One of the simplest techniques in trading is to watch the charts for double tops or double bottoms - and when they arrive, look for either a continuation or a reversal. If the reversal is the signal then it often is huge and what's more it often happens FAST.
Here's how this works.
We will look first at a double top.
That means that a share which has an Open, Low, High and Close ever day and is drawn on a OHLC chart, and the item we are looking at is the High.
Let's assume a share has been trending upwards over a considerable period and has reached an all time high. This is the first top. It then goes down to a lower level, over any period of time, ' maybe a few days, ' maybe a few months, ' maybe a year, and rises to the top again. ' This is the second top.
This is when you watch the signals for a reverse or a continuation.
Because it has reached a new top at a similar value to the earlier one, (can be plus a few points e.g. 5205 5209 at different times are possible double top figures) this is not a signal to trade. The share might just as easily go through that top (resistance level) and go higher. If that happens then the 'double top' has never existed and the signal should be ignored.
But if the High reaches the exact - or very similar (within a few cents) of the earlier top and then starts to move lower, a double top has been signaled and it is time to go short on that share or index or commodity or currency - or whatever set of signals you are observing.
But don't rush in.
First let the reversal prove itself.
The proof is when the share moves lower and continues to do this for more than 2 days. If it is moving lower on the third day the proof is there.
Here's another signal that is often but not always a reverse sign.
Here's the lack of proof sign. A share reaches an all time high and then goes lower. It makes another reach for the top and starts moving upwards again. It gets close to the top on this second run and then begins to move down. Sometimes, but not always, this is a good short position. It has in fact a 2/3rds chance of continuing down. But if it is hitting that top more than once the chances are really 50/50 that it will create anew all time high or will move lower.
No one knows which of these is true.
Knowledge of the whole market is helpful. Bull or Bear. Knowledge of the sector this share falls into is also helpful. Knowledge of the number of buyers and number of Sellers in the market is also helpful.
Knowledge of the Volume is also helpful. Knowledge of the momentum is also helpful. And Candlestick charts often give warning signals in such double-top- double-bottom situations. ' And other specialised technical analysis items can/should be checked.
If you are holding real shares and are a chart watcher and see such a double top - it may be your sign to sell. After all because it is a top you are making a profit. If the shares are high quality, and you want to hold them for a long period, you can buy them back later when they have fallen.
I'll be introducing a little more on such technical analysis later.
Let us look now at double bottoms. As a commodity trader I have found that these are very strong in currencies, certain hard commodities, and especially blue chip quality shares.
A share has been moving downwards and reaches a 12 month Low point. It rallies for a while and then begins going lower again. When it reaches the same low as the previous low - and this may be a 12 month low, the share reaches what is known as a support level and buyers return to the share and it starts to rise again.
Once the rise is confirmed you re in a new bullish mode and the share may well continue to rise and rise substantially as the 'herd' instinct takes over and people begin buying for no other reason than that others are buying.
Your aim is not to be a part of the herd but to be in the market ahead of the herd because you correctly evaluated a set of buying signals.
What are the chances of a double top being effective? What are the chances of a double bottom being effective.
I have found the following figures apply to blue chip shares and currencies which are my area of special interest.
While observing potential double tops I observe the following.
If a high quality blue chip share reaches an all time high there is a 75% chance that it will go higher and a 25% chance that it will turn around right at that point and move lower.
If a share (not necessarily blue chip) reaches an annual low the chances are 75% chance that it will continue lower and a 25% chance that it will immediately reverse and rise again.
This does depend on the quality of the commodity/stock you are watching.
If you are following blue chips, Australian dollars, or other high quality items you know that the odds are good that the reverse will take place. The odds are also good that the 75/25 figures will prove correct. So please wait until a turnaround proves itself before entering a market.
Important If you are following what used to be called penny dreadfuls or really cheap low quality stocks then the chances are that the 75% lower will eventuate.
Good Puts if confirmed and if you can get Puts on such shares.
Remember companies do go out of business and these are not the kind of companies I specialise in observing. My 75/25% apply to blue chips and quality shares.
I have used the terms support and resistance here.
A word about Support and Resistance.
This is too long a subject to look at in depth here. But when a share reaches certain low levels, and these changing levels can easily be determined from your charts, they are at a support level ( support being a level that attracts buyers simply on lower prices) It may be the share has reached these levels on several occasions and bounced off them.
Shares that reach support levels will often rise as buyers are re-attracted to that share mainly on price. And then the herd joins, the crowd factor comes into play, and the price rises.
If a share rises and a top is rejected by buyers because the sellers are asking too much, the share will begin to move downwards from the resistance levels. Other sellers will join the herd, the crowd factor eventuates, and the price will roll downwards.
Support and resistance levels are alive and by that I mean subject to change from day to day.
I have seen a share bounce off a $31.00 day top, day after day after day and then move considerably lower. A few weeks later, the sentiment of the market regarding that share is more positive, and the share has moved straight through this $31.00 level and a new resistance level then appeared at $31.50.
Be aware of support and resistance as part of your regular daily observations.
On many occasions shares may only move between the same support and resistance levels for a long period of time. This can be tradeable and is known as a sideways market. But the greatest trades come after an anticipated market direction change and a breakout occurs.
I'll send lesson five tomorrow.
Great Trading.
Next Page - Lesson 5 - the Power of Leverage
