Variations from standard price patterns
As
in most other areas of market analysis, real-life
examples are usually some variation of the ideal. For
one thing, sometimes the two peaks are not at exactly
the same price level. On occasion, the second peak will
not quite reach the level of the first peak, which is
not too problematical. What does cause some problems is
when the second peak actually exceeds the first peak by
a slight margin. What at first may appear to be a valid
upside breakout and resumption of the uptrend may turn
out to be part of the topping process. To help resolve
this dilemma, some of the filtering criteria already
mentioned may come in handy.
Filters
Most
chartists require a close beyond a previous
resistance peak instead of just an intraday
penetration. Second, a price filter of some type
might be used. One such example is a percentage
penetration criterion (such as 1% or 3%). Third, the
two day penetration rule could be used as an example
of a time filter. In other words, prices would have
to close beyond the top of the first peak for two
consecutive days to signal a valid penetration.
Another time filter could be a Friday close beyond
the previous peak. The volume on the upside breakout
might also provide a clue to its reliability.
These
filters are certainly not infallible, but do serve
to reduce the number of false signals (or whipsaws)
that often occur. Sometimes these filters are
helpful, and sometimes they're not. The analyst must
face the realization that he or she is dealing with
percentages and probabilities, and that there will
be times when bad signals occur. That's simply a
fact of trading life.
It's
not that unusual for the final leg or wave of a bull
market to set a new high before reversing direction.
In such a case, the final upside breakout would
become a "bull trap." We'll show you some indicators
later on that may help you spot these false
breakouts.
The Term "Double Top"
Greatly Overused
The
terms "double top and bottom" are greatly overused in
the financial markets. Most potential double tops or
bottoms wind up being something else. The reason for
this is that prices have a strong tendency to back off
from a previous peak or bounce off a previous low. These
price changes are a natural reaction and do not in
themselves constitute a reversal pattern. Remember that,
at a top, prices must actually violate the previous
reaction low before the double top exists.
Time Between Peaks or
Troughs Is Important
Finally,
the size of the pattern is always important. The longer
the time period between the two peaks and the greater
the height of the pattern, the greater the potential
impending reversal. This is true of all chart patterns.
In general, most valid double tops or bottoms should
have at least a month between the two peaks or troughs.
Some will even be two or three months apart. (On longer
range monthly and weekly charts, these patterns can span
several years.) Most of the examples used in this
discussion have described market tops.
Variations from Standard Price
Patterns