leright shoulder. A double left shoulder increases the odds of a dou-ble right shoulder.
Tactics
Market tactics play an important role in all trading. Not all tech-nical traders like to wait for the breaking of the neckline beforeinitiating a new position. As Figure 5.3 shows, more aggressivetraders, believing that they have correctly identified a head andshoulders bottom, will begin to probe the long side during theformation of the right shoulder. Or they will buy the first techni-cal signal that the decline into the right shoulder has ended.
Some will measure the distance of the rally from the bottomof the head (points C to D) and then buy a 50% or 66% retracementof that rally. Still others would draw a tight down trendline alongthe decline from points D to E and buy the first upside break of thattrendline. Because these patterns are reasonably symmetrical, somewill buy into the right shoulder as it approaches the same level asthe bottom of the left shoulder. A lot of anticipatory buying takesplace during the formation of the right shoulder. If the initial longprobe proves to be profitable, additional positions can be added onthe actual penetration of the neckline or on the return move backto the neckline after the breakout.
The Failed Head And Shoulders Pattern
Once prices have moved through the neckline and completed ahead and shoulders pattern, prices should not recross the neckline114 Chapter 5
 
Figure 5.3 Tactics for a head and shoulders bottom. Many technicaltraders will begin to initiate long positions while the right shoulder (E) isstill being formed. One-half to two-thirds pullback of the rally from pointsC to D, a decline to the same level as the left shoulder at point A, or thebreaking of a short term down trendline (line 1) all provide early opportuni-ties for market entry. More positions can be added on the breaking of theneckline or the return move back to the neckline.
again. At a top, once the neckline has been broken on the down-side, any decisive close back above the neckline is a serious warn-ing that the initial breakdown was probably a bad signal, and cre-ates what is often called, for obvious reasons, a failed head andshoulders. This type of pattern starts out looking like a classic headand shoulders reversal, but at some point in its development(either prior to the breaking of the neckline or just after it), pricesresume their original trend.
There are two important lessons here. The first is that noneof these chart patterns are infallible. They work most of the time,but not always. The second lesson is that technical traders mustalways be on the alert for chart signs that their analysis is incor-rect. One of the keys to survival in the financial markets is to keeptrading losses small and to exit a losing trade as quickly as possi-ble. One of the greatest advantages of chart analysis is its abilityMajor Reversal Patterns 115
to quickly alert the trader to the fact that he or she is on thewrong side of the market. The ability and willingness to quicklyrecognize trading errors and to take defensive action immediatelyare qualities not to be taken lightly in the financial markets.
The Head And Shoulders as aConsolidation Pattern
Before moving on to the next price pattern, there’s one final pointto be made on the head and shoulders. We started this discussionby listing it as the best known and most reliable of the majorreversal patterns. You should be warned, however, that this for-mation can, on occasion, act as a consolidation rather than areversal pattern. When this does happen, it’s the exception ratherthan the rule. We'll talk more about this in Chapter 6, “Con-tinuation Patterns.”
TRIPLE TOPS AND BOTTOMS
Most of the points covered in the treatment of the head andshoulders pattern are also applicable to other types of reversal pat-terns. (See Figures 5.4a-c.) The triple top or bottom, which is muchrarer in occurrence, is just a slight variation of that pattern. Themain difference is that the three peaks or troughs in the triple topor bottom are at about the same level. (See Figure 5.4a.) Chartistsoften disagree as to whether a reversal pattern is a head and shoul-ders or a triple top. The argument is academic, because both pat-terns imply the exact same thing.
The volume tends to decline with each successive peak atthe top and should increase at the breakdown point. The tripletop is not complete until support levels along both of the inter-vening lows have been broken. Conversely, prices must closethrough the two intervening peaks at the bottom to complete atriple bottom. (As an alternate strategy, the breaking of thenearest peak or trough can also be used as a reversal signal.)Heavy upside volume on the completion of the bottom is alsoessential. 
Figure 5.4a_A triple top. Similar to the head and shoulders except that allpeaks are at the same level. Each rally peak should be on lighter volume. Thepattern is complete when both troughs have been broken on heavier volume.The measuring technique is the height of the pattern projected downward fromthe breakdown point. Return moves back to the lower line are not unusual.
 
