Market School: Chart Patterns – Double Bottom

Chart Patterns is a new series of Market School posts that we will be releasing in the coming weeks.
Implication

A Double Bottom is considered a bullish signal, indicating a possible reversal of the current downtrend to a new uptrend.

Description

Double Bottoms are considered to be among the most common of the patterns. Since, they seem to be so easy to identify, the Double Bottom should be approached with caution by the investor.

The Double Bottom is a reversal pattern of a downward trend in a stock’s price. The Double Bottom marks a downtrend in the process of becoming an uptrend.

A Double Bottom occurs when prices form two distinct lows on a chart. A Double Bottom is only complete, however, when prices rise above the high end of the point that formed the second low.

The two lows will be distinct. The pattern is complete when prices rise above the highest high in the formation. The highest high is called the “confirmation point”.

Analysts vary in their specific definitions of a Double Bottom. According to some, after the first bottom is formed, a rally of at least 10% should follow. That increase is measured from high to low. This should be followed by a second bottom. The second bottom returning back to the previous low (plus or minus 3%) should be on lower volume than the first. Other analysts maintain that the rise registered between the two bottoms should be at least 20% and the lows should be spaced at least a month apart.

Sometimes the two lows comprising a Double Bottom are not at exactly the same price level. This does not necessarily render the pattern invalid. Analysts advise that if the second low varies in price from the first low by more than 3% or 4%, the pattern may be less reliable.

The bottoms will have a significant amount of time between them – ranging from a few weeks to a year depending on whether an investor is viewing a weekly chart or a daily chart.

Generally, volume in a Double Bottom is usually higher on the left bottom than the right. Volume tends to be downward as the pattern forms. Volume does, however, pick up as the pattern hits its lows. Volume increases again when the pattern completes, breaking through the confirmation point.

Important Characteristics

Following are important characteristic to look for in a Double Bottom.

Downtrend Preceding Double Bottom

The Double Bottom is a reversal formation. It begins with prices in a downtrend.

Time between Bottoms

Analysts pay close attention to the “size” of the pattern – the duration of the interval between the two lows. Generally, the longer the time between the two lows, the more important the pattern is as a good reversal. Some analysts suggest that investors should look for patterns where at least one month elapses between the bottoms. It is not unusual for a few months to pass between the dates of the two bottoms.

Increase from First Low

Some analysts argue the increase in price that occurs between the two bottoms should be consequential, amounting to approximately 20% of the price. Other analysts are not so definite or demanding concerning the price increase. For some, an increase of at least 10% is adequate. The rise between the lows tends to look rounded but it can also be irregular in shape.

Volume

Volume tends to be heaviest during the first low and lighter on the second. It is common to see volume pick up again at the time of breakout.

Pullback after Breakout

A pullback after the breakout is usual for a Double Bottom.

Trading Considerations

Duration of the Pattern

Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to move to its target price. The shorter the pattern the sooner the price move. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration.

Target Price

The target price provides an important indication about the potential price move that this pattern indicates. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern should be considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.

Inbound Trend

The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least two times the duration of the pattern.

Criteria that Support

Support and Resistance

Look for a region of support or resistance around the target price. A region of price consolidation or a strong Support and Resistance Line at or around the target price is a strong indicator that the price will move to that point.

Location of Moving Average

The Double Bottom should be below a Moving Average of appropriate length. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Direction of Moving Average Trend

The Moving Average should change direction within the duration of the pattern and should head in the direction indicated by the pattern. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Volume

A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern. In addition, the volume during the duration of the pattern should be declining on average.

Other Patterns

Other reversal patterns (such as Bullish and Bearish Engulfing Lines and Islands) that occur at the peaks and valleys indicate strong resistance at those points. The presence of these patterns inside a Double Bottom is a strong indication in support of this pattern.

Criteria that Refute

No Volume Spike on Confirmation

The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable.

Location of Moving Average

If the Double Bottom is above the Moving Average then this pattern should be considered less reliable. Compare the location of the pattern to a Moving Average of appropriate length. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Moving Average Trend

Look at the direction of the Moving Average Trend. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average. A Moving Average that is trending in the opposite direction to that indicated by the pattern is an indication that this pattern is less reliable.

Short Inbound Trend

An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.

