1. Technical analysis
-- Technical Analysis of Stock Trends by Robert D. Edwards, John
Magee, and W. H. C. Bassetti
-- Dow Theory for the 21st
Century: Technical Indicators to
improving your investment results by Jack Schannep
Technical analysis is the attempt to forecast stock prices on the
basis of market-derived data.
Technicians (also known as quantitative analysts or chartists)
usually look at price, volume and psychological indicators over
They are looking for trends and patterns in the data that
indicate future price movements.
3. The Potential Rewards
This chart, from Norman Fosbeck, shows how market timing
can benefit your returns. The only problem is that you have to
be very good at it.
Alternative Market Strategies (1964 to 1984)
Strategy Avg. Annual Gain $10,000 Grows To
Buyand Hold 11.46% 87,500$
Avoid Bear Markets 21.48% 489,700$
Longand Short Major Swings 27.99% 1,391,200$
Longand Short Every5% Swing 93.18% 5,240,000,000$
4. The Potential Rewards
This chart, from Barron’s, shows the benefit of being smart
enough to miss the worst 5 days of the year between Feb 1966
and Oct 2001.
Source: “The Truth About Timing,” by Jacqueline Doherty, Barron’s (November 5, 2001)
• Bar Charts and Japanese Candlestick Charts
• Point and Figure Charts
Major Chart Patterns
6. What is Technical Analysis?
The study of market dynamics by evaluating the market’s own
• Figuring out what others think of a stock based on the history
of prices (CHARTing)
• Assumes a degree of market efficiency
7. What do Technicals offer?
A sense of current markets:
• Where are the markets going?
A verification on fundamental analysis
• Enable to spot good bargains based on how certain set of
fundamentals are valued in the market.
8. Charting the Market
Chartists use bar charts, candlestick, or point and figure charts
to look for patterns which may indicate future price
They also analyze volume and other psychological indicators
(breadth of the market, % of bulls vs % of bears, put/call ratio,
Strict chartists don’t care about fundamentals at all.
9. Drawing Bar (OHLC) Charts
Each bar is composed of 4
Note that the candlestick
body is empty (white) on up
days, and filled (some
color) on down days
for a sample charts
10. Types of Charts: Bar Charts
This is a bar (open, high, low, close or OHLC) chart of AMAT
from early July to mid October 2001.
11. Types of Charts: Japanese Candlesticks
This is a Japanese Candlestick (open, high, low, close) chart of
AMAT from early July to mid October 2001
12. Drawing Point & Figure Charts
Point & Figure charts are
independent of time.
An X represents an up
An O represents a down
The Box Size is the number
of points needed to make an
X or O.
The Reversal is the price
change needed to recognize
a change in direction.
Typically, P&F charts use a
1-point box and a 3-point
13. Three Basic Functions of Technical Analysis
• Where is the market going?
• Tops and Bottoms
Is the market going up or down?
• How do peaks and bottoms align?
•Increasing Bull Trend, Decreasing Bear Trend
•Combination of trend lines at the top and bottom
17. Reversals Patterns
When will the market change?
• Gaps, 1-day moves
• Double Top and Double Bottom
• Flags and Pennants
• Head-and-Shoulders and Reverse Head-and-Shoulders
A gap is an area on a price chart in which there were no trades.
Normally gap occurs between the closing price of one day and the
opening price of the next day. Gaps normally appear more frequently
on daily charts than on weekly or monthly charts
Gaps on price charts indicate that something important has happened
to the fundamentals or the psychology of the market participants that
accompanies this market movement.
Gaps can be subdivided into four basic categories:
• Common gaps,
• Breakaway gaps,
• Runaway gaps,
• Exhaustion gaps.
28. Double Top (Bearish Reversal)
The Double Top Reversal is a bearish reversal pattern. The pattern can
be identified when two consecutive peaks that are roughly equal are
made with a moderate trough in-between
The classic Double top formation indicate atleast an intermediate
reversal, if not long term, from bullish to bearish trend.
Many a times potential Double Top Reversals can form during a long
term uptrend, but the reversal can not be confirmed until the key
support is broken.