Figure 5.4b__A triple bottom. Similar to a head and shoulders bottomexcept that each low is at the same level. A mirror image of the triple topexcept that volume is more important on the upside breakout.Major Reversal Patterns 117
 
(KBH) Kaufman & Broad Home
 
Weekly Bar Chart
Triple Bottom
 
 
 
 
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Figure 5.4c A triple bottom reversal pattern. Prices found support justbelow 12 three times on this chart before launching a major advance. Thebottom formation on this weekly chart lasted two full years, thereby giving itmajor significance.
The measuring implication is also similar to the head andshoulders, and is based on the height of the pattern. Prices willusually move a minimum distance from the breakout point atleast equal to the height of the pattern. Once the breakout occurs,a return move to the breakout point is not unusual. Because thetriple top or bottom represents only a minor variation of the headand shoulders pattern, we won’t say much more about it here.
DOUBLE TOPS AND BOTTOMS
A much more common reversal pattern is the double top or bottom.Next to the head and shoulders, it is the most frequently seen andthe most easily recognized. (See Figures 5.5a-e.) Figures 5.5a and118 Chapter 5
A c
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Figure 5.5a Example of a double top. This pattern has two peaks (A andC) at about the same level. The pattern is complete when the middle troughat point B is broken on a closing basis. Volume is usually lighter on the sec-ond peak (C) and picks up on the breakdown (D). A return move back to thelower line is not unusual. The minimum measuring target is the height of thetop projected downward from the breakdown point.
 
Figure 5.5b Example of a double bottom. A mirror image of the doubletop. Volume is more important on the upside breakout. Return moves back tothe breakout point are more common at bottoms.Major Reversal Patterns 119
 
bs/14/97 (UTX) United Technologies C
 
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Figure 5.5c Example of a double bottom. This stock bounced sharply offthe 68 level twice over a span of three months. Note that the second bottomwas also an upside reversal day. The breaking of resistance at 80 completedthe bottom.
5.5b show both the top and bottom variety. For obvious reasons,the top is often referred to as an “M” and the bottom as a “W.”The general characteristics of a double top are similar to that of thehead and shoulders and triple top except that only two peaksappear instead of three. The volume pattern is similar as is themeasuring rule.
In an uptrend (as shown in Figure 5.5a), the market sets anew high at point A, usually on increased volume, and thendeclines to point B on declining volume. So far, everything is pro-ceeding as expected in a normal uptrend. The next rally to pointC, however, is unable to penetrate the previous peak at A on aclosing basis and begins to fall back again. A potential double tophas been set up. I use the word “potential” because, as is the casewith all reversal patterns, the reversal is not complete until the120 Chapter 5
 
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Figure 5.5d_ Example of a double top. Sometimes the second peak doesn’tquite reach the first peak as in this example. This two month double top sig-
naled a major decline. The actual signal was the breaking of support near 46(see box).
previous support point at B is violated on a closing basis. Untilthat happens, prices could be in just a sideways consolidationphase, preparing for a resumption of the original uptrend.
The ideal top has two prominent peaks at about the sameprice level. Volume tends to be heavier during the first peak andlighter on the second. A decisive close under the middle trough atpoint B on heavier volume completes the pattern and signals areversal of trend to the downside. A return move to the breakoutpoint is not unusual prior to resumption of the downtrend.
Measuring Technique for the Double Top
The measuring technique for the double top is the height of thepattern projected from the breakdown point (the point where theMajor Reversal Patterns 121
 
07/15/97 (“OTC) Nasdaq Composite Index
 
Daily Bar Chart
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Double Bottom
 
 
 
 
 
