Thursday, January 19, 2012

Price Patterns of Stocks

By looking at stock charts, an investor can spot different price patterns of stocks. Today I'll illustrate 2 famous chart patterns here.

Head and Shoulders
A head and shoulders formation, by its name, consists of a head and two shoulders. The left and the right shoulders represent two smaller rallies before and after the big head (big rally).

Reverse Head and Shoulders

Trend Reversal Point

Draw a line connecting the two troughs at the base of the head. This line is known as the neckline. When the neckline is breeched on the right shoulder, it sends a warning signal to traders that the price is going to plunge.

Similarly, for the reverse head and shoulders, we draw a neckline to connect the two small rallies beside the head. Once the price surge passes the neckline on the right shoulder, it indicates a positive move in the price.

In order for the trend reversal to materialise, the violation of the necklines in both cases has to be supported by an expanded volume at the right shoulders.

Double Top

A double tops formation consists of two peaks, like a Twin Tower. The two peaks may not be of the same height. The interesting part about this price pattern is that when the price is forming the second rally, its volume is lighter than before (the first rally). This shows that investors have lost their buying interest and the rising price may not be sustainable.

Trend Reversal Point

Draw a line at the bottom of the trough between the two tops as shown in the above. As soon as the line is violated at the right peak, followed by an expanding volume, the stock will experience heavy selling by investors.

Double Bottom

Double bottoms has a similar effect as the double top, but in the opposite way. Here, you’ll see two troughs with volume declining in the second bottom.

Trend Reversal Point

Draw a line at the peak between the two troughs. When the line is violated at the right trough with an increasing volume, investors are snapping up the stocks and pushing the price higher.

However, there is no guarantee that when the trendline is violated, the prices will move accordingly. Sometimes they are just a temporary interruption in the prevailing trend. It could be a false alarm, or whipsaw, for the trend reversal.

Last but not least, when you see a big chart pattern forming infront of you, its a warning sign that there is going to be a big price movement as shown in the chart below.

Happy investing,

Pauline Yong

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