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10/21/02  

Chart Patterns

To the uninitiated, trading is gambling, pure and simple. Knowledge of history, technical and fundamental, can improve your odds. Identifying patterns that historically have been predictive of certain types of price action will further move pure gambling into the area of art and science. Actually, it is a little of both. Here are some common patterns to look for. 

Double Tops and Bottoms- This occurs when a stock hits a high or a low after a sizable move, pullsback but fails to hit the old high (or low). A variation of the Double Top (or bottom) is the 1-2-3-4 chart pattern. The 1 is a new low for a given time period, while the 2 is a subsequent bounce and a retest of old low with a failure to breach the immediately prior low, followed by a move up again which breaks the the downtrend. Finally, 4 is where the stock price rises above the channel created by the first low and bounces up. If the 1-2-3-4 is accompanied by a big increase in volume it is normally a good sign for a retracement or some magnitude back into major overhead resistance or major moving averages. A top pattern is just the reverse.

Other Double Bottoms include the Cup and Handle. The breakout should be accompanied by strong volume significantly higher than recent trading.

Head and Shoulder Tops and Bottoms- This is a less common topping or bottoming pattern than the cup and handle, and may be more powerful. A Head and Shoulder involves a new high, a pullback, a break new another new high which takes out the recent high and pullback to same area as the first pullback, and a final retest of the old high and a subsequent failure. The sell signal occurs when the neckline (which is the low of the H&S formation) is breached.

Basing Patterns and Topping Patterns- These patterns can be broad and lengthy from the perspective of time and represent stocks trading in narrow ranges for long periods while continuing to fail to breach old lows. Once the price breaches the top the narrow trading range, a lengthy uptrend can ensue. The broader the base, generally the longer the subsequent price move. The Topping process is the reverse.

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