 
Figure 5.5e Price patterns show up regularly on the charts of major stockaverages. On this chart, the Nasdaq Composite Index formed a double bot-tom near the 1470 level before turning higher. The break of the down trend-line (see box) confirmed the upturn.
middle trough at point B is broken). As an alternative, measure theheight of the first downleg (points A to B) and project that lengthdownward from the middle trough at point B. Measurements atthe bottom are the same, but in the other direction.
VARIATIONS FROM THEIDEAL PATTERN
As in most other areas of market analysis, real-life examples areusually some variation of the ideal. For one thing, sometimes thetwo peaks are not at exactly the same price level. On occasion, thesecond peak will not quite reach the level of the first peak, whichis not too problematical. What does cause some problems is when122 Chapter 5
the second peak actually exceeds the first peak by a slight margin.What at first may appear to be a valid upside breakout andresumption of the uptrend may turn out to be part of the toppingprocess. To help resolve this dilemma, some of the filtering crite-ria already mentioned may come in handy.
Filters
Most chartists require a close beyond a previous resistance peakinstead of just an intraday penetration. Second, a price filter ofsome type might be used. One such example is a percentage pene-tration criterion (such as 1% or 3%). Third, the two day penetrationtule could be used as an example of a time filter. In other words,prices would have to close beyond the top of the first peak for twoconsecutive days to signal a valid penetration. Another time filtercould be a Friday close beyond the previous peak. The volume onthe upside breakout might also provide a clue to its reliability.
These filters are certainly not infallible, but do serve toreduce the number of false signals (or whipsaws) that often occur.Sometimes these filters are helpful, and sometimes they’re not.The analyst must face the realization that he or she is dealing withpercentages and probabilities, and that there will be times whenbad signals occur. That’s simply a fact of trading life.
It’s not that unusual for the final leg or wave of a bull mar-ket to set a new high before reversing direction. In such a case, thefinal upside breakout would become a “bull trap.” (See Figures5.6a and b.) We’ll show you some indicators later on that mayhelp you spot these false breakouts.
The Term “Double Top” Greatly Overused
The terms “double top and bottom” are greatly overused in thefinancial markets. Most potential double tops or bottoms wind upbeing something else. The reason for this is that prices have astrong tendency to back off from a previous peak or bounce off aprevious low. These price changes are a natural reaction and donot in themselves constitute a reversal pattern. Remember that, ata top, prices must actually violate the previous reaction low beforethe double top exists.Figure 5.6aExample of a falsebreakout, usuallycalled a bull trap.Sometimes near theend of a majoruptrend, prices willexceed a previouspeak before failing.Chartists use vari-ous time and pricefilters to reduce suchwhipsaws. This top-ping pattern wouldprobably qualify asa double top.
 
 
(oa/14/97 (JPM) Morgan J P & Co IncDaily Bar Chart
 
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Figure 5.6b Example of a false breakout. Notice that the upside breakoutwas on light volume and the subsequent decline on heavy volume—a nega-tive chart combination. Watching the volume helps avoid some false break-outs, but not all.124 Chapter 5
 
Notice in Figure 5.7a that the price at point C backs off fromthe previous peak at point A. This is perfectly normal action in anuptrend. Many traders, however, will immediately label this patternas a double top as soon as prices fail to clear the first peak on thefirst attempt. Figure 5.7b shows the same situation in a downtrend.It is very difficult for the chartist to determine whether the pullbackfrom the previous peak or the bounce from the previous low is justa temporary setback in the existing trend or the start of a doubletop or bottom reversal pattern. Because the technical odds usuallyfavor continuation of the present trend, it is usually wise to awaitcompletion of the pattern before taking action.
 
Figure §.7a Example of anormal Figure §.7b Example of a nor-pullback from a previous peak before mal bounce off a previous low. This is
resumption of the uptrend. This is normal market action and not to benormal market action and not to be confused with a double bottom. Pricesconfused with a double top. The dou- _ will normally bounce off a previousble top only occurs when support at low at least once, causing premature
point B is broken. calls for a double bottom.Major Reversal Patterns 125
 
Time Between Peaks or TroughsIs Important
Finally, the size of the pattern is always important. The longer thetime period between the two peaks and the greater the height ofthe pattern, the greater the potential impending reversal. This istrue of all chart patterns. In general, most valid double tops orbottoms should have at least a month between the two peaks ortroughs. Some will even be two or three months apart. (On longerrange monthly and weekly charts, these patterns can span sever-al years.) Most of the examples used in this discussion havedescribed market tops. The reader should be aware by now thatbottoming patterns are mirror images of tops except for some ofthe general differences already touched upon at the beginning ofthe chapter.
SAUCERS AND SPIKES
Although not seen as frequently, reversal patterns sometimes takethe shape of saucers or rounding bottoms. The saucer bottomshows a very slow and very gradual turn from down to sidewaysto up. It is difficult to tell exactly when the saucer has been com-pleted or to measure how far prices will travel in the oppositedirection. Saucer bottoms are usually spotted on weekly ormonthly charts that span several years. The longer they last, themore significant they become. (See Figure 5.8.)
Spikes are the hardest market turns to deal with because thespike (or V pattern) happens very quickly with little or no transi-tion period. They usually take place in a market that has gotten sooverextended in one direction, that a sudden piece of adversenews causes the market to reverse direction very abruptly. A dailyor weekly reversal, on very heavy volume, is sometimes the onlywarning they give us. That being the case, there’s not much morewe can say about them except that we hope you don’t run intotoo many of them. Some technical indicators we discuss in laterchapters will help you determine when markets have gotten dan-gerously over-extended. (See Figure 5.9.)126 Chapter 5
 
