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Reversal patterns, or tops and bottoms, indicate a radical change
in a long-term trend.
Tops are usually less stable and shorter than bottoms.
Bottoms usually have smaller price variations and
are slower to set up.
A breakout through a trend line is used together
with a reversal pattern for monitoring price level- and timing-related
The longer the time required for the formation of a pattern
and the greater the price fluctuations within it are, the more substantial
the forthcoming price movement is likely to be. The time frame is,
normally, from several days to several months. Intraday patterns
are much less reliable.
Reversal patterns offer some of the most important opportunities
for entering a market with a good profit potential. They usually
represent fundamental changes in the underlying character of a particular
market, and often go on to yield big moves.
However, a market top or bottom is often difficult to identify.
It is even more difficult to choose the appropriate entry and exit
points. One of the related problems is distinguishing between the
actual change in a trend and a mere congestive phase in the middle
of a move. In most cases, it is advisable to wait for prices to
actually confirm a trend reversal by developing
one of these well-tested and reliable reversal patterns. The actual
buy or sell signals are based on a breakout in the direction of
the new trend.
The most popular Reversal Patterns include: head and shoulders,
double tops and bottoms, and V-Top.
Head and Shoulders
The head and shoulders pattern is formed by three peaks.
The center peak, or head, is somewhat higher than
its two lower, and not necessarily symmetrical, shoulders.
The line connecting the bottoms of the two shoulders is called the
neckline. Due to unsteadiness, the neckline is
seldom symmetric or precisely horizontal.
The pattern is not complete until the neckline is broken. It is
advisable to wait for confirmation.
Volume should be assessed to confirm the validity
of reversal patterns. Volume is, normally, the heaviest during the
formation of the left shoulder. It also tends to be quite heavy
when a price is approaching the peak. The real confirmation of a
developing Head and Shoulders pattern comes with the formation of
the right shoulder, which is invariably accompanied by a distinctly
This pattern consists of two tops of almost equal height.
A line is drawn below and parallel to the resistance line that connects
the two tops. The neckline is a strong support for price level but
As with a Head and Shoulders, after the two rallies and their respective
reversals are completed, the double tops is confirmed only when
the neckline is broken. The support line then becomes a resistance
line, which often holds a market rebound.
A Double Bottom pattern is a mirror image of a double top pattern:
The average height of the bottoms gives a good indication of the
The V-Top pattern is an unusual pattern in that a sharp
trend switches from one direction to the other without
warning and with high volume at or just after the turnaround.
Technical Analysis Education provided in part by ChartFilter.com
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