THE TRIPLE BOTTOM FORMATION

Technical analysis divides price patterns into two main types: continuation and reversal.

A continuation pattern represents a pause in the dominant trend. For example, an ascending triangle is often a continuation pattern. The assumption with the continuation formation is that prices will leave the formation in the same direction as they came in. One would therefore expect an ascending triangle to break out to the upside. The pattern therefore has a bullish bias.

A true reversal formation by definition occurs much more rarely than a continuation or consolidation formation. This type of pattern is seen only at major turning points in a market. A reversal formation must have a prior trend to reverse. Either an uptrend will turn into a downtrend, or the reverse will occur.

Many different price patterns can serve as reversal formations. At the top, a stock or market may form a head and shoulders pattern, create a broadening top, a double or triple top, a diamond, or even a descending or symmetrical triangle. A bottom reversal formation might be an inverted head and shoulders, a double or triple bottom, a saucer bottom or an ascending triangle. Note that some formations, such as triangles, can be both continuation and reversal formations and should be interpreted from that perspective.

A reversal formation should be judged by three criteria: the height of the formation, the length of time it takes to build and the number of shares traded within it. A reversal that covers a large amount of chart distance, takes many months to achieve, and involves a large amount of shares traded should be thought of as a major reversal.

As the name implies, a triple bottom is a formation in which three separate price bottoms can be identified on the chart. For the S&P 500, these levels were the bottom in July 2002 at 775, the bottom in October 2002 at 768 and the final bottom in March 2003 at 788. On the topside of the pattern were the July 2002 high at 965 and the January 2003 high at 954.

Until the S&P was able to clear, or break out, of resistance at the 965 level, I regarded this formation as a potential triple bottom. With the weekly close above 965 this pattern is now actual, or confirmed.

Eventually, therefore, the market should work its way higher -- much higher. While I have heard some CNBC commentary identifying 1050 as a potential target, in the longer term I derive a target at approximately the 1175 level through using the measuring principle.

The height of the pattern is approximately 200 points (765-965). The measuring principle says to add the height of the pattern, which is 200 points, to the breakout level, which is 965. The calculation is 965 + 200 = 1165. That is very close to the top end of the trading range identified in the first section of this newsletter at 1175. Remember that is the eventual target. I don't expect the market to reach that level soon. While 1175 may seem like an outrageous level, it should be noted that the S&P reached that level as recently as April 2002.

With a confirmed triple bottom in place, our overall swing trading strategy should now be adjusted. In the three-year bear market, the predominant strategy was short sell rally tops. Now the strategy changes to buy the bottom of corrections, or as the saying goes, "buy on the dips."

Targets may also be set a little higher and a bit longer time frame used for swing trading. Clearly, I don't expect the market to go straight up. The market never makes things that easy. But with a confirmed triple bottom, the overall trend should be up from here. While corrections may be shorted, the overall direction of trading should be from the long side.

Good trading!

Dr. Melvin Pasternak
Editor
The StreetAuthority Swing Trader