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Double Tops

December 22, 2006
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As we approach the year end and indexes are beginning to show signs of weakness, I though it would be good to look at the double top, a bearish reversal pattern.
Simply put, a double top reversal pattern is at the end of an uptrend where an M-like pattern forms. A new high for the uptrend is followed by selling off around 10-20% or more and a climb back to the high which then acts as resistance. If the stock or index then sells down from that resistance level and then breaks the low of the trough between the two peaks, it is a double top pattern.
Ideally, we want to see volume increasing into the selling off of the peaks and more modest in the buying up into the second peak. The pattern can take anywhere from a couple weeks to many months.
The pattern is confirmed on a break below the support from the trough between the peaks and, as always, a spike in volume makes the pattern all the more significant. Also, as with all support/resistance breaks, a retracement to test the line from the other side can be a great entry point.
To find the projected target from the pattern, measure the distance from the peaks to the low of the trough between them and then find your target at that same distance below the support from the trough low.
For a more official description, here is a good run down on the Double Top Reversal pattern from Stockcharts.com.
We’ve been pretty bullish in the short and long term lately, so finding lots of double top examples is not very easy. Here are a few, old and new:

The bursting of tech bubble shows us doubles tops on the NDX and the $NWX, the AMEX Networking index. The NDX(Nasdaq 100) firs put in its top in March 2000 with a shooting star and then a second effort at a new high, which failed. This formed a double top pattern when it broke below the lows between the two peaks. After that ran its course and reached the target fairly quickly, the market struggled back to about half its recent slide only to put in another double top pattern. The second peak of that pattern on 9/1/2000 was confirmed the next day as an evening star reversal candlestick pattern, giving further strength to the potential double top. It then moved down, broke support and completed the pattern by hitting its target fairly quickly.

While the NDX peaked in March, the NWX Networking index was still going strong until July of that year. Picture perfect shooting star candle with confirmation on 7/17/2000. (This pattern could be called an Evening Star Pattern, though the second day of the three day pattern is really supposed to have a gap up.) The second peak is completed with a bearish engulfing pattern on 9/5/2000, the same day the NDX put in it’s final peak of the second Double Top pattern. All thoughts of bullishness in the tech world were gone from that day forward until years later.

There is no volume to support these patterns, but such is the reality with indexes. One could argue that the nature of an index being a group of stocks makes the factor of volume not as essential to the chart.

HP made a nice one early this year and shows subdued volume on the climb to test the first high and then ramping up volume in the sell-off at resistance. Picture perfect retracement to retest the broken support line for a bearish entry. Though it still hasn’t reached the official target of $10 lower than the break, it made half of that projected move in the month of July alone.

It may be a stretch to call it a double top, but the NDX today broke what might be called a double top. The distance between the highs and the low in between them is only about 3% and this is a shorter time frame. But it would probably be a good thing if we were all on the right side of a 3% pullback in the market. The NDX 100 is referred to (so I hear) as “The Generals” since it is the big cap of the tech stocks. They are seen as leaders of the Nasdaq. If these guys are breaking down….Uh oh.
Here’s a bearish article, Tough Times Ahead for Big Cap Tech.

To make it more fun and personal, we can look at ISE from our own little stable.
The formation is certainly there, but I’m not going to get too excited about this one just yet. Until it breaks the support, it’s still just a potential pattern. Furthermore, the volume on the rise into the second peak was quite substantial and the sell-off volume hasn’t been very dramatic. On the bearish side, though, we did break the uptrend and the stock with a P/E of 36.7 is trading at quite a premium to its group(P/E of 21.5). It has PEG of 1.65.

As these charts and others start to give us some potential bearish signs, now would be a good time to start looking for potential bearish charts for when the market does confirm a turn around.

Have a great weekend!

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