30. Double Bottom (Bullish Reversal)
The Double Bottom Reversal is a bullish reversal pattern. The pattern
can be identified when two consecutive troughs that are roughly equal
are made with a moderate peak in-between.
The classic Double bottom formation indicate an intermediate or a
long term reversal, from bearish to bullish trend.
Many a times potential Double Bottom Reversals can form during a
long term down trend, but the reversal can not be confirmed until the
key resistance is broken.
32. Flags and Pennants
Flag : A flag is a small rectangle pattern that slopes against the
previous trend. If the previous move was up, then the flag would slope
down and vice versa. The sharp advance or decline that form a Flag is
always fueled by expansion of volumes, hence indicating the
continuance of the trend.
Pennant: A pennant is a small symmetrical triangle that begins wide
and converges as the pattern matures. The slope is usually neutral.
Pennant formation is also supported by expansion of volumes.
Duration: Flags and pennants are short-term patterns that can last
from 1 to 12 weeks. some consider 8 weeks as a time frame for
formation of a reliable pattern. Ideally, these patterns will form
between 1 and 4 weeks.
Break: For a flag or pennant, a break above resistance /support signals
that the previous trend of advance /decline has resumed.
33. Flags and Pennants
Flagpole: The flagpole is the distance from the first resistance or
support break to the high or low of the flag/pennant. The sharp advance
(or decline) that forms the flagpole should break a trend line or
resistance/support level. A line extending up from this break to the high
of the flag/pennant forms the flagpole.
Targets: The length of the flagpole can be applied to the resistance
break or support break of the flag/pennant to estimate the advance or
36. Head and Shoulders
The Head and Shoulders reversal pattern is formed with a
precedence of up trend.
It is made up of a three successive peaks called
• A left shoulder,
• A head,
• A right shoulder, and a neckline.
• Other parts playing a role in the pattern formation are
volume, the breakout, price target and support turned
The Competition of H&S pattern indicate an onset of bearish
Where as the inverse H&S pattern is formed on a preceding
down trend. Competition of this pattern indicates an onset of
43. Support and Resistance
What prices will people be willing to buy and sell?
• Support - “Buying (actual or potential) in sufficient volume to
halt a downtrend in prices for an appreciable period”
• Resistance - “Selling (actual or potential) in sufficient volume
to satisfy all bids”
•Stops prices from increasing
• Fibonacci retracements and extensions are used to identify
support and resistance levels and also as indicatiors for
45. Fibonacci Retracement/ Extensions
Retracement levels suggested by Fibonacci sequence indicates potential
trend reversals, resistance and support levels.
Different retracement levels are 61.8% (deeper), 50%, 38.2%
(moderate) and 23.6% (shallow).
Note Retracement levels are not hard reversal points they only serve as
alert zones for potential reversals. The retracement levels are to be used
in combination with other technical tools like momentum oscillators ,
chaikin money flow (CMF), gaps, trend lines etc.
Fibonacci extension is calculated when the price retraces more than
100% of the prior move. It works well when stocks are at new highs or
new lows – with no obvious support or resistance levels on the chart.
The two common Fibonacci ratios used for calculating extensions are
1.618 and 1.272.
49. Trend Lines
There are three basic kinds
• An Up trend where
prices are generally
• A Down trend where
prices are generally
• A Trading Range.
50. Support & Resistance
Support and resistance lines
indicate likely ends of
Resistance results from the
inability to surpass prior
Support results from the
inability to break below to
What was support becomes
resistance, and vice-versa.
51. Simple Moving Averages
A moving average is
simply the average price
(usually the closing price)
over the last N periods.
They are used to smooth
out fluctuations of less
than N periods.
This chart shows MSFT
with a 10-day moving
average. Note how the
moving average shows
much less volatility than
the daily stock price.
1 21 41 61 81 101 121 141 161 181 201 221 241
52. Price Patterns
Technicians look for many patterns in the historical time series
These patterns are reputed to provide information regarding the
size and timing of subsequent price moves.
But don’t forget that the EMH says these patterns are illusions,
and have no real meaning. In fact, they can be seen in a
randomly generated price series.
