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Two Bearish Stock Chart Patterns to Watch

Posted By timparker On 06/06/2012 @ 2:15 pm In Investing | 1 Comment

In the first article of this series [3] we learned how to read a chart. We looked at only three parts: The price action of the stock, (or index, commodity, etc.) the moving averages, and the volume. Although there are plenty of other layers complexity that we could apply, many of the best technicians don’t go far beyond this. William O’Neil, in his book, How to Make Money in Stocks: A Winning System in Good Times and Bad, doesn’t go much beyond these indicators either. Don’t get yourself bogged down in indicators like Bollinger bands, stochastics, or the many other overlays to a chart. They will do little to help.

With that in mind, let’s take a look at two chart patterns that  indicate bad times may be ahead. It’s important to note that trying to time the market is largely a fool’s game but if you see these chart patterns emerge, increasing your hedging is well advised. Hedging is simply insurance. When bearish trends emerge, you might short a stock or buy a put option as insurance. Let’s check these out.

Head and Shoulders

In part two of this series, we looked at the reverse head and shoulders pattern which indicated to us that good times were ahead but the head and shoulders pattern is not good news. Keep in mind that until the right shoulder forms, the price action on the chart could indicate a healthy ascent to the upside but once the stock fails to reach a higher high than the head, and it breaks the neckline, it’s time to increase your hedging. When I did a lot more trading, I would increase my hedging when I saw the stock fail to regain the high.

Also remember that rarely do these patterns look as textbook as the example above.

Double Top

A double top patterns will look a lot like a sideways pattern where the stock trades in a range for a long period of time lulling the trader in to thinking that it’s only a matter of time before the stock breaks the sideways pattern and heads higher. Looking at the chart above, notice that the stock had a healthy ascent but formed a top around $60. Because the stock failed to break through that top on high volume, the stock sold off to the $53 area indicating a resting period. Later in the range, the stock once again attempted to break through the $60 level on high volume. This formed the second top.

When a stock fails to break a level twice and those tests are separated by a significant period of time, this is a double top pattern and that will often be a bad sign as it was in this case.

Finally

Remember the William O’Neil book I mentioned earlier? The best traders often mention this book as one of the best books they’ve read. William O’Neil is famous for the CAN-SLIM method and in 1984, he began publishing the Investor’s Business Daily, a newspaper crafted for the smaller investor. If you aren’t familiar with O’Neil and the IBD, head to your local library and check it out.

O’Neil believes in keeping chart reading simple and these two patterns, along with the patterns I mentioned in the second article in the series, are the most common and reliable patterns to watch. Good luck!


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