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like. They’re very slow and gradual, but usually mark major turns. This bot-tom lasted four years.
 
 
 
 
 Major Reversal Patterns 127
 
    
 
                 
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Figure 5.9 Example of a v reversal pattern. These sudden reversals takeplace with little or no warning. A sudden price drop on heavy volume is usu-ally the only telltale sign. Unfortunately, these sudden turns are hard to spotin advance.128 Chapter 5
CONCLUSION
We've discussed the five most commonly used major reversal pat-terns—the head and shoulders, double and triple tops and bot-toms, the saucer, and the V, or spike. Of those, the most commonare the head and shoulders, and double tops and bottoms. Thesepatterns usually signal important trend reversals in progress andare classified as major reversal patterns. There is another class ofpatterns, however, which are shorter term in nature and usuallysuggest trend consolidations rather than reversals. They are aptlycalled continuation patterns. Let’s look at this other type of patternin Chapter 6. 
INTRODUCTION
The chart patterns covered in this chapter are called continuationpatterns. These patterns usually indicate that the sideways priceaction on the chart is nothing more than a pause in the prevail-ing trend, and that the next move will be in the same direction asthe trend that preceded the formation. This distinguishes thisgroup of patterns from those in the previous chapter, which usu-ally indicate that a major trend reversal is in progress.
Another difference between reversal and continuationpatterns is their time duration. Reversal patterns usually takemuch longer to build and represent major trend changes.Continuation patterns, on the other hand, are usually shorterterm in duration and are more accurately classified as near termor intermediate patterns.
Notice the constant use of the term “usually.” The treat-ment of all chart patterns deals of necessity with general tenden-cies as opposed to rigid rules. There are always exceptions. Eventhe grouping of price patterns into different categories sometimes
129130 Chapter 6
becomes tenuous. Triangles are usually continuation patterns, butsometimes act as reversal patterns. Although triangles are usuallyconsidered intermediate patterns, they may occasionally appearon long term charts and take on major trend significance. A vari-ation of the triangle—the inverted variety—usually signals amajor market top. Even the head and shoulders pattern, the bestknown of the major reversal patterns, will on occasion be seen asa consolidation pattern.
Even with allowances for a certain amount of ambiguityand the occasional exception, chart patterns do generally fallinto the above two categories and, if properly interpreted, canhelp the chartist determine what the market will probably domost of the time
TRIANGLES
Let’s begin our treatment of continuation patterns with the tri-angle. There are three types of triangles—symmetrical, ascend-ing, and descending. (Some chartists include a fourth type of tri-angle known as an expanding triangle, or broadening formation.This is treated as a separate pattern later.) Each type of trianglehas a slightly different shape and has different forecastingimplications.
Figures 6.la-c show examples of what each trianglelooks like. The symmetrical triangle (see Figure 6.1a) showstwo converging trendlines, the upper line descending and thelower line ascending. The vertical line at the left, measuringthe height of the pattern, is called the base. The point of inter-section at the right, where the two lines meet, is called theapex. For obvious reasons, the symmetrical triangle is alsocalled a coil.
The ascending triangle has a rising lower line with a flator horizontal upper line (see Figure 6.1b). The descending tri-angle (Figure 6.1c), by contrast, has the upper line decliningwith a flat or horizontal bottom line. Let’s see how each one isinterpreted.Continuation Patterns 131
 
Figure 6.la_ Example of a bullish symmetrical triangle. Notice the twoconverging trendlines. A close outside either trendline completes the pattern.The vertical line at the left is the base. The point at the right where the twolines meet is the apex.
Figure 6.1b = Example of an ascending triangle. Notice the flat upper lineand the rising lower line. This is generally a bullish pattern.132 Chapter 6
 
