But if the share price was 380p, then the expected 20p fall in the share price is worth only 5 per cent – not worth the risks involved.
Careful interpretation of the vertical scale is especially important when reading a share manual which gives a graph for every share. Nestling alongside a graph such as the middle one in Figure 3.4 you might find another with a totally different scale, say from 400p to 800p. The graphs could look similar, but they aren’t. Work out the percentage difference between the highest price used on the scale and the lowest: 200p is 18 per cent higher than 170p; 800p is 100 per cent higher than 400p.
And the same caution, in a lower key, also applies to the timescale. Is it measured in years or weeks? What looks like a sharp movement on a graph measured in years, could in reality have taken three or four months to roll out. With the chartist typically looking for a short-term payback, what might appear to have been a golden opportunity might in practice have been just too long and drawn out to bear.
On the next few pages is a series of figures depicting the most commonly quoted identifiable patterns which, when they form after an uptrend, are said to denote that a downtrend should follow. Customarily, books on technical analysis accompany their accounts of these famous patterns with descriptions of what’s happening in the minds of investors as the patterns are carved out along the lines of: ‘Investors expecting support at this level, having seen it before, are now shocked that it does not occur . . . the market argument now moves over to the bears.’ We will dispense with all that. Even if accurate, such descriptions are neither here nor there: the fact is that these patterns are supposed to tell you a trend is over. The main patterns are as follows:
● Head and shoulders(see Figures 3.5 to 3.7): most chartists suggest that the head and shoulders pattern is (a) ‘reliable’, meaning that on a good fraction of occasions its occurrence is indeed followed by a fall in price, and (b) frequent.
● Double top(see Figure 3.8).
● Triple top(see Figure 3.9).
● Saucer top(see Figure 3.10) the saucer is inverted – it looks like a shallow hill.
● Descending triangle(see Figure 3.11).
● V(again, inverted: see Figure 3.12).
The six patterns above normally form over the course of a few weeks, quite possibly months. The three below would typically form within a day or two. They may well be part of one of the first six and if so would be seen as emphasising the message given by the larger pattern:
● Spike(see Figure 3.12).
● Island top(see Figure 3.13).
● Key reversal(see Figure 3.14).
The price objective after the right shoulder has been completed remains the difference between the top of the head and the neckline directly below (a). This should be measured from the point where the neckline is breached by the right shoulder (b).
a b
A head and shoulders can also demonstrate a falling neckline.
Figure 3.5 Head and shoulders
Figure 3.6 Head and shoulders with rising neckline
neckline
Price reversal after a head and shoulders should at least equal the
difference between the neckline and the head left shoulder
right shoulder head
1
Minor reaction after a strong rally to form a minor peak which becomes the left shoulder. This reaction establishes the neckline for the head and shoulders (although that it is a head and shoulders is not at this point evident).
2
Price recovers and establishes a new, higher peak.
5
Another reaction, with volume reckoned to be heavier than normal. This time, the price fails to find support at the neckline.Voilà! The right shoulder and the head and shoulders is complete. Now the price should continue to fall.
3
A second, more significant, reaction going past the peak of the left shoulder, but finding support at the neckline. The upside- down V formed by 2 and 3 is the head.
4
Another rally, this time ending below the previous peak.
This rally theoretically takes place on slim volume.
head and shoulders is not complete until the neckline is breached after
the right shoulder
Possibly the chartists’favourite indicator. It comprises five phases.
Figure 3.7 Head and shoulders in real life
One that proved right: Glaxo
One that didn’t: Argos
Figure 3.8 Double top
One that proved right: BET
One that didn’t: Burton One that proved right: BET
Figure 3.9 Triple top
One that proved right: Abbey National
One that didn’t: Rolls-Royce
Figure 3.10 Saucer top or rounded top
One that proved right: BT
One that didn’t: Cable & Wireless
The saucer top is also known as a rounded top
Figure 3.11 Descending triangle
One One
O that proved right: Eurotunnel
One One
O that didn’t: Grana
base
target
{
Price reversal after a
the ’ as
One that proved right: Eurotunnel
One that didn’t: Granada
Figure 3.12 Vs and spikes
Vs and spikes are two separate patterns. A spike occurs over a few days at most. The V could be a few weeks in the making. A V isn’t necessarily accompnied by a spike.
A V that proved right: Great Universal Stores
One that didn’t: Pan Andean
Figure 3.13 Island top
1996
The island top pattern can be detected only on a bar chart. It involves a day or two’s tradiing ranges being entirely above the ranges of the preceding and following days. It can be part of one of the preceding patterns and help to confirm them.
One that proved right: British Biotech
One that didn’t Powergen
Figure 3.14 Key reversal
1 New high (intra-day)
3 C lose is a sharp reversal of preceding
2 Intra-day low is lower than for several preceding days
1992
1993
Key reversal is another bar-chart only pattern.
After a ‘good run’ in one direction or another, the trend is sharply reversed by a wide-ranging day’s trading which sees (in a bearish key reversal) (1) a new intro-day high, (2) an intro-day low which is lower than for several days past and (3) a closing price at or close to the day’s low. Prices may now be expected to continue to fall away for several days One that proved right: GKN
One that didn’t: National Westminster
Many of the formations described on the preceding pages have variants, notably the diamond and the multiple top (more tops than a triple top).
Several of the books listed in Further Reading will give you a more complete rundown on subspecies, although each author has favourites and blind spots.
The target price movement following a V, double or triple top or saucer is worked out in the same way as that for a head and shoulders. A neckline is drawn through the beginning and end of the formation and the price difference between the neckline and the extreme high or low measured.
This result is then subtracted from the price at the right of the neckline, to arrive at the target price (see Figures 3.5. and 3.6).
The target price after a breakout from a triangle is calculated by measuring the base of the triangle. The result is subtracted from the point at which the triangular pattern is breached to give a target price at which a first serious reaction to the downtrend may be expected (see Figure 3.11).
Spikes, islands and key reversals do not lend themselves to the calculation of target prices.
All the patterns, with the exception of the V, should in theory be seen to complete themselves before trading action is taken. However, as the second half of the pattern invariably takes up some of the price movement from which the technical analyst seeks to benefit, advanced practitioners sometimes attempt to anticipate their completion, using secondary indicators, for instance, to confirm that the volume of trading in the right shoulder of a head and shoulders indeed conforms to the theoretical pattern (see Figure 3.5).
The V, which equates to a sudden and unjustified (but you only know that for sure after the event) surge of optimism about the share in question, is the one pattern for which the chartist might consider that acting before completion is generally to be encouraged. The usual account of market psychology that accompanies renditions of the V strikes me as having more than a grain of truth about it. The first, upside, half of the V (or the downside half in a V marking a bottom) is reckoned to be especially important if it occurs on high volume. In this event, so the chartists’
account goes, a lot of shares have changed hands and more or less everyone who wanted to be ‘in’ is in. They share ownership of the company with fellow shareholders who, in this case, are all sitting on a handsome profit. Outside are very few buyers. It wouldn’t be difficult for these ingredients to turn into a share price reversal.