Let's put our technical analysis hats back on today. On
Thursday, I introduced you to trading ranges, breakouts, and
breakdowns. We'll take this analysis one step further today and
look at six important technical patterns.
These all require a basic understanding of trading ranges,
resistance and support lines.
missed Thursday's issue where I discussed these, view it on our
blog website here
Now, I'd like to discuss the first three technical patterns.
Tomorrow, I'll follow up with three more.
Double tops or bottoms:
In this common pattern, price trends repeatedly move toward the top
or bottom of a trading range. A double top forms when the stock
price spikes close to resistance, retreat, and then spikes once
When a stock's price double tops without successfully breaking
through resistance, technicians believe it foreshadows a decline in
price. So the expected stock price movement to watch for following
the double top is for the price to move downward.
Questcor Pharmaceuticals (Nasdaq: QCOR)
experienced a double top between December 2008 and January 2009 as
the chart below clearly shows. As the pattern often foreshadows,
the double top was followed by a sharp decline in price.
In a double bottom, the opposite occurs. Price trends down to
support and spikes twice, only to retreat. This anticipates a rise
in price after the double bottom.
Double tops and bottoms are very common patterns. They are easy
to spot and interpret. However, as with all patterns, a double top
or bottom can also be misread. False indicators do occur, so it
helps to have some experience in chart interpretation and a working
knowledge of a company's fundamentals.
Head and shoulders:
In this chart pattern, price spikes upward in three parts. The
first and third represent the outline of a figure's shoulders, and
the second is the head. The head spike is typically higher than the
two shoulders and often reaches right to the level of
Prices tend to fall following a head and shoulders formation.
This is a fairly reliable pattern, and the total amount of the
decline is usually twice the difference between the neckline and
the top of the head.
The illustration below from my book,
The Small-Cap Investor: Secrets to Winning Big with Small-Cap
clearly shows this pattern.
A reverse head and shoulders displays the same pattern, but on
the downside and at support. It consists of three downward price
spikes, with the middle one (the upside down head) moving lower
than the first and third shoulders. It usually precedes a price
The triangle is most often a continuation pattern, which means it
confirms the current trend and gives a signal that price is going
to keep moving in the same direction (up or down). Some very
specific triangle patterns can also be reversal signals, which mean
the current trend is slowing down and price levels may turn in the
opposite direction in the near future.
There are two primary triangle patterns: ascending and
descending. Triangles generally start out with their widest trading
range and then narrow.
An ascending triangle is characterized by a narrowing trading
range with price levels finishing on the higher side of the range,
or even culminating in a breakout above previously established
This is a bullish pattern for the stock. Below is a six month
chart for a technology stock in the
Small Cap Investor PRO
portfolio. After moving higher following an uptrend, the price of
the stock reaches a wall of resistance. Each time the price moves
up to the resistance point it quickly moves lower. Buyers are still
interested in the stock, so each downward move is met with buying.
As a result, each pullback brings less downward movement. Finally,
the buyers overwhelm the stock and the price quickly breaks out
above the former resistance level. You can learn more about
Small Cap Investor PRO
Ascending Triangle Pattern
Conversely, a descending triangle ends up with the narrowest
portion ending on the lower side - near support - or even breaking
out beneath it. This is a bearish signal and, just as the ascending
triangle implies a continuing upward trend, the descending triangle
implies that the downward trend is going to continue.
Just like most things, understanding technical stock price
movement takes practice. But to a trained eye, a stock chart can
give the astute investor an idea where the stock price may go.
Practice before you act, and gain confidence. You'll be glad you
did when you start to make profitable trades.