A price pattern that signals a change in the prevailing trend is known as a reversal pattern. These patterns signify periods where either the bulls or the bears have run out of steam. The established trend will pause and then head in a new direction as new energy emerges from the other side (bull or bear).
For example, an uptrend supported by enthusiasm from the bulls can pause, signifying even pressure from both the bulls and bears, then eventually giving way to the bears. This results in a change in trend to the downside.
When price reverses after a pause, the price pattern is known as a reversal pattern. Examples of common reversal patterns include.
1.Head and shoulder
On the technical analysis chart, the Head and shoulders formation occurs when a market trend is in the process of reversal either from a bullish or bearish trend; a characteristic pattern takes shape and is recognized as reversal formation.
2.Head and shoulders bottom
This formation is simply the inverse of a Head and Shoulders Top and often indicates a change in the trend and market sentiment. The formation is upside down and the volume pattern is different from a Head and Shoulder Top. Prices move up from first low with increase volume up to a level to complete the left shoulder formation and then fall down to a new low. A recovery move follows that is marked by somewhat more volume than seen before to complete the head formation. A corrective reaction on low volume occurs to start formation of the right shoulder and then a sharp move up due to heavier volume again breaks though the neckline.
Another difference between the Head and Shoulders Top and Bottom is that the Top Formations are completed in a few weeks, whereas a Major Bottom (left, right shoulder or the head) usually takes longer, and as observed, may be prolonged for a period of several months or sometimes even more than a year.
**importance of neckline
The neckline drawn on the pattern represents a support level, it cannot be assumed that a Head and Shoulder formation is complete unless the support level is broken. Such breakthrough may happen to be on greater volume or may not. Breakthroughs should be observed with great care. Serious drops can occur if a breakthrough is more than three to four percent.
When a stock drifts through the neckline on small volume, there may also be a wave up in some cases, although it has been observed that such a rally normally will not cross the general level of the neckline before selling pressure increases and a steep decline occurs, after which prices may due to greater volume.
3.double top
The double top is a frequent price formation at the end of a bull market. It appears as two consecutive peaks of approximately the same price on a price-versus-time chart of a market. The two peaks are separated by a minimum in price, a valley. The price level of this minimum is called the neck line of the formation. The formation is completed and confirmed when the price falls below the neck line, indicating that further price decline is imminent or highly likely.
The double top pattern shows that demand is outpacing supply (buyers predominate) up to the first top, causing prices to rise. The supply-demand balance then reverses; supply outpaces demand (sellers predominate), causing prices to fall. After a price valley, buyers again predominate and prices rise. If traders see that prices are not pushing past their level at the first top, sellers may again prevail, lowering prices and causing a double top to form. It is generally regarded as a bearish signal if prices drop below the neck line.
The time between the two peaks is also a determining factor for the existence of a double top pattern. If the tops appear at the same level but are very close in time, then the probability is high that they are part of the consolidation and the trend will resume.
Volume is another indicator for interpreting this formation. Price reaches the first peak on increased volume then falls down the valley with low volume. Another attempt on the rally up to the second peak should be on a lower volume.
4.double bottom
A double bottom is the end formation in a declining market. It is identical to the double top, except for the inverse relationship in price. The pattern is formed by two price minima separated by local peak defining the neck line. The formation is completed and confirmed when the price rises above the neck line, indicating that further price rise is imminent or highly likely.
Most of the rules that are associated with double top formation also apply to the double bottom pattern. Volume should show a marked increase on the rally up while prices are flat at the second bottom
How to trade Triple Top
If the price makes three distinct attempts to conquer the selling pressure at a certain level or a range, and fails to do so, the price is witnessing diminishing strength. The pattern thus formed is called 'Triple Top'. These three distinct peaks indicate resistance which becomes the stop loss for a downtrend rally.
One can keep the stop loss level slightly above the resistance point. As we go further and the price breaks down on the immediate support, the target is identified as the difference of resistance line and the support line. If the price fails to rebound around the difference value, then the next downside may see a severe sell-off.
Sometimes the price makes wild swings during intra-day sessions, showing a breakout; however, one should wait for a decisive close.
6.triple bottom
As the name suggests, a triple bottom chart has three lows and it signals a reversal of the prevailing downtrend. A triple bottom stock pattern can be formed on a line, bar or a candlestick chart. It is a bullish reversal pattern and is formed after a considerable downward price trend.