Underlying Behavior

A Double Bottom consists of two well-defined lows at approximately the same price level. This shape is formed because prices fall to a support level, rally and pull back up, then fall to the support level again before increasing and eventually breaking through the resistance line.

Market School: Chart Patterns – Ascending Triangle

Chart Patterns is a new series of Market School posts that we will be releasing in the coming weeks.

Implication

An Ascending Continuation Triangle is considered a bullish signal. It indicates a possible continuation of the current uptrend.

Description

An Ascending Continuation Triangle shows two converging trendlines. The lower trendline is rising and the upper trendline is horizontal.

This pattern occurs because the lows are moving increasingly higher but the highs are maintaining a constant price level.

The pattern will have two highs and two lows, all touching the trendlines.

This pattern is confirmed when the price breaks out of the triangle formation to close above the upper trendline.

Volume is an important factor to consider. Typically, volume follows a reliable pattern: volume should diminish as the price swings back and forth between an increasingly narrow range of highs and lows. However, when breakout occurs, there should be a noticeable increase in volume. If this volume picture is not clear, investors should be cautious about decisions based on this Triangle.

Important Characteristics

Following are important characteristics about this pattern.

Occurrence of a Breakout

Technical analysts pay close attention to how long the Triangle takes to develop to its apex. The general rule is that prices should break out – clearly penetrate one of the trendlines – somewhere between three-quarters and two-thirds of the horizontal width of the formation. The break out, in other words, should occur well before the pattern reaches the apex of the Triangle. The closer the breakout occurs to the apex the less reliable the formation.

Duration of the Triangle

The Triangle is a relatively short-term pattern. It may take between one and three months to form.

Shape of Triangle

The horizontal top trendline need not be completely horizontal but it should be close to horizontal.

Volume

Investors should see volume decreasing as the pattern progresses toward the apex of the Triangle. At breakout, however, there should be a noticeable increase in volume.

Trading Considerations

Duration of the Pattern

Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to move to the target price. The shorter the pattern the sooner the price move. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration.

Target Price

The target price provides an important indication about the potential price move that this pattern indicates. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern should be considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.

Inbound Trend

The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least two times the duration of the pattern.

Criteria that Support

Support and Resistance

Look for a region of support at the lowest low and a line of resistance at the top of the Triangle.

Moving Average

Compare prices to the 200 day Moving Average. When prices are close to or touch the 200 day Moving Average this signal is considered stronger.

Volume

A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern. In addition, the volume during the duration of the pattern should be declining on average.

Criteria that Refute

No Volume Spike on Breakout

The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable.

Short Inbound Trend

An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.

Underlying Behavior

This pattern with its increasingly higher lows and constant highs indicates that buyers are more aggressive than sellers. The pattern forms because a supply of shares is available at a fixed price. When the supply depletes, the shares quickly break out from the top trendline and move higher.

Market School: Japanese Candlesticks – Bearish Kicking

Icon Bearish KickingA bearish kicking pattern is formed when a long green candlestick (Green Marubozu) is followed by a long red one (Red Marubozu). After the Green Marubozu, the market gaps sharply lower on the opening and it opens with a gap below the prior session’s opening thus forming a Red Marubozu.

Bearish Kicking Pattern is a strong sign showing that the market is headed downward. The previous market direction is not important for this pattern.

Intensifying Factors:
- The smaller the shadow, the stronger the reversal signal.
- If on the second day there is heavy volume.

Bearish Kicking

 

The bearish Three Black Crows pattern is included in our Daily Stocks Pro iPad and Japanese Candlestick iPhone apps.

For a full list of Japanese Candlestick Patterns tracked by these apps visit our Japanese Candlesticks Page.

 

 

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Market School: Japanese Candlesticks – Bearish Three Black Crows

Icon Three Black CrowsThree Black Crows is a group of three red candlesticks with consecutively lower closes, the opposite of the bearish Three Black Crows pattern is the bullish Three White Soldiers. If the pattern appears after high prices, then it is a sign of a strong reversal.

After the market stays at a high price for too long, we see a significant attempt downward shown by long red candlestick. Rally continues in the next two days, which forces bulls to close their long positions. Each of the red candlesticks should close at, or near, its lows.

Be cautious, smaller body on the third day could be a signal of weakening pattern.