53. Head and Shoulders
This formation is
characterized by two small
peaks on either side of a
This is a reversal pattern,
meaning that it signifies a
change in the trend.
54. Double Tops and Bottoms
These formations are
similar to the H&S
formations, but there is no
These are reversal patterns
with the same measuring
implications as the H&S.
Triangles are continuation
Typically, triangles should
break out about half to
three-quarters of the way
through the formation.
56. Rounded Tops & Bottoms
Rounding formations are
characterized by a slow
reversal of trend.
57. Broadening Formations
These formations are like
These formations usually
signal a reversal of the
58. Technical Indicators
There are, literally, hundreds of technical indicators used to
generate buy and sell signals.
A few of them are :
• Moving Average Convergence/Divergence (MACD)
• Relative Strength Index (RSI)
• On Balance Volume (OBV)
• Bollinger Bands
MACD was developed by Gerald Appel as a way to keep track
of a moving average crossover system.
Appel defined MACD as the difference between a 12-day and
26-day moving average. A 9-day moving average of this
difference is used to generate signals.
One can look for signal line crossovers, centerline crossovers
and divergences to generate signals.
When this signal line goes from negative to positive, a buy
signal is generated.
When the signal line goes from positive to negative, a sell
signal is generated.
MACD is best used in choppy (trendless) markets, and is
subject to whipsaws (in and out rapidly with little or no profit).
61. Relative Strength Index (RSI)
RSI was developed by Welles Wilder as an oscillator to gauge
RSI is a rescaled measure of the ratio of
average price changes on up days / average price changes on down days.
The most important thing to understand about RSI is that a level above
70 indicates a stock is overbought, and a level below 30 indicates that it
is oversold (it can range from 0 to 100).
Also, realize that stocks can remain overbought or oversold for long
periods of time, so RSI alone isn’t always a great timing tool.
63. On Balance Volume (OBV)
On Balance Volume was developed by Joseph Granville, one of
the most famous technicians of the 1960’s and 1970’s.
OBV is calculated by adding volume on up days, and
subtracting volume on down days. A running total is kept.
Granville believed that “volume leads price.”
To use OBV, you generally look for OBV to show a change in
trend (a divergence from the price trend).
If the stock is in an uptrend but OBV turns down, then that can
be taken as a signal that the price trend may soon reverse.
65. Bollinger Bands
Bollinger bands were created by John Bollinger (former FNN
technical analyst, and regular guest on CNBC).
These are used to identify M-Tops and W-Bottoms or to determine the
strength of the trend.
Bollinger Bands are two volatility bands (Std. deviations) placed
above and below a moving average of the closing price.
A buy signal is given when the stock price closes below the lower
band, and a sell signal is given when the stock price closes above the
When the bands contract, that is a signal that a big move is coming,
but it is impossible to say if it will be up or down.
It appears that the buy signals by BB are far more reliable than the sell
69. Dow Theory
This theory was first stated by Charles Henry Dow in a series
of columns in the WSJ between 1900 and 1902.
Dow (and later Hamilton and Rhea) believed that market trends
forecast trends in the economy.
A change in the trend of the DJIA (industrial average) must be
confirmed by a trend change in the DJTA (transportation
average) in order to generate a valid signal.
70. Tenets of Dow Theory
The Markets have three trends:
• down trend
Trends Have 3 Phases
• Accumulation Phase
• Public participation Phase
• The excess Phase and hence one c
The Markets Discount All news
• (EHM Holds good and hence one can beat the market only by timing it
Averages must confirm to each other
Trends Must be confirmed by volumes
Trends exist until definitive signals prove they have ended
71. Dow Theory Trends
• Called “the tide” by Dow, this is the trend that defines the
long-term direction (up to several years). Others have
called this a “secular” bull or bear market.
• Called “the waves” by Dow, this is shorter-term departures
from the primary trend (weeks to months)
Day to day fluctuations
• Not significant in Dow Theory
73. Does Dow Theory Work?
According to Martin Pring, if you had invested $44 in 1897 and
followed all buy and sell signals, by 1981 you would have
accumulated about $18,000.
If you had simply invested $44 and held that portfolio, by 1981
you would have accumulated about $960.
