MY MAILBAG:

You showed examples of V shaped bottoms in a recent article comparing to double bottoms. Can't they be both? Any explanation of why V reversals are the most common and why not seen at tops? Also, what did you think of today's (7/7/11) market action from technical standpoint?

MY RESPONSE:

As to the current technical picture, it's still pretty bullish for the major market indexes. Using the S&P 500 (SPX) as the example, the stand out chart development was the breakout above the secondary top at 1345. Since SPX has retraced so much of the last decline, we can reasonably assume that the index is going to at least retest the 1370 top and retrace a full 100% of the last downswing. SPX is not yet 'fully' registering an overbought RSI extreme and my very pivotal bullish/bearish sentiment indicator at bottom is NOT yet showing an 'overbought' bullish extreme either. The price pattern AND the two indicators suggest there's more room on the upside so to speak. Whether SPX breaks out above 1370 is a harder guess. There could be double top that forms; or not.

MORE ON V-BOTTOMS AND TOPS:

I wrote about the common types of trend reversal chart patterns in my last Trader's Corner article of 6/30/11 .

When a single bottom looks has the follow highlighted shape, as here with the Nasdaq Composite chart, it's typically simply called a V-bottom in chart terms.

When there are two V-bottoms where the low end or apex of the 'V' bottoms occur in the same area, I'd no longer refer to the pattern as 'two' V-bottoms, but rather as a double bottom. A double bottom is a potent sign that the trend has turned back up. A double bottom or double top formation is a potent sign that the trend, be it the short (e.g., as seen on hourly charts), intermediate (daily chart view) or long-term trend (weekly chart), has reversed.

V-TOPS/BOTTOMS HAVE SYMMETRY

If you look at a V-bottom or V-Top (an inverted 'V') in terms of the apex or tip of the 'V', the pattern will typically have sides that have approximately the same number of bars on the left as on the right side; this is generally the case for the two V-bottoms shown above on the Nas Composite daily chart.

Tops might trace out what looks like an upside-down 'V' but are often 'irregular' in shape. An example is seen with the weekly COMP chart shown below. Example number 1 below on the weekly COMP chart would be more accurately called a Head & Shoulder's Top.

Why we would identify the pattern this way is that the Head & Shoulder's pattern has a measuring implication for a 'minimum' downside objective that doesn't exist if we view this as an 'irregular' V-top. The measuring implication for a Head & Shoulder's top (or bottom) formation is explained in a prior Trader's Corner article. V-top number '2' below has the upside down 'V' shape and is symmetrical but is a secondary top only and in that sense isn't 'the' top like pattern # 1 is. It's a secondary confirming top.

A 'V' bottom is contrasted with bottoms with price lows that form in the same area multiple times; a bottom that is the low end of a trading range or a rectangle or 'line' formation. The same is true, only in reverse, for the tops of trading ranges. Then there are rounding bottoms and rounding tops and these are typically MORE significant for a major reversal move.

V reversals are not as frequently as definitive for a bottom or top as the others mentioned. They ('V' formations) tend to form in more volatile markets where there are sudden and sharp moves but that might not necessarily reverse the trend. This pattern is usually good for a substantial move after the top/bottom of the 'V' forms in the 'reversal' direction. As to 'V' type tops, we should probably call them reverse V-tops, but no one does; unlike a 'reverse' Head & Shoulders bottom.

As implied by the shape of the letter "V" in technical analysis terms the pattern is where an intraday or intraweek low or high forms at the end of a price move when prices go into a final steep descent or ascent, followed by an equally sharp countertrend move. The same descriptive term is given to a top that is formed by a sharp advance, followed by an equally steep decline; such a top could also be called an inverted V-top.

As part of the discussion of V tops and bottoms, it's useful and appropriate to describe a spike and also what is sometimes called a 'thrust'day. A spike is simply a sharp run up or decline whose hourly, daily or weekly high or low substantially exceeds the respective high or low of the bar or bars (e.g., day or days) that immediately preceded the spike, as well as for some time AFTER the spike has occurred. What we often see on daily charts at tops is a spike high well above the prior day or days, but a close that is well under that day’s intraday peak. At bottoms we often see a spike low that is well under the prior day or days, but a close that is well up from the intraday bottom.

When a daily close is below the low of the prior day, it is sometimes also qualified as a downthrust day. When a close is above the high of the prior day, this is also sometimes called an upthrust day. Analogous to mechanical power, whenever 'thrust' is used in technical analysis it implies a strong force pushing the market in one direction or another. However, in the markets, a force pushing strongly in one direction may reverse by the close. As emphasized in the candlestick charting method, the close tends to be more important than an intraday high or low well beyond the prior day’s high or low, if the close is less extreme than the spike high or low.

An even stronger case for a trend reversal, after an uptrend has been underway for some time, is suggested by a day with a jump to a high well above the prior day or days (a spike), but a close that is under the low of the prior day - a down thrust day. Conversely, a stronger case for a trend reversal is made well into a downtrend, when there is low well under what has gone before (a spike low), followed by an up thrust day whose close is above the prior day’s high.

The concept of the thrust day, taking into account the close, relative to whether it is below or above the prior day’s low or high, is something that is not necessarily significant as a single event. Thrust days are quite common; a series of them is what is significant. A strongly up trending market typically will have a number of up thrust days and a market in a pronounced decline, a number of down thrust days.

Stocks, futures or FX instruments that are thinly traded, or are volatile in general or just in a particular period such as during a top or bottom, are more prone to exhibit spikes and thrust days. The chart below some sharp down spikes and thrust days:

'V' tops and bottoms often have a spike high or low at the end of the climb or at the very bottom, but not always. The discussion on spikes, including spikes that have closes above or below the prior day’s price range (up or down thrust days) is often relevant to V-reversal tops or bottoms as they are often part of the V-top or V-bottom pattern.

It's sometimes common to see steep V-top patterns such as in the major top in my next weekly chart; Yahoo had a pronounced spike high at the very top and in the center of an inverted V-top:

You can cover up the price scale and the dates at bottom and imagine that this is a 15, 30 or 60-minute chart also; the PATTERN is the same.

The chart below, of bellwether GE is an example of a classic V-bottom formation; such bottoms may or may not have as many instances of very steep angles making up the sides of the 'V' as is sometimes the case with tops, especially in commodities:

VOLUME AS AN ANCILLARY INDICATOR OF V-BOTTOMS OR TOPS:

An obvious difficulty in predicting a reversal based on a V bottom or top pattern is that they are not always easy to identify until the reversal move is under way. While they are developing they are not much different in appearance than from a pronounced further price spurt, followed by a correction.

However, when there is also a definite spike high or low and/or a thrust day or days, accompanied by a confirming surge in volume, these provide further technical clues pointing toward the appearance of a reversal pattern.

We can take the chart above and add volume to the price picture alone. The jump in daily volume that mirrored the spike low (bottom of the 'V'), offers an excellent confirmation of the likelihood of an upside reversal as suggested by a close in the middle of the daily range, which was followed by a strong rebound in prices in the following day and days:


GOOD TRADING SUCCESS!