Intensifying factors:
- If the opening price are above the middle of the previous day’s body.
- If pattern appears at a low price area after a period of stable prices.

[Real-Time Stock Chart via Daily Stocks for iPad]
Three Black Crows

The bearish Three Black Crows pattern is included in our Daily Stocks iPad and Japanese Candlestick iPhone apps.

For a full list of Japanese Candlestick Patterns tracked by these apps visit our Japanese Candlesticks Page.

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Market School: Japanese Candlesticks – Bearish Three Outside Down

Three Outside Down Japanese CandlestickThree Outside Down is a three candlestick top reversal formation, (The opposite of the bearish Three Outside Down pattern is the bullish Three Outside Up). It is another name for the Confirmed Bearish Engulfing Pattern (the third day is the confirmation).

After an established uptrend, day one continues the trend with a green candlestick which suggests that the bulls are still in command. The second day is a long red day that engulfs the body of the first day, closing well below the previous days open. The third day is red candlestick with an even lower close than the second day.

Intensifying factors:

- If there is light volume on the first day and heavy volume on the second and the third day.

[Real-Time Stock Chart via Daily Stocks for iPad]
Real-Time Chart showing three outside down pattern via daily stocks for ipad

The bearish Three Outside Down pattern is included in our Daily Stocks iPad and Japanese Candlestick iPhone apps.

For a full list of Japanese Candlestick Patterns tracked by these apps visit our Japanese Candlesticks Page.

Market School: Chart Patterns – Bullish Head and Shoulders

Chart Patterns is a new series of Market School posts that we will be releasing in the coming weeks.

Implication

A Head and Shoulders Bottom is considered a bullish signal. It indicates a possible reversal of the current downtrend into a new uptrend.

Description

The Head and Shoulders bottom is a popular pattern with investors. This pattern marks a reversal of a downward trend in a financial instrument’s price.

Volume is absolutely crucial to a Head and Shoulders Bottom. An investor will be looking for increasing volumes at the point of breakout. This increased volume definitively marks the end of the pattern and the reversal of a downward trend in the price of a stock.

A perfect example of the Head and Shoulders Bottom has three sharp low points created by three successive reactions in the price of the financial instrument. It is essential that this pattern form following a major downtrend in the financial instrument’s price.

The first point – the left shoulder – occurs as the price of the financial instrument in a falling market hits a new low and then rises in a minor recovery. The second point – the head happens when prices fall from the high of the left shoulder to an even lower level and then rise again. The third point – the right shoulder – occurs when prices fall again but don’t hit the low of the head. Prices then rise again once they have hit the low of the right shoulder. The lows of the shoulders are definitely higher than that of the head and, in a classic formation, are often roughly equal to one another.

The neckline is a key element of this pattern. The neckline is formed by drawing a line connecting the two high price points of the formation. The first high point occurs at the end of the left shoulder and beginning of the downtrend to the head. The second marks the end of the head and the beginning of the downturn to the right shoulder. The neckline usually points down in a Head and Shoulders Bottom, but on rare occasions can slope up.

The pattern is complete when the resistance marked by the neckline is “broken”. This occurs when the price of the stock, rising from the low point of the right shoulder moves up through the neckline. Many technical analysts only consider the neckline “broken” if the stock closes above the neckline.

The volume sequence should progress beginning with relatively heavy volume as prices descend to form the low point of the left shoulder. Once again, volume spikes as the stock hits a new low to form the point of the head. It is possible that volume at the head may be slightly lower than at the left shoulder. When the right shoulder is forming, however, volume should be markedly lighter as the price of the stock once again moves lower.

It is most important to watch volume at the point where the neckline is broken. For a true reversal, experts agree that heavy volume is essential.

Variations of the Head and Shoulders Bottom

There are a few notable variations for this pattern.

Multiple Head and Shoulders Patterns

Many valid Head and Shoulders patterns are not as well defined as the classical head with a shoulder on either side. It is not uncommon to see more than two shoulders and more than one head. A common version of a multiple Head and Shoulders pattern includes two left shoulders of more or less equal size, one head, and then two right shoulders that mimic the size and shape of the left shoulders.

