Chart Reversal Patterns Prepared by: chartsniper, F&M Associates
Double Top Reversal
Bearish pattern (except for P&F charts) Two consecutive peaks that are roughly equal with a moderate trough in between Typically found on bar, line and candlestick charts
P&F Charts
Bullish pattern Upside resistance breakout
Signals
Significant uptrend of several months Until key support is broken, pattern cannot be confirmed First peak should mark the highest point in the uptrend After the first peak, a decline takes place (10-20%). Volume doesn’t always follow Second peak occurs with low volume and meets resistance from the previous high (first peak) Time period between peaks can vary from many weeks to many months (1-3 months being the norm) = + 3% from the previous high Decline from peak, gap down or two with increase in volume, sharp decline (Demand loses against Supply) – Support test Breaking the support with increase in volume. Breaking the low points between the peaks Support turns resistance and tested before exiting a position or shorting Price target – Distance between support reak (new resistance) and the Peak.
Double Bottom Reversal
Bullish pattern Must have a downtrend of several months Two consecutive troughs that are roughly equal with a moderate peak in between
Signals
Significant downtrend of several months Until key resistance is broken, the pattern is not complete First trough marks the lowest point in the downtrend After first trough, advance takes place (10-20%). Volume does not follow all the time Demand is increasing, but not strong enough for a breakout (hesitation due to downtrend) Second trough – decline from the reaction high with a low volume and meets support Time period between troughs can vary from many weeks to many months (1-3 months being the norm) = + 3% from the previous low Advance from trough, gap up or two with increase in volume, sharp advance (Demand wins against Supply) – Resistance test ChMF above 10% = Intense buying pressure Breaking the resistance with an increase in volume. Breaking the high points between the troughs Resistance turns support. A short correction to test the resistance. Good for verying before exiting a short position and going long Price target – Distance between resistance break and the trough
*notes: Triple top and bottom reversals are almost the same as Double top and bottom
The three (3) tops/bottom must be roughly equal. Reversals of these type are often accompanied by an expansion of volume
Head and shoulders Top (Reversal)
A Head and Shoulders reversal pattern forms after an uptrend, and its completion marks a trend reversal. The pattern contains three successive peaks with the middle peak (head) being the highest and the two outside peaks (shoulders) being low and roughly equal. The reaction lows of each peak can be connected to form support, or a neckline.
Signals
Existence of a prior uptrend to establish a possible reversal pattern. (Note: Without a prior uptrend to reverse, there cannot be a Head and Shoulders reversal pattern (or any reversal pattern for that matter).) Formation of the Left Shoulder – A peak that marks the high point in the current trend. After the peak, a decline ensues to confirm the formation of the left shoulder. (1) Left shoulder decline (low) usually does not exceed the trend line (marking the uptrend) Formation of the head - From the low of the left shoulder, an advance begins that exceeds the previous high and marks the top of the head (Highest in the uptrend). (2) After peak, a decline ensues to mark the second point of the neckline. Decline usually breaks the trend line. Formation of the Right Shoulder - The advance from the low of the head forms the right shoulder. This peak is lower than the head (a lower high) and usually in line with the high of the left shoulder (roughly equal) Decline from the right shoulder SHOULD break the neckline Forming the neckline – Connecting the lows from the decline of the left shoulder and the head. Slope of the neckline measures the degree of BEARISHNESS of the pattern (Downward slope is more bearish than upward slope)
Volume Volume plays a major role in confirming the pattern
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.
Neckline break
H&S pattern is not complete until neckline support is broken with an expansion in volume for decisiveness
Support Turned Resistance
Once support is broken, it is common for this same support level to turn into resistance. Sometimes, but certainly not always, the price will return to the support break, and offer a second chance to sell.
Price Target
Distance from the neckline to the top of the head Any price target should serve as a rough guide, and other factors should be considered as well. These factors might include previous support levels, Fibonacci retracements, or long-term moving averages.
Head and shoulders bottom (Reversal)
Also called inverse head and shoulders Relies HEAVILY on volume for confirmation Major reversal pattern after a downtrend. Completion changes the trend (Down to Up) The pattern contains three successive troughs with the middle trough (head) being the deepest and the two outside troughs (shoulders) being shallower. Ideally, the two shoulders would be equal in height and width. The reaction highs in the middle of the pattern can be connected to form resistance, or a neckline.
Signals
The existence of a prior downtrend for this to be a reversal pattern. Without a prior downtrend to reverse, there cannot be a Head and Shoulders Bottom formation. Left Shoulder: While in a downtrend, the left shoulder forms a trough that marks a new reaction low in the current trend. After forming this trough, an advance ensues to complete the formation of the left shoulder Head: From the high of the left shoulder, a decline begins that exceeds the previous low and forms the low point of the head. After making a bottom, the high of the subsequent advance forms the second point of the neckline (2). High of the advance sometimes breaks the trend line Right Shoulder: The decline from the high of the head (neckline) begins to form the right shoulder. (Lower than head, but roughly equal to the left shoulder) When the advance from the low of the right shoulder breaks the neckline, the Head and Shoulders Bottom reversal is complete. Neckline: Connecting the advances from the left and the right shoulder The neckline can slope up, slope down, or be horizontal. The slope of the neckline will affect the pattern's degree of BULLISHNESS: an upward slope is more bullish than downward slope.
