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The Traders Wheel
4/25/98 by Alan Farley

Topping Patterns – Fire and Ice

Every popular topping formation has its own unique pattern features. But all tell a common tale of crowd disillusionment. Whether printed in the manic highs and lows of the Head & Shoulders or the slow capitulation of the Rising Wedge, the final result remains the same. Price breaks sharply to lower levels while unhappy stockholders unload positions as quickly as they can.

Early in a rally, value and improving fundamentals attract knowledgeable holders. But as an uptrend develops, the motivation for new participants becomes vastly different. News of a stock's rise generates excitement and attracts a greedier crowd. These momentum players slowly outnumber the value investors and stock movement becomes more volatile. The issue continues to push upward as this frantic buying crowd feeds on itself well beyond most reasonable price targets.

Both fire and ice will kill uptrends. As long as the greater fool mechanism holds, each new long allows the previous one to turn a profit. Eventually one of two forces puts a final end to the upside action. A shock event suddenly kills the buying enthusiasm, forcing a sharp and immediate reversal. Or the trend’s fuel just runs out as the last interested buyer enters one last position.

Many traders mistakenly assume bulls turn into bears immediately following a dramatic, high volume reversal. They enter short sales well before the physics of topping and decline rob the crowd of its momentum. In fact, these early shorts provide fuel for the sharp covering rallies seen in most topping formations.

Skilled traders will wait and measure the process of crowd disillusionment before they enter large short sales. Decline characteristics can be predicted with great accuracy using pattern analysis. While they wait, the repeating character of this topping event provides a natural playground for swing positions.

No chart pattern better illustrates this slow evolution from bull market to bear decline than the Descending Triangle. Within this simple structure, the technician can examine how life drains slowly from a dynamic uptrend. Variations of this destructive formation precede more breakdowns than any other reversal. And they can be found doing their dirty deeds in all time frames and all markets.

iom99.gif (6222 bytes) Parabola of the Decade? Iomega's 1996 vertical ride signaled easy fortunes for some and quick ruin to others. After the first monster rally ended in a bloody 3-day decline, late shorts paid a painful price as IOM snapped back in a 2-day 30% rally. Eventually the frantic crowd surrendered, triggering a powerful decline that continues 3 years later.

 

 
Article contributed by The HARD Right Edge, which presents highly original workshops, tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission, which presents highly original workshops, tutorials, strategies and resources on multi-trend technical analysis and and short term trading. Article reprinted here with permission.
 
 

 

 
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Last modified: April 02, 2001

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