74. Elliot Wave Principle
R.N. Elliot formulated this idea in a series of articles in
Financial World in 1939.
Elliot believed that the market has a rhythmic regularity that
can be used to predict future prices.
The Elliot Wave Principle is based on a repeating 8-wave cycle,
and each cycle is made up of similar shorter-term cycles (“Big
fleas have little fleas upon their backs to bite 'em - little fleas
have smaller fleas and so on ad infinitem”).
Elliot Wave adherents also make extensive use of the Fibonacci
76. Does Elliot Wave Work?
Who knows? One of the biggest problems with Elliot Wave is
that no two practitioners seem to agree on the wave count, and
therefore on the prediction of what’s to come.
Robert Prechter (the most famous EW practitioner) made
several astoundingly correct predictions in the 1980’s, but
hasn’t been so prescient since (he no longer gets much press
For example, in 1985 he predicted that the market would peak
in 1987 (correct), but he thought it would peak at 3686 (± 100
The DJIA actually peaked on 25 August 1987 at 2722.42, more
than 960 points lower.
Common Gap, also referred to as a trading gap or an area gap, is usually uneventful. In fact, they can be caused by a stock going ex-dividend when the trading volume is low. These gaps are common and usually get closed/filled fairly quickly. &quot;Getting filled&quot; means that the price action at a later time (few days to a few weeks) usually retraces at the least to the last day before the gap. This is also known as closing the gap.
A common gap usually appears in a trading range or congestion area, and reinforces the apparent lack of interest in the stock/counter at that time. Many times this is further intensified by low trading volume. Being aware of these types of gaps is good, but doubtful that they will produce a trading opportunities.
Notice in the chart shows how prices spent over 2 months without going lower than about 41. But when they did, it was with increased volume and a downward breakaway gap.
Breakaway gaps reflect a price break out (upside or down side) from a trading range or congestion area. Such gaps are always followed by significant increase in volumes. Volume will (should) pick up not only because of the increased enthusiasm, but many are holding positions on the wrong side of the breakout and need to cover or sell them. It is better if the volume does not happen until the gap occurs. This means that the new change in market direction has a chance of continuing. And hence the gap may not get filled at all or may take a long time.
The point of breakout now becomes the new support (if an upside breakout) or resistance (if a downside breakout). The trader has to acknowledge this change in trend and trade accordingly.
A good confirmation for trading gaps is if they are associated with classic chart patterns. For example, if an ascending triangle suddenly has a breakout gap to the upside, this can be a much better trade than a breakaway gap without a good chart pattern associated with it. The chart below shows the normally bullish ascending triangle (flat top and rising, lower trend line) with a breakaway gap to the upside, as you would expect with an ascending triangle.
Runaway gaps (also called ‘measuring gaps’) occur when there is an increased interest in a stock. For runaway gaps to the upside, it usually represents traders who did not get in during the initial move of the up trend and while waiting for a retracement in price, decided it was not going to happen. Increased buying interest happens all of a sudden, and the price gaps above the previous day&apos;s close. This type of runaway gap represents an almost panic state in traders. Also, a good uptrend can have runaway gaps caused by significant news events that cause new interest in the stock. The chart shows a significant increase in volume during and after the runaway gap.
Runaway gaps can also happen in downtrends. This usually represents increased liquidation of that stock by traders and buyers who are standing on the sidelines. These can become very serious as those who are holding onto the stock will eventually panic and sell – but sell to whom? The price has to continue to drop and gap down to find buyers.
This is an interpretation that is hard to find examples for, but it is a way of helping one decide how much longer a trend will last. The theory is that the measuring gap will occur in the middle, or half way, through the move.
Exhaustion gaps are those that happen near the end of a good up- or downtrend accompanied by an exceptionally high volume and a large price difference. They are many times the first signal of the end of that move. They can easily be mistaken for runaway gaps if one does not notice the exceptionally high volume.
