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| Spotting trend reversals |
| Vinod Sharma / Mumbai Jul 05, 2009, 00:16 IST |
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Understanding double top and bottom...
As it is important to follow a trend, it is also crucial to identify signs of trend reversal. The double top and double bottom are reversal chart patterns where an existing trend is unable to continue. This leads to reversal by taking resistance or support at or around the previous tops or bottoms. These chart patterns look like a "W" (for a double bottom) or an "M" (double top).
DOUBLE TOP
The double-top pattern is formed at the peaks of an upward trend and is a clear signal that the preceding upward trend is weakening and buyers are losing interest. On completion of this pattern, the trend is considered to be reversed and the security is expected to move lower.
The pattern starts with the formation of a new high during the upward trend which faces resistance. Then in the second stage, the price starts to recoup towards the level of resistance found in the previous rise. A sell off brings it back to the earlier support level. The pattern is confirmed when the underlying trend breaks down the support level. It's not mandatory that the price should reverse exactly from the previous peak; rather, it should be close to the previous peak. Before initiating the trade, one should always wait for the price to breach crucial support. Otherwise it could be disastrous because it creates the possibility for trend reversal which is yet to be confirmed. This pattern illustrates a war between buyers and sellers where buyers are attempting to push the security but are facing resistance. After this goes on a couple of times, the buyers in the market start to give up and the sellers start taking control.
TARGET AND STOPLOSS
The target is measured vertically from the highest point to the bottom of the trough between the two peaks. The difference is then added to the breakout point which, ultimately, sets the profit booking point. The stoploss should be placed just above the last peak.
VOLUMEs
The volumes add to confirmation of the reversal when volumes are dry at the time of the second peak and must be higher at the time of support violation. This move increases the chances of trend reversal, which would otherwise leave less confidence and reliability. Some time after breaking the support level, the price starts recovering. In this scenario, the support which was breached becomes the resistance for the pattern, and the price resumes the downward journey.
DOUBLE BOTTOM
This pattern will closely look like the shape of a "W".
Formation of a double bottom takes place when the underlying trend is down. After a fall in the prices, the trend starts bottoming out and forms broad-based support. This prevents the underlying trend from moving even lower. Thereafter, the underlying trend starts retracing on the upside, but finds resistance. In the second phase, another round of sell-off takes place and the previous low is tested. The initiation of the double bottom pattern takes place when the trend again starts rising after taking support around the previous bottom. The pattern gets confirmation when the price moves above the resistance the security faced on the previous move.
The writer is director and head of research, Anagram Capital
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