Figure 6.1¢ Example of a descending triangle. Notice the flat bottom lineand the declining upper line. This is usually a bearish pattem.
THE SYMMETRICAL TRIANGLE
The symmetrical triangle (or the coil) is usually a continuationpattern. It represents a pause in the existing trend after whichthe original trend is resumed. In the example in Figure 6.la, theprior trend was up, so that the percentages favor resolution ofthe triangular consolidation on the upside. If the trend hadbeen down, then the symmetrical triangle would have bearishimplications.
The minimum requirement for a triangle is four reversalpoints. Remember that it always takes two points to draw atrendline. Therefore, in order to draw two converging trendlines,each line must be touched at least twice. In Figure 6.la, the tri-angle actually begins at point 1, which is where the consolida-tion in the uptrend begins. Prices pull back to point 2 and thenrally to point 3. Point 3, however, is lower than point 1. Theupper trendline can only be drawn once prices have declinedfrom point 3.
Notice that point 4 is higher than point 2. Only whenprices have rallied from point 4 can the lower upslanting line bedrawn. It is at this point that the analyst begins to suspect the heor she is dealing with the symmetrical triangle. Now there are fourreversal points (1, 2, 3, and 4) and two converging trendlines.
While the minimum requirement is four reversal points,many triangles have six reversal points as shown in Figure 6.1a.Continuation Patterns 133
This means that there are actually three peaks and three troughsthat combine to form five waves within the triangle before theuptrend resumes. (When we get to the Elliott Wave Theory, we’llhave more to say about the five wave tendency within triangles.)
Time Limit for Triangle Resolution
There is a time limit for the resolution of the pattern, and that isthe point where the two lines meet—at the apex. As a general rule,prices should break out in the direction of the prior trend some-where between two-thirds to three-quarters of the horizontalwidth of the triangle. That is, the distance from the vertical baseon the left of the pattern to the apex at the far right. Because thetwo lines must meet at some point, that time distance can be mea-sured once the two converging lines are drawn. An upside break-out is signaled by a penetration of the upper trendline. If pricesremain within the triangle beyond the three-quarters point, thetriangle begins to lose its potency, and usually means that priceswill continue to drift out to the apex and beyond
The triangle, therefore, provides an interesting combina-tion of price and time. The converging trendlines give the priceboundaries of the pattern, and indicate at what point the patternhas been completed and the trend resumed by the penetration ofthe upper trendline (in the case of an uptrend). But these trend-lines also provide a time target by measuring the width of the pat-tern. If the width, for example, were 20 weeks long, then the break-out should take place sometime between the 13th and the 15thweek. (See Figure 6.1d.)
The actual trend signal is given by a closing penetration ofone of the trendlines. Sometimes a return move will occur back tothe penetrated trendline after the breakout. In an uptrend, thatline has become a support line. In a downtrend, the lower linebecomes a resistance line once it’s broken. The apex also acts as animportant support or resistance level after the breakout occurs.Various penetration criteria can be applied to the breakout, simi-lar to those covered in the previous two chapters. A minimumpenetration criterion would be a closing price outside the trend-line and not just an intraday penetration.134 Chapter 6
 
 
psv2ere7 (DELL) Dell Computer Corp
 
Daily Bar Chart
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A Bullish Symmetrical Triangle
 
 
 
 
 