Flat Shoulders

The classic Head and Shoulders pattern is made up of three sharply pointed components – the head and two shoulders. This is not always the case. Sometimes, the shoulders can lack sharp low points and instead be quite rounded. This does not affect the validity of the pattern.

Important Characteristics

Following are important characteristics for this pattern.

Symmetry

In a classic Head and Shoulders Bottom, the left and right shoulders hit their relative low points at approximately the same price and level. In addition, the shoulders are usually about the same distance from the head. Experts like to see symmetry but variations are not lethal to the validity of the pattern.

Volume

It is critical to watch the volume sequence as this pattern develops. Volume will usually be highest on the left shoulder and lowest on the right. Investors, looking to ensure that volume increases in the direction of the trend, should ensure that a “burst” in volume occurs at the time the neckline is broken.

Duration of Pattern

It is not unusual for a Head and Shoulders bottom to take several months to develop. Volume activity in stocks is characteristically less after a period of declining prices than after a bull market. Because of this lower volume, bottoms take longer to form and tend to be smaller than tops

Need for a Downtrend

This is a reversal pattern which marks the transition from a downtrend to an uptrend.

Slope of the Neckline

In a well-formed pattern, the slope will not be too steep, but don’t automatically discount a formation with a steep neckline. Some experts believe an upward sloping neckline is more bullish than a downward sloping one. Others say slope has little to do with the stock’s degree of bullishness.

Trading Considerations

Duration of the Pattern

Consider the duration of the pattern and its relationship to your trading time horizons. The duration of the pattern is considered to be an indicator of the duration of the influence of this pattern. The longer the pattern the longer it will take for the price to reach the Target Price. The shorter the pattern the sooner the price move. If you are considering a short-term trading opportunity, look for a pattern with a short duration. If you are considering a longer-term trading opportunity, look for a pattern with a longer duration. The duration of the pattern is sometimes called the “width” or “length” of the pattern.

Target Price

The target price provides an important indication about the potential price move that this pattern indicates. Consider whether the target price for this pattern is sufficient to provide adequate returns after your costs (such as commissions) have been taken into account. A good rule of thumb is that the target price must indicate a potential return of greater than 5% before a pattern should be considered useful. However you must consider the current price and the volume of shares you intend to trade. Also, check that the target price has not already been achieved.

Inbound Trend

The inbound trend is an important characteristic of the pattern. A shallow inbound trend may indicate a period of consolidation before the price move indicated by the pattern begins. Look for an inbound trend that is longer than the duration of the pattern. A good rule of thumb is that the inbound trend should be at least two times the duration of the pattern.

Criteria that Support

Support and Resistance

Look for a region of support or resistance around the target price. A region of price consolidation or a strong Support and Resistance Line at or around the target price is a strong indicator that the price will move to that point.

Location of Moving Average

The Head and Shoulders Bottom should be below the Moving Average. Compare the location of the pattern to a Moving Average of appropriate length. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Moving Average Trend

The Moving Average should change direction within the duration of the pattern and should head in the direction indicated by the pattern. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Volume

Volume will usually be highest on the left shoulder and lowest on the right.

A strong volume spike on the day of the pattern confirmation is a strong indicator in support of the potential for this pattern. The volume spike should be significantly above the average of the volume for the duration of the pattern.

Other Patterns

Other reversal patterns (such as Bullish and Bearish Engulfing Lines and Islands) that occur at the peaks and valleys indicate strong resistance at those points. The presence of these patterns inside a Head and Shoulders is a strong indication in support of this pattern.

Criteria that Refute

No Volume Spike on Confirmation

The lack of a volume spike on the day of the pattern confirmation is an indication that this pattern may not be reliable. In addition, if the volume has remained constant, or was increasing, over the duration of the pattern, then this pattern should be considered less reliable.

Location of Moving Average

If the Head and Shoulders Bottom is above the Moving Average then this pattern should be considered less reliable. Compare the location of the pattern to a Moving Average of appropriate length. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average.

Moving Average Trend

Look at the direction of the Moving Average Trend. For short duration patterns use a 50 day Moving Average, for longer patterns use a 200 day Moving Average. A Moving Average that is trending in the opposite direction to that indicated by the pattern is an indication that this pattern is less reliable.

Short Inbound Trend

An inbound trend that is significantly shorter than the pattern duration is an indication that this pattern should be considered less reliable.

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