Upside objectives can be roughly guessed at in two of three types of bottoms reversal patterns. Bull flags, a type of continuation pattern, also has approximate upside objectives.

Before I go into a bit more on the major types of reversal patterns, with a focus on UPSIDE reversals of trends, I got a Subscriber question that's pertinent to further potential gains in the market. Also, someone asked me to elaborate more on the recent rounding bottom that led to the strong rally of this week.

MY MAILBAG:

In a bull flag as you explained it recently im not quite sure how to figure a next objective once prices break out up or take off again?

MY RESPONSE:

Well, I may not have been completely precise in explaining it when I wrote on this subject in my 5/28 Trader's Corner article. Actually, the method of 'measuring' a next upside objective (once an upside breakout occurs) is only as precise as it is clear as to the length of a preceding 'flagpole'. When I read this it sounds like a bit of mumble-jumble. The aforementioned article and a chart illustration will help clarify what the heck these terms mean.

My first chart is of the hourly S&P 500 (SPX) through today, 6/30/11. I've made some notations on the chart relating to the rounding bottom pattern as well as 3 bull flag formations. I want to focus solely here on the 'measuring' objective implied by the bull flags.

A bull or bear flag formation, depending on the direction of the move, begins with an UPWARD 'thrust' or sharp advance in the case of a 'bull flag' pattern. In a bull flag the sharp advance will generally occur over 1-2 bars, sometimes 3. Look at any of the strong advances seen below that I've labeled as 'bull flags'. When such an advance occurs over ONE bar (in a daily chart, one DAY, in an hourly chart, one HOUR), which is then followed by a sideways move over 3-4 bars, the 'flagpole' is the distance carried by this first advance to where the (sideways) consolidation begins. If there's a sharp advance over two bars, then the length of the so-called 'flagpole' is the point distance of the two bars together. The dotted vertical line is the 'flagpole'.

The length of the flagpole in the 3 examples above is ADDED to the upside 'breakout point' on the down sloping (imagined) flag to give a minimum next price objective. This is a rule of thumb measurement for a 'minimum' next objective. There's no magic here. The next move may carry beyond the minimum implied objective. Sometimes the move DOESN'T carry as far as projected.

Typically, a move to the targeted price will occur rapidly after the breakout takes place; i.e., after the thrust above the upper end of the imagined bull flag. The foregoing suggests potential for a further, typically rapid, advance to around 1333 in SPX.

One further example of the 'measuring' implication of a bull flag is seen in the following daily stock chart. Which stock is immaterial here; my focus is on the pattern only.

The same measuring implication applies to the DOWNSIDE potential once there's a breakout below the lower end of a bear flag. I tend to call this downside breakout a 'breakdown' point, just to make the expected action clearer. My chart highlights seen next is based on price action in ExxonMobil (XOM). The flag pattern is a little different and this flag variation is commonly called a 'pennant'. I tend to simply also call it a flag, but the trendlines drawn through the highs and lows of the consolidation (seen after the sharp downside move) don't slope in the SAME direction; e.g., unlike the bull flag seen on the left. A pennant shape is not just seen with bear flags, it just happens to be so in THIS example.

The 'minimum' downside objective implied by the above bear flag pattern is a rule of thumb measurement. Such objectives are not always completely realized or may of course be realized later; i.e., after the date of this article.

ROUNDING BOTTOMS

The S&P 500 hourly chart first seen above, is repeated next, only without the 'flag' patterns being notated. I will make some further points about the rounding bottom as a type of bottoming pattern and a possible 'measuring implication' for an upside objective based on the rounding bottom.

Rounding bottoms, rounding 'turns' and 'saucer' bottoms are synonyms for the same rounding formation. A rounding bottom represents a struggle between buying demand and selling pressure that is nearly equal. Through the first part of the formation, the sellers have the upper hand. Through the second part of the rounding bottom the buyers gradually gain ascendance.

When the rounding bottom is 'successful' (as a predictor) in the sense of leading to a significant advance the average rise is as much as a 50% gain in stocks. This same research on daily or weekly charts wasn't done for the indexes. The most likely rise was 20% in stocks. The per cent rise is based on the lowest levels at the bottom of the saucer formation.

One possible 'measuring' implication for how high prices will go coming out of the rounding bottom formation is to subtract the lowest low of the bottom mid-point of the saucer before it starts to round up to the right. Subtract this value from the top or lip of the saucer. Add the difference to the value of the saucer 'lip' to get a target price or a 'minimum' price objective. This measure works about a third of the time, so price targets have to be flexible, so trade exit is done at signs that an advance is faltering or reversing. An example based on this 'measuring' rule of thumb is highlighted below on the hourly SPX chart.

V-BOTTOMS

Far and away the most common type bottom in stocks and stock index is the V-shaped bottom or simply 'V-bottom'. You've seen this countless times. And, there are NO 'measuring' implications for V-bottoms as to the expected 'height' of the subsequent advance. V-bottoms are most often accompanied by an oversold extremes in technical indicators like the Relative Strength Index (RSI); high levels of bearishness or low bullish sentiment is another characteristic.

In stocks, unlike commodities, it's rare to see V-shaped TOPS. This is because there is gradual accumulation of stocks and phased in buying, then buying on pullbacks as congestion happens where the market or stock is unable to make much further headway. Buying interest on the way up, or at tops, is not a 1-time decision, rather is a series of decisions to accumulate stock(s) among funds. Not so, with declines as there is a tendency to dump stock(s) rapidly as FEAR takes over. This eventually leads to a sold-out market, high bearishness and an eventual rapid recovery leading to the steep sides of the V-bottom pattern.

RECTANGLE BOTTOMS

Much less common than V-bottoms, are rectangle bottoms, which occur perhaps somewhat more frequently than rounding bottoms. Unlike V-bottom however, there IS a 'measuring' implication for the next advance once there is a breakout above the top end of the rectangle. There should be 2-3 or more highs in the same area to define the top end of a rectangle and 2-3 or more lows in the same area to define the low end of a rectangle.

That's all there is in bottoms patterns, the 3 types: V-shaped, rounding and rectangular. There are no others. All types are quite identifiable and should be bought 1) either shortly after the 'V' is apparent; or 2) when the 'rounding' pattern of lows becomes apparent; or 3) when there's a breakout above the top (resistance) end of a rectangle.

With the rectangle bottom especially, there is a couple of good 'measuring' implications for a next advance; one more conservative and equal to a 'minimum' expected move and the other a more aggressive, or 'maximum', target.


GOOD TRADING SUCCESS!