 
Figure 6.1d_ = Dell formed a bullish symmetrical triangle during the fourthquarter of 1997. Measured from left to right, the triangle width is 18 weeks.Prices broke out on the 13th week (see circle), just beyond the two-thirds point.
Importance of Volume
Volume should diminish as the price swings narrow within thetriangle. This tendency for volume to contract is true of all con-solidation patterns. But the volume should pick up noticeably atthe penetration of the trendline that completes the pattern. Thereturn move should be on light volume with heavier activityagain as the trend resumes.
Two other points should be mentioned about volume. Asis the case with reversal patterns, volume is more important onthe upside than on the downside. An increase in volume is essen-tial to the resumption of an uptrend in all consolidation patterns.
The second point about volume is that, even thoughtrading activity diminishes during formation of the pattern, aclose inspection of the volume usually gives a clue as to whetherContinuation Patterns 135
the heavier volume is occurring during the upmoves or down-moves. In an uptrend, for example, there should be a slight ten-dency for volume to be heavier during the bounces and lighteron the price dips.
Measuring Technique
Triangles have measuring techniques. In the case of the sym-metrical triangle, there are a couple of techniques generallyused. The simplest technique is to measure the height of the ver-tical line at the widest part of the triangle (the base) and mea-sure that distance from the breakout point. Figure 6.2 shows thedistance projected from the breakout point, which is the tech-nique I prefer.
The second method is to draw a trendline from the topof the base (at point A) parallel to the lower trendline. Thisupper channel line then becomes the upside target in anuptrend. It is possible to arrive at a rough time target for pricesto meet the upper channel line. Prices will sometimes hit thechannel line at the same time the two converging lines meet atthe apex.
Figure 6.2 Thereare two ways to takea measurement froma symmetrical trian-gle. One is to mea-sure the height of thebase (AB); projectthat vertical distancefrom the breakoutpoint at C. Anothermethod is to draw aparallel line upwardfrom the top of thebaseline (A) parallelto the lower line inthe triangle.
 136 Chapter 6
THE ASCENDING TRIANGLE
The ascending and descending triangles are variations of the sym-metrical, but have different forecasting implications. Figures 6.3aand b show examples of an ascending triangle. Notice that theupper trendline is flat, while the lower line is rising. This patternindicates that buyers are more aggressive than sellers. It is consid-ered a bullish pattern and is usually resolved with a breakout tothe upside.
Both the ascending and descending triangles differ fromthe symmetrical in a very important sense. No matter where inthe trend structure the ascending or descending triangles appear,they have very definite forecasting implications. The ascendingtriangle is bullish and the descending triangle is bearish. The sym-metrical triangle, by contrast, is inherently a neutral pattern. Thisdoes not mean, however, that the symmetrical triangle does nothave forecasting value. On the contrary, because the symmetrical
 
Figure 6.3a An ascending triangle. The pattern is completed on a deci-sive close above the upper line. This breakout should see a sharp increase involume. That upper resistance line should act as support on subsequent dipsafter the breakout. The minimum price objective is obtained by measuringthe height of the triangle (AB) and projecting that distance upward from thebreakout point at C.Continuation Patterns 137
("DWT X) Dow Transportation
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Figure 6.3b The Dow Transports formed a bullish ascending triangle nearthe end of 1997. Notice the flat upper line at 3400 and the rising lower line.This is normally a bullish pattern no matter where it appears on the chart.
 
 
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triangle is a continuation pattern, the analyst must simply look tosee the direction of the previous trend and then make the assump-tion that the previous trend will continue.
Let’s get back to the ascending triangle. As already stated,more often than not, the ascending triangle is bullish. The bullishbreakout is signaled by a decisive closing above the flat uppertrendline. As in the case of all valid upside breakouts, volumeshould see a noticeable increase on the breakout. A return moveback to the support line (the flat upper line) is not unusual andshould take place on light volume.
Measuring Technique
The measuring technique for the ascending triangle is relativelysimple. Simply measure the height of the pattern at its widest138 Chapter 6
 
point and project that vertical distance from the breakout point.This is just another example of using the volatility of a price pat-tern to determine a minimum price objective.
The Ascending Triangle as a Bottom
While the ascending triangle most often appears in an uptrendand is considered a continuation pattern, it sometimes appears asa bottoming pattern. It is not unusual toward the end of a down-trend to see an ascending triangle develop. However, even in thissituation, the interpretation of the pattern is bullish. The break-ing of the upper line signals completion of the base and is con-sidered a bullish signal. Both the ascending and descending trian-gles are sometimes also referred to as right angle triangles.
THE DESCENDING TRIANGLE
The descending triangle is just a mirror image of the ascending, andis generally considered a bearish pattern. Notice in Figures 6.4aand b the descending upper line and the flat lower line. This pat-tern indicates that sellers are more aggressive than buyers, and isusually resolved on the downside. The downside signal is regis-tered by a decisive close under the lower trendline, usually onincreased volume. A return move sometimes occurs which shouldencounter resistance at the lower trendline.
The measuring technique is exactly the