It is almost a state of panic if the gap appears during a long down move and pessimism has set in. Selling all positions to liquidate holdings in the market is not uncommon. Exhaustion gaps are quickly filled as prices reverse their trend. Likewise, if they happen during a bull move, some bullish euphoria overcomes trades, and buyers cannot get enough of that stock. The prices gap up with huge volume; then, there is great profit taking and the demand for the stock totally dries up. Prices drop, and a significant change in trend occurs. Exhaustion gaps are probably the easiest to trade and profit from. In the chart, notice that there was one more day of trading to the upside before the stock plunged. The high volume was the giveaway that this was going to be, either, an exhaustion gap or a runaway gap. Because of the size of the gap and the near doubling of volume, an exhaustion gap was in the making here.
Prior Trend: With any reversal pattern, there must be an existing trend to reverse. In the case of the Double Top Reversal, a significant uptrend of several months should be in place.
First Peak: The first peak should mark the highest point of the current trend. As such, the first peak is fairly normal and the uptrend is not in jeopardy (or in question) at this time.
Trough: After the first peak, a decline takes place that typically ranges from 10 to 20%. Volume on the decline from the first peak is usually inconsequential. The lows are sometimes rounded or drawn out a bit, which can be a sign of tepid demand.
Second Peak: The advance off the lows usually occurs with low volume and meets resistance from the previous high. Resistance from the previous high should be expected. Even after meeting resistance, only the possibility of a Double Top Reversal exists. The pattern still needs to be confirmed. The time period between peaks can vary from a few weeks to many months, with the norm being 1-3 months. While exact peaks are preferable, there is some leeway. Usually a peak within 3% of the previous high is adequate.
Decline from Peak: The subsequent decline from the second peak should witness an expansion in volume and/or an accelerated descent, perhaps marked with a gap or two. Such a decline shows that the forces of demand are weaker than supply and a support test is imminent.
Support Break: Even after trading down to support, the Double Top Reversal and trend reversal are still not complete. Breaking support from the lowest point between the peaks completes the Double Top Reversal. This too should occur with an increase in volume and/or an accelerated descent.
Support Turned Resistance: Broken support becomes potential resistance and there is sometimes a test of this newfound resistance level with a reaction rally. Such a test can offer a second chance to exit a position or initiate a short.
Price Target: The distance from support break to peak can be subtracted from the support break for a price target. This would infer that the bigger the formation is, the larger the potential decline.
While the Double Top Reversal formation may seem straightforward, technicians should take proper steps to avoid deceptive Double Top Reversals. The peaks should be separated by about a month. If the peaks are too close, they could just represent normal resistance rather than a lasting change in the supply/demand picture. Ensure that the low between the peaks declines at least 10%. Declines less than 10% may not be indicative of a significant increase in selling pressure. After the decline, analyze the trough for clues on the strength of demand. If the trough drags on a bit and has trouble moving back up, demand could be drying up. When the security does advance, look for a contraction in volume as a further indication of weakening demand.
Prior Trend: With any reversal pattern, there must be an existing trend to reverse. In the case of the Double Bottom Reversal, a significant downtrend of several months should be in place.
First Trough: The first trough should mark the lowest point of the current trend. As such, the first trough is fairly normal in appearance and the downtrend remains firmly in place.Peak: After the first trough, an advance takes place that typically ranges from 10 to 20%. Volume on the advance from the first trough is usually inconsequential, but an increase could signal early accumulation. The high of the peak is sometimes rounded or drawn out a bit from the hesitation to go back down. This hesitation indicates that demand is increasing, but still not strong enough for a breakout.
Second Trough: The decline off the reaction high usually occurs with low volume and meets support from the previous low. Support from the previous low should be expected. Even after establishing support, only the possibility of a Double Bottom Reversal exists, and it still needs to be confirmed. The time period between troughs can vary from a few weeks to many months, with the norm being 1-3 months. While exact troughs are preferable, there is some room to maneuver and usually a trough within 3% of the previous is considered valid.
Advance from Trough: Volume is more important for the Double Bottom Reversal than the double top. There should clear evidence that volume and buying pressure are accelerating during the advance off of the second trough. An accelerated ascent, perhaps marked with a gap or two, also indicates a potential change in sentiment.
Resistance Break: Even after trading up to resistance, the double top and trend reversal are still not complete. Breaking resistance from the highest point between the troughs completes the Double Bottom Reversal. This too should occur with an increase in volume and/or an accelerated ascent.