The first bottom is formed when the price of the security declines but bounces back from a specific level. The sellers are in control of the market, but are unable to take the price below the support level. The bulls take over at the support level and take the price starts rising but faces resistance at a level. The bulls are not able to take the price over the breakout point.
At the price touches the resistance, the bears take control and drive down the price towards the support level but are again unable to take it below the support level. The second bottom is formed. The bulls take over from there and drive the price higher. After a point, however, the bears become dominant and drive down the price to the support level. The bears fail for the third time to drive the price below the support level, forming the third bottom. On the chart, a triple bottom pattern looks like a classical zigzag pattern.
Gaps occur when there is empty space between two trading periods that’s caused by a significant increase or decrease in price. For example, a stock might close at $5.00 and open at $7.00 after positive earnings or other news.
There are three main types of gaps: Breakaway gaps, runaway gaps, and exhaustion gaps. Breakaway gaps form at the start of a trend, runaway gaps form during the middle of a trend, and exhaustion gaps for near the end of the trend.
A gap is a capital market term, used to describe discontinuation in a price chart caused due to change in market fundamentals when the market is closed. If the price of an asset significantly rises or falls from the previous day’s closing without any trade taking place in between, a gap occurs. It can occur due to significant market news to sway investors’ sentiment either positively or negatively like, earning calls after-hours.
Gaps are common occurrences, but not all of them are of equal significance. Experienced traders know which gaps to take note of and which to ignore. Mainly, gaps in stock market are categorized into four types. Check them out below.
Types of gaps
Gaps are easy to spot but determining its importance and interpreting it is what needs knowledge and practice. Here are the four types of gaps that occur in a price line.
Common gaps
Common gaps are also called trading gaps or area gaps. Usually caused by regular market forces and don’t require a special event. As the name suggests, these are common occurrences and non-eventful. So, these also get filled up as quickly, meaning the market retrace after a few days or weeks to its original level.
In a price chart, a common gap appears as a non-linear jump or drop from one point to the next.
How will you identify a common gap? There is no significant market news that can cause a market rally, and these gaps are usually smaller in size. Common gaps get filled up as fast as they appear.
Breakaway gaps:
It occurs when the price tries to break away from the congestion area. To understand breakaway gaps better, we must understand what congestion area is. Congestion area refers to the price range in the market where the trading is happening for a while. The highest point in the congestion is usually called the resistance when approached from below. Similarly, the lowest point, when approached from above, refers to as the support level. A breakaway gap occurs when the market breaks out of the resistance or support barrier. It needs market enthusiasm to cause a switch in trend. That is, either too many buyers for upward movement or sellers for the downtrend swing.
When a breakaway gap occurs volume of the stock should also pick up, preferably after the gap happens to conform the direction change. A new support level is created where the market breaks out. Conversely, the new resistance level is adjusted where the trend breaks downward. Breakaway gaps, unlike common gaps, when appears, usually take a longer time to fill up.
A good breakaway gap happens when it is associated with the classical price chart.
Runaway gaps
Runaway gaps can happen in both uptrend and downtrend, it usually is a representation of a sudden change in interest or perception about a stock among traders, accompanied by a shift in demand to spike buying or selling.
Runaway gap, when associated with an uptrend indicates a change in traders’ interest in the stock. Traders, who might have missed the previous uptrend may go for a frenzied buying spree after realizing that a retracement might not happen. This cause the trade volume and price to shoot up suddenly and significantly.
Similarly, a runaway gap in a downtrend is a representation of excess liquidity in the market. It may lead to a downward spiral. Seller may panic and sell the stocks, which might cause the stock price to dive lower.
Traders use a concept of measuring the gap to decide how long the trend will continue. It usually happens in the middle of a trend.
Exhaustion gap
As the name suggests, it occurs at the end of a prolonged uptrend or downtrend, indicating a trend change. It is often associated with a rise in price along with an increase in volume. Exhaustion gaps can be mistaken for runaway gaps. To distinguish between the two, traders compare both price and quantity. If both price and volume increase, it is called an exhaustion gap.
Check out the chart below. Notice that the price rise is accompanied by an increase in volume, which is why it is an exhaustion gap.
Conclusions
To trade efficiently, traders should be able to identify and interpret gaps correctly. Even though they are common in daily trade charts, they aren’t free from limitations. A critical concept that associates with gaps is ‘filling’. It is a concept where market readjusts to the price level nullifying the sudden change caused by the gap.
Failing to identify a gap or reacting to it may cause one to miss an opportunity to exit or enter a market, which means it weighs heavily on profit or loss from a trade.
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