Reversal Patterns

In the last lesson we discussed Fibonacci retracement levels in the current lesson we are to discuss reversal patterns.

Reversal patterns are formations that the price action takes and according to some analysts  indicate that a reversal in trend is taking place. For example from an uptrend its about to change to a down trend and vice versa.

Preliminary points for all reversal patterns include but are not limited to:

• Existence of prior trend
• The first signal of an impending trend reversal is the breaking of an important trend line
• The larger the pattern, the greater the subsequent move
• Topping patterns are usually shorter in duration and more volatile than bottoms
• Bottoms usually have smaller price ranges and take longer to build
• Volume is usually more important on the upside

Most common reversal patterns:

• Head and Shoulders
• Double tops and bottoms
• Triple tops and bottoms
• Ascending and Descending Wedge

Making a start with the head and shoulders formation. It consists of three peaks where the center peak is the highest. A neckline is drawn connecting the lowest points of the head. A break through the neckline provides a “Sell opportunity” implying that the former downward trend has been reversed and price action is now heading southwards

Another variation of the head and shoulders formation is the inverted head shoulders. It consists of three lows where the center trough is the lowest. A neckline is drawn connecting the highest points of the head. A break through the neckline provides a “Buy opportunity” as it would imply that the prior downtrend has been reversed and prices are on the rise.

The double top pattern consists of two peaks at about the same level. The pattern is completed when the support marked by the middle trough is broken, signalling that the upward momentum is over and prices are to drop lower than the support line drawn. In a reverse mode we also have the double bottom which is a mirror image of the Double Top. The top is also referred as M and bottom as W due to their resemblance to the relative letters. Similarly we also have triple tops and bottoms which are very similar to double tops and bottoms, but instead of two peaks, we have three peaks or three troughs at the same about level.

Last but not least we have the wedge which is being identified by two converging trend lines that come together at an apex.What distinguishes the wedge is its noticeable slant either to the upside or the downside. A rising wedge is considered bearish as the price actions finds it more and more difficult to form higher peaks and thus is expected to succumb to the bears ultimately while for similar reasons a falling wedge is considered bullish.

In the next lesson we are to discuss continuation patterns