Resistance Turned Support: Broken resistance becomes potential support and there is sometimes a test of this newfound support level with the first correction. Such a test can offer a second chance to close a short position or initiate a long.
Price Target: The distance from the resistance breakout to trough lows can be added on top of the resistance break to estimate a target. This would imply that the bigger the formation is, the larger the potential advance.
It is important to remember that the Double Bottom Reversal is an intermediate to long-term reversal pattern that will not form in a few days. Even though formation in a few weeks is possible, it is preferable to have at least 4 weeks between lows. Bottoms usually take longer than tops to form and patience can often be a virtue. Give the pattern time to develop and look for the proper clues. The advance off of the first trough should be 10-20%. The second trough should form a low within 3% of the previous low and volume on the ensuing advance should increase. Volume indicators such as Chaikin Money Flow or OBV or Accumulation/Distribution can be used to look for signs of buying pressure.
Flags and Pennants are short-term continuation patterns that mark a small consolidation before the previous move resumes. These patterns are usually preceded by a sharp advance or decline with heavy volume, and mark a mid-point of the move.
Even though flags and pennants are common formations, identification guidelines should not be taken lightly. It is important that flags and pennants are preceded by a sharp advance or decline. Without a sharp move, the reliability of the formation becomes questionable and trading could carry added risk. Look for volume confirmation on the initial move, consolidation and resumption to augment the robustness of pattern identification.
An example of a Flag formation and target estimation:
Sharp Move: After consolidating for three months, HWP broke above resistance at 28 to begin a sharp advance. The 5-April high and 16-Feb trend line marked resistance and the breakout occurred with a volume expansion. The stock advanced from 28 to 38 in a mere 4 weeks. (Note: It is also possible that a small pennant formed in early May with resistance around 31).
Flagpole: The distance from the breakout at 28 to the flag&apos;s high at 38 formed the flagpole.
Flag: Price action was contained within two parallel trend lines that sloped down.
Duration: From a high at 38 to the breakout at 36, the flag formed over a 23-day period.
Breakout: The first break above the flag&apos;s upper trend line occurred on 21-June without an expansion of volume. However, the stock gapped up a week later and closed strong with above-average volume (red arrows)
Volume: To recap - volume expanded on the sharp advance to form the flagpole, contracted during the flag&apos;s formation and expanded right after the resistance breakout.
Targets: The length of the flagpole measured 10 points and was applied to the resistance breakout at 36 to project a target of 46.
Previous Trend: It is important to establish the existence of a preceding uptrend for this to be a reversal pattern. Without a prior uptrend to reverse, there cannot be a Head and Shoulders reversal pattern (or any reversal pattern for that matter).
Left Shoulder: While in an uptrend, the left shoulder forms a peak that marks the high point of the current trend. After making this peak, a decline ensues to complete the formation of the shoulder (1). The low of the decline usually remains above the trend line, keeping the uptrend intact.
Head: From the low of the left shoulder, an advance begins that exceeds the previous high and marks the top of the head. After peaking, the low of the subsequent decline marks the second point of the neckline (2). The low of the decline usually breaks the uptrend line, putting the uptrend in jeopardy.
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. Normally it is expected that the left and right shoulders are in symmetry but need not be so every time. The decline from the peak of the right shoulder should break the neckline.
Neckline: The neckline forms by connecting low points 1 and 2. Low point 1 marks the end of the left shoulder and the beginning of the head. Low point 2 marks the end of the head and the beginning of the right shoulder. Depending on the relationship between the two low points, the neckline can slope up, slope down or be horizontal. The slope of the neckline will affect the pattern&apos;s degree of bearishness: a downward slope is more bearish than an upward slope. Sometimes more than one low point can be used to form the neckline.
Volume: As the Head and Shoulders pattern unfolds, volume plays an important role in confirmation. Volume can be measured as an indicator (OBV, Chaikin Money Flow) or simply by analyzing volume levels. 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: The head and shoulders pattern is not complete and the uptrend is not reversed until neckline support is broken. Ideally, this should also occur in a convincing manner, with an expansion in volume.
