BASIC TECHNIQUES
Some Patterns Are Common To All Technicians
Price Patterns, Part II
by Martin J. Pring
This veteran market analyst takes a look at the patterns of price formation.
Last time, I covered the basics of chart patterns using rectangles as an example. This time, I will expand on the subject by taking a look at several different patterns. To recap some of the major points:
1 Price patterns are clearly definable trading ranges that form on a chart. There are two types -- reversal and consolidation.
2 The significance of a pattern is relative to its size; the longer it takes to complete, the more significant the formation is.
3 The minimum ultimate measuring objective for a price pattern is obtained by calculating its maximum depth at the breakout point and projecting it in the direction of the breakout.
FIGURE 1: HEAD AND SHOULDERS TOP. Breaking below the neckline is the traditional signal to short a top.
HEAD AND SHOULDERS
Perhaps the most notorious price formation of all is the head-and-shoulders formation, a pattern that appears at both bottoms and tops. At market peaks, it consists of a final rally (the head) separated by two smaller ones (the left and right shoulders), as shown in Figure 1. The line connecting the lows is referred to as the neckline and the measuring objective is obtained by calculating the distance from the head to the neckline, then projecting that down. The principle is, therefore, identical with the measuring objective for rectangles.
Volume considerations are important, since volume should be exceptionally heavy during the formation of the left shoulder and/or the head; buying volume should be noticeably less during the right-shoulder rally.
Head-and-shoulder formations come in several varieties. For instance, the example in Figure 1 contains a horizontal neckline. In this instance, when the price violates the neckline, it also breaks below the previous low. In effect, the completion of the head and shoulders signals that a series of declining peaks and troughs is now in force. Alternatively, the line can slope up, at which point the formation is known as an upward sloping head and shoulders (Figure 2), or down, when it is referred to as a downward sloping head and shoulders.
Martin J. Pring founded the International Institute for Economic Research in 1981. He pioneered the introduction of videos as an educational tool for technical analysis in 1987, and was the first to introduce educational interactive CDs in this field. His Website is http://www.Pring.com, and he may be reached at info@Pring.com.
Excerpted from an article originally published in the October 2000 issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2000, Technical Analysis, Inc.
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