This week I am going to continue our study of chart reversal patterns by first covering double and triple tops and bottoms, then rounded tops and bottoms. Next week I will cover spike (V) tops and bottoms and wedges (usually called continuation patterns).

In our August 25th issue of The ETF Authority I used this educational section to cover the head and shoulders reversal pattern in great detail. Many of the signatures of a head and shoulders reversal are present in double and triple tops and bottoms, so we will not need to go into great detail here. If you haven't done so already, then I suggest you review our August 25th issue before reading this week's lesson.

DOUBLE TOPS AND BOTTOMS
The double top or double bottom is probably the second most recognized pattern by the novice trader and technical analyst. The pattern itself is simple to recognize. In the case of a double top, a rally to a new high is followed by a correction, then a second rally to that prior high. The pattern is confirmed when prices ultimately drop below the interim low set between the two peaks. Meanwhile, in the case of a double bottom, a drop to a new low is followed by a correction, then a second fall to that prior low. The pattern is confirmed when prices rise above the interim high set between the two lows.

NOTHING IS THAT SIMPLE
So, a stock moves to a new high, dips, matches its prior high, then falls to a new interim low. You've got a confirmed double top, correct? WRONG! You need to do a little homework first. Along those lines, you should never forget that volume is part of the equation as well. Volume should be strongest at the first high. Since the trend is up, the drop following the first peak should be marked by lower turnover. Volume should then pick back up again as the stock moves to its second high, but it should remain lower than it was at the first peak.

Once the second high is made, volume sometimes increases. However, in most cases it does not. Turnover ought to increase after the particular stock/fund you're examining falls below the interim low. If it does not, then I would think twice about aggressively trading the pattern.

IS THAT ALL THERE IS TO IT?
Not exactly. Double reversals do not necessarily always occur at the exact same price level. Sometimes the second top or bottom does not quite reach the prior extreme. Meanwhile, other times the extreme is bested. This means that you should not anticipate a double top by placing a stop at the prior extreme.

When examining a potential double reversal, it also helps to look for other clues for a top or bottom. First of all, for it to be a true reversal, the underlying stock/fund needs to have a trend to reverse. Secondly, if the particular security you're examining posts the same high on consecutive days, then it does not qualify as a double top. Typically, I look for several days -- and preferably at least a week or more -- between peaks or troughs. At times, months may intervene between double tops and bottoms (see chart below). Thirdly, to add to my comfort in seeking confirmation, I feel more confident when an important trendline breaks and when there is a momentum divergence as well.

PRICE PROJECTIONS
A confirmed double top or double bottom should provide you with a pretty clear target as to where the stock/fund is headed next. The preferred way to calculate this target is to take the distance from the double top (bottom) to the interim corrective low (high) and project that same amount from the breakout area.

There are a couple of caveats regarding this technique:

• You can get negative prices this way, which is why I prefer to use percentage moves instead for all but the smallest price patterns.
• Other measurement techniques may be more accurate, such as might be determined via Elliott Wave-based projections and retracements.

TRIPLE TOPS AND BOTTOMS
I will be honest -- I have never been a big fan of triple tops and bottoms. This is largely because, more often than not, triple tops fail. In other words, when a market approaches a prior double top or double bottom, we usually see a breakout in the direction of the prior trend rather than a reversal.

A triple top is a close relative to a head and shoulders top (likewise, a triple bottom and inverted head and shoulders are also similar). The main difference is that in a triple top, the three highs are very close in price, while the left shoulder and right shoulder are typically a distance from the head/high. Furthermore, a head and shoulders requires the middle price to be the highest. This is not a requirement for a triple top.

One triple bottom that appears to be confirmed can be seen on the monthly chart of the CRB Commodity Price Index (see below). Prices touched the mid/upper-182 range three times between February 1999 and October 2001. However, the first pair represented a double bottom in its own right, and from the longer-term perspective, this could actually be seen as one bottom on the monthly timeframe. The current breakout would project a move north of 280.

The same rules regarding measurement apply here as in double reversals and head and shoulders -- the distance between the interim reaction and the peak should then be projected from the breakout level to determine the final price target.

Volume patterns are also similar. Each new top or bottom should come on lower volume, with the interceding corrections also seeing a decrease in volume. Turnover however, should increase upon confirmation (breakout) and will sometimes rises as prices move away from the final (third) peak.

Again, successful triple tops and bottoms are very rare, so I wouldn't spend a whole lot of time looking for them. Also please don't ever tell me you've found a quadruple reversal pattern! It just doesn't exist as a class of reversals. I'm not saying that it has never occurred, but its appearance is simply not common enough (if it happens at all) to be classified as a reversal pattern.

ROUNDED TOPS AND BOTTOMS
As a person who specializes in Elliott Wave Theory, rounded tops and bottoms are one of the most difficult classes of patterns to deal with. After all, it's nearly impossible to find acceptable wave counts for these patterns. However, the actual identification of such price moves is really quite easy.

Before I continue with the identification of these patterns, it is worth noting that rounded tops and bottoms are also commonly referred to as saucer tops/bottoms and cup and handles (the latter requires a small ledge at the right side of the pattern before prices break out, but is essentially the same as the saucer). The cup and handle terminology was popularized by Investors Business Daily.

Rounded reversal patterns are most often associated with bear market bottoms. The idea here is that the market under discussion is so weak that nobody is interested in owning the asset under consideration. The pattern looks similar to the bottom of a cup or saucer (and the inverse of this on a rounded top). It can also be said to look like a smile. The volume pattern is also that of a saucer, both for tops and bottoms, as volume dries up slowly as prices approach their extreme, then slowly increases until price breaks out. The breakout is confirmed by an increase in volume and is often accompanied by a long-term trendline break (a gap is common on confirmation as well).

Good trading!

Steven Poser
Editor
The ETF Authority
New York, NY