Preliminary Points Common to All Major Reversal Patterns

Before beginning our discussion of the individual major reversal patterns, there are a few preliminary points to be considered that are common to all of these reversal patterns.

1. A prerequisite for any reversal pattern is the existence of a prior trend.

2. The first signal of an impending trend reversal is often the breaking of an important trend line.

3. The larger the pattern, the greater the subsequent move.

4. Topping patterns are usually shorter in duration and more volatile than bottoms.

5. Bottoms usually have smaller price ranges and take longer to build.

6. Volume is usually more important on the upside.

The Need for a Prior Trend. The existence of a prior major trend is an important prerequisite for any reversal pattern. A market must obviously have something to reverse. A formation occasionally appears on the charts, resembling one of the reversal patterns. If that pattern, however, has not been preceded by a trend, there is nothing to reverse and the pattern is suspect. Knowing where certain patterns are most apt to occur in the trend structure is one of the key elements in pattern recognition.

A corollary to this point of having a prior trend to reverse is the matter of measuring implications. It was stated earlier that most of the measuring techniques give only minimum price objectives. The maximum objective would be the total extent of the prior move. If a major bull market has occurred and a major topping pattern is being formed, the maximum implication for the potential move to the downside would be a 100% retracement of the bull market, or the point at which it all began.

The Breaking of Important Trend lines. The first sign of an impending trend reversal is often the breaking of an important trend line. Remember, however, that the violation of a major trend line does not necessarily signal a trend reversal What is being signaled is a change in trend. The breaking of a major up trend line might signal the beginning of a sideways price pattern, which later would be identified as either the reversal or consolidation type. Sometimes the breaking of the major trend line coincides with the completion of the price pattern.

The Larger the Pattern, the Greater the Potential. When we use the term "larger," we are referring to the height and the width of the price pattern. The height measures the volatility of the pattern. The width is the amount of time required to build and complete the pattern. The greater the size of the pattern-that is, the wider the price swings within the pattern (the volatility) and the longer it takes to build-the more important the pattern becomes and the greater the potential for the ensuing price move.