Over the last few days this series of articles has discussed continuation set ups. These included the popular breakouts and pullbacks. along with 123 inside continuation set ups.

Today several reversal patterns receive attention. Each will not be discussed in the detail that the continuation patterns were primarily as they are counter trend patterns. In a sense they are the opposite of continuation patterns as they signal a possible reversal rather than a continuation in a stocks direction.

Many of these can be traded but any trader doing so needs to be very nimble and know exactly what they are doing as initially they pit any trader or investor using them against the current trend. A better way to use of them is to be aware of them so that they may receive some notice that the trend may be in jeopardy. Good advice might be to be patient and see if the trend really changes before trading in a new direction, while suspending trades with the current trend until it is clear this issue is resolved. Remember you can always get back in a stock, and what would be nicer than to get back in at a lower price should a reversal pattern turn out to be a shakeout or false alarm.

It is very likely you have heard of many of these: Double tops, island reversals, climactics, rounded and square tops, head and shoulders, broken pivots, and we have to also include failed continuation patterns like buy set ups and breakouts.

• Double tops are perhaps the most recognized pattern as they are easy to spot. VRSN is such a example. Notice in the chart of VRSN that a new high was reached and after falling back it traded back up to the proor high. Remmember that this pattern, or any others, are not about exact specific points — but areas. In this case VRSN was withn 10c of the prior high.
• The way in which stock prices can react to double tops can differ. They can pullback again for another try at the former high at a later time, they can fall again but also go below the last lower pivot to break the trend which would complete a reversal. In the chart of VRSN things went sideways as supply and demand equalized. For the time being demand is not strong enough over supply to break out to new highs, and supply is not strong enough over demand to cause the stock to fall.
• VRSN has a couple of things worth noting that have been discussed before in this sereis. Did you notice the failed break out in the prior base on 03-19? This failure to break out probably led to the pullback that took place over the next week. Then as it came back up again it could only go sideways. Also you could have expected resistance to have an effect as the stock came back up to the previous base from which it fell, and therefore that it would have a tougher time getting through it easily. As traders we do not know yet if it will evntually break out, which we could then trade as a possible break out when it does, or if it will continue to base for an extended period of time, or if it will fall back again. But we can watch for the clues.

Charts courtesy of StockCharts.com

• An island reversal is also easy to spot. However not anywhere near as common. These can be reversals all by themselves in just one candlestick bar becasue of the severe sudden shock they can bring to holders of a stock. The SQNM chart has such an island reversal.
• Try to imagine you were a buyer of SQNM on that last green bar before the sudden drop on 03-02. You can see the volume thta day was over 5 times that of any normal day! Now imagine what you would be feeling on 03-16 when the price gapped so far below where you bought. Everyone that bought that day or the 9 days after that are trapped. They have a huge unexpected loss. This is what is meant by shock. The psychology of this is gut wrenching. You can observe from the volume of the selling that hordes of traders and investors were selling from the sudden fear on that day. The drop not only took out that huge green high volume bar but also several green bars before it. If you could have put all the people who sold in a stadium it would have looked like chaos as all of them were trying to climb over each other to get to the exits. You can see the damage to the chart since then. Many now will not trust it.
• A climactic reversal is also demonstrated by SQNM. Wouldn’t it have been nice if some of those people had some warning that SQNM could fall ahead of time? Especially if you were one of them? Well, there is. SQNM went what is known as climactic. It went up 14 days in a row! Over 100% in those few days! You might ask yourself what those buyers were thinking when they bought SQNM at $8.00 or so. The awful truth though is this is all too comon in the markets and represents an example of a minature mania. People who did this would likely not have done so had they looked at it. Certainly not if they had educated themselves. The stock was clearly ‘extended’ in price for one advance, but something else is speaking even louder. Note the volume on that last green up day. If these people who bought then were put in the same stadium they must have looked like they were all trying to climb over each other just to buy it.
• The multiple days up in a row and the high volume at the end of the run tell a seasoned trader to be very aware. This is a big flashing sign that says the advance is near the end — not the beginning. There are professional traders who stalk events like this to short them. You can see from the price movement that a short seller who took a position after this started to fall could have made more money in a few hours than what it takes weeks to make on the long side in most stocks. Fear is the stronger emotion between fear and greed. I should also note there were ‘upgrades’ on this stock from some brokerage firms that came out towards the end of this run.
• Rounded and square tops are frequent and found on all time frames. They often make the intraday and daily support and resistance that voids are found to trade. VRSN and SQNM have square tops. If you have been reading here to learn about trading and investing you already know they are reference points for resistance, and in these cases are likely points traders will sell if the price gets back up.
• Broken pivots and failed patterns are simply areas where support fails and supply overcomes demand. This is normal in the ebb and flow of the markets. You need to pay atention to possible trend changes when this occurs so you do not end up on the wrong side of the trend in your trades and invesmtents. It will be like trying to swim ‘against the tide’. An interesting chart and a focal point of many traders now is the US dollar. You can look this up on the chart of UUP, an ETF for the dollar like you can any stock. It has now made a lower high and a lower low and is flashing a warning.

It is important to note that any of these events do not mean a trend change is eminent. But they are putting you on notice to pay attention. Another important thing to be aware of it that any one of these is not a trading signal by itself, with the possible exception of an island reversal due to it’s extreme shock. As mentioned above a chart can exhibit several issues or elements that can help deliver a clearer message.

Trade with a plan.

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A series of articles is listed here as a quide to writing a personal trading and investing plan. These articles are excerpts from Create Your Trading Plan — How to plan for success in the markets. written by myself.