidence of a trend, not as primary evidence. Volume can also be used to confirm price changes. When a trend starts, and there is no pick up in volume activity, that may mean that the trend is weak and does not have commitment. Volume precedes the price. If there is a pick up in volume, then that may mean that a change in price may be approaching. The direction of the movement during this increase in volume can be indicative of the upcoming action. In the following sessions we explain some important reversal patterns

Double tops and double bottoms:

Double top and double bottom formations are also called ‘M’ and ‘W’ patterns. A double top is simply two peaks. The pattern forms when the share price makes a run up to a particular level, then drops back from that level, then make a second run at that level, and then finally drop back off again resulting in a ‘M’ shaped formation. It is a reversal pattern. For confirmation that a double top has actually formed and that a reversal in the uptrend is at hand, a common strategy is to look for declining volume going into the second peak and rising volume on a break below the bottom of the trough which has formed between the two peaks (support).Here too, volume plays an important part.

Example of Double top:

Double Bottom

This is the opposite chart pattern of the double top as it signals a reversal of the downtrend into an uptrend. The pattern forms when the share price makes a run down to a particular level, then trades up from that level then makes a second run down to at or near the same level as the first bottom, and then finally trades back up again, resulting in a ’W’ shaped formation. For confirmation that a double bottom has formed and that a reversal in the downtrend is at hand , a common strategy is to look for declining volume going into the second trough and rising volume on the break of the peak which has formed between the two troughs (resistance).

Example of double Bottom:

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Continuing patterns 3 : Cup with handle

As its name implies, there are two parts to the pattern: The cup and the handle. A cup-and-handle pattern resembles the shape of a tea cup on a chart. This is a bullish continuation pattern where the upward trend has paused, and traded down, but will continue in an upward direction upon the completion of the pattern. The ‘cup’ is a bowl-shaped consolidation and the ‘handle’ is a short pullback followed by a breakout. There should be a substantial increase in volume on the breakout above the handle’s resistance. The stronger the volume on the upward breakout, the clearer the sign that the upward trend will continue. The Shape of the cup itself is also important: it should be a nicely rounded formation, similar to a semi-circle.

Example of a Cup with handle:

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