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: After breaking neckline support, the projected price decline is found by measuring the distance from the neckline to the top of the head. This distance is then subtracted from the neckline to reach a price target. 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.
The above chart shows the formation of a Head and Shoulders reversal with a slightly upward sloping neckline. Key points include:
The low at 17.5 marked the end of the left shoulder and the beginning of the head (1).
During the advance to 20.5, volume was still high, but not as high as during the left shoulder advance. However, during the next advance to 20, volume decreased significantly.
Volume continued to decline until the breaking of the neckline. (Note red line on volume bars.)
The decline from 20.5 to 17.5 formed the second low point (2).
During the decline of the right shoulder and neckline break, volume expanded (red oval), and Chaikin Money Flow turned negative.
After the initial decline, there was a return to the neckline break (black arrow). Even during this decline, Chaikin Money Flow remained negative. The subsequent decline took the stock below 11.
The measurement from neckline to the top of the head was 3. With the neckline break at 17.5, this would imply a move to around 14.5. The July &apos;98 low was 13.5. After a decline from 20.5, at least, a short reaction rally could have been expected.
The head and shoulders pattern is one of the most common reversal formations. It is important to remember that it occurs after an uptrend and usually marks a major trend reversal when complete. While it is preferable that the left and right shoulders be symmetrical, it is not an absolute requirement. They can be different widths as well as different heights. Identification of neckline support and volume confirmation on the break can be the most critical factors. The support break indicates a new willingness to sell at lower prices. Lower prices combined with an increase in volume indicate an increase in supply. The combination can be lethal, and sometimes, there is no second chance return to the support break. Measuring the expected length of the decline after the breakout can be helpful, but don&apos;t count on it for your ultimate target.
Inverse Head and Shoulders pattern is similar to the normal H&S pattern, but relies more heavily on volume patterns for confirmation.
As a major reversal pattern, the Head and Shoulders Bottom forms after a downtrend and marks an onset of up trend.
OBV can be used to confirm a price trend, upside breakout or downside break. The chart for Best Buy (BBY) shows three confirming signals as well as confirmation of the price trend. OBV and BBY moved lower in December-January, higher from March to April, lower from May to August and higher from September to October. The trends in OBV matched the trend in BBY.
OBV also confirmed trend reversals in BBY. Notice how BBY broke its down trendline in late February and OBV confirmed with a resistance breakout in March. BBY broke its up trendline in late April and OBV confirmed with a support break in early May. BBY broke its down trendline in early September and OBV confirmed with a trendline break a week later. These coincident signals indicated that positive and negative volume were in harmony with price.
Some times OBV moves step –for-step with the price of the underlying security.
If the closing price is above the prior close price then: Current OBV = Yesterday&apos;s OBV + Current Volume If the closing price is below the prior close price then: Current OBV = Yesterday&apos;s OBV - Current Volume If the closing prices equals yesterday&apos;s closing price then: Current OBV = Yesterday&apos;s OBV (no change)
A &quot;W-Bottom&quot; forms in a downtrend and involves two reaction lows. In particular, Bollinger looks for W-Bottoms where the second low is lower than the first, but holds above the lower band. There are four steps to confirm a W-Bottom with Bollinger Bands. First, a reaction low forms. This low is usually, but not always, below the lower band. Second, there is a bounce towards the middle band. Third, there is a new price low in the security this low holds above the lower band. The ability to hold above the lower band on the test shows less weakness on the last decline. Fourth, the pattern is confirmed with a strong move off the second low and a resistance break. This indicates onset of a bullish pattern.
M-Top is similar to a double top. However, the reaction highs are not always equal. The first high can be higher or lower than the second high. Bollinger suggests looking for signs of non-confirmation when a security is making new highs. This is basically the opposite of the W-Bottom. A non-confirmation occurs with three steps. First, a security forges a reaction high above the upper band. Second, there is a pullback towards the middle band. Third, prices move above the prior high, but fail to reach the upper band. This is a warning sign. The inability of the second reaction high to reach the upper band shows waning momentum, which can foreshadow a trend reversal. Final confirmation comes with a support break or bearish indicator signal.