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.