Volume
Without the proper expansion of volume, the validity of any breakout becomes suspect. Volume can be measured as an indicator (ChMF or the absolute value of the volume) Volume levels during the first half of the pattern are less important than in the second half. Volume on the decline of the left shoulder is usually pretty heavy and selling pressure quite intense. The intensity of selling can even continue during the decline that forms the low of the head. After this low, subsequent volume patterns should be watched carefully to look for expansion during the advances. The advance from the low of the head should show an increase in volume and/or better indicator readings, (CMF > 0 =buying pressure or rise in OBV). After the reaction high forms the second neckline point, the right shoulder's decline should be accompanied with light volume. It is normal to experience profit-taking after an advance. Volume analysis helps distinguish
between normal profit-taking and heavy selling pressure. With light volume on the pullback, indicators like CMF and OBV should remain strong. The most important moment for volume occurs on the advance from the low of the right shoulder. For a breakout to be considered valid, there needs to be an expansion of volume on the advance and during the breakout. Neckline Break
H&S pattern is not complete until neckline resistance is broken with an expansion in volume for decisiveness
Resistance Turned Support
Once resistance is broken, it will become the new support for the trend. Often, the price will return to the resistance break, and offer a second chance to buy.
Price Target
Measuring the distance from the neckline to the bottom of the head then added to the neckline. Any price target should serve as a rough guide, and other factors should be considered, as well. These factors might include previous resistance levels, Fibonacci retracements or long-term moving averages.
Falling Wedge (Reversal)
Bullish pattern Begins wide at top and contracts as prices move lower Forms a cone which slopes down as the highs and lows converge (always sloping down) Cannot be confirmed until a resistance break
Signals
Basically must have a prior trend to reverse. Pattern usually forms in 3-6 months At least two (2) reaction highs to form the upper resistance line (Lower highs) At least two (2) reaction lows to form the lower support line (Lower lows) The two lines must converge and form a cone Shallower (less deep) lows indicate a slowing selling pressure
Resistance break
Break from the 2nd reaction high A correction may happen to test the newfound resistance. Also a 2nd chance to buy at support There has to be an expansion of volume to gain conviction and to make sure the pattern will not fail
Rising Wedge (Reversal)
Bearish pattern Begins wide at bottom and contracts as prices move higher Forms a cone which slopes up as the highs and lows converge (always sloping up) Cannot be confirmed until a support break
Signals
Basically must have a prior trend to reverse. Pattern usually forms in 3-6 months At least two (2) reaction highs to form the upper resistance line (Higher highs) At least two (2) reaction lows to form the lower support line (Higher lows) The two lines must converge and form a cone
Support break
Break from the 2nd reaction low A reaction rally may happen to test the newfound resistance. Also a 2nd chance to sell at resistance There has to be an expansion of volume to gain conviction and to make sure the pattern will not fail
Volume
Volume declines as the prices rise and the pattern matures
Rounding Bottom (Reversal)
Long-term reversal pattern Best suited for weekly charts Long consolidation period that reverses bearish bias to bullish bias
Signals
Ideally, the low of a rounding bottom will mark a new low or reaction low. In practice, there are occasions when the low is recorded many months earlier and the security trades flat before forming the pattern. When the rounding bottom does finally form, its low may not be the lowest low of the last few months. The first portion of the rounding bottom is the decline that leads to the low of the pattern. Some are quite jagged with a number of reaction highs and lows, while others trade lower in a more linear fashion. The low of the rounding bottom can resemble a "V' bottom, but should not be too sharp and should take a few weeks to form. Because prices are in a long-term decline, the possibility of a selling climax exists that could create a lower spike. Advance: The advance off of the lows forms the right half of the pattern and should take about the same amount of time as the prior decline. Advance should not be too sharp or else the pattern is doubtful Bullish confirmation comes when the pattern breaks above the reaction high that marked the beginning of the decline at the start of the pattern. However, rounding bottoms represent longterm reversal and this new support level may not be that significant. Volume: In an ideal pattern, volume levels will track the shape of the rounding bottom: high at the beginning of the decline, low at the end of the decline and rising during the advance. Increase in volume during breakout
Bump and Run Reversal (Reversal)
is a reversal pattern that forms after excessive speculation drives prices up too far, too fast.
Signals
Lead-in Phase: The first part of the pattern is a lead-in phase that can last 1 month or longer and forms the basis from which to draw the trend line. Prices advance in an orderly manner, and there is no excess speculation. The trend line should be moderately steep. If it is too steep, then the ensuing bump is unlikely to be significant enough. If the trend line is not steep enough, then the subsequent trend line break will occur too late. Angle of 30 to 45 degrees is preferable. Visual assessment is often enough to measure the soundness of the trend line Bump Phase: The bump forms with a sharp advance, and prices move further away from the lead-in trend line. Ideally, the angle of the trend line from the bump's advance should be about 50% greater than the angle of the trend line extending up from the lead-in phase. Roughly speaking, this would call for an angle between 45 and 60 degrees. If it is not possible to measure the angles, then a visual assessment will suffice. Bump Validity: It is important that the bump represent a speculative advance that cannot be sustained for a long time. The distance from the highest high of the bump to the lead-in trend line should be at least twice the distance from the highest high in the lead-in phase to the lead-in trend line. These distances can be measured by drawing a vertical line from the highest highs to the lead-in trend line. Bump Rollover: After speculation dies down, prices begin to peak and a top forms. Sometimes, a small double top or a series of descending peaks forms. Prices begin to decline towards the lead-in trend line, and the right side of the bump forms. Volume: As the stock advances during the lead-in phase, volume is usually average and sometimes low. When the speculative advance begins to form the left side of the bump, volume expands as the advance accelerates. Run Phase: The run phase begins when the pattern breaks support from the lead-in trend line. Prices will sometimes hesitate or bounce off the trend line before breaking through. Once the break occurs, the run phase takes over, and the decline continues. Support Turns Resistance: After the trend line is broken, there is sometimes a retracement that tests the newfound resistance level. Potential support-turned-resistance levels can also be identified from the reaction lows within the bump.
