Head and Shoulders Bottom

The Head and Shoulders Bottom, sometimes referred to as an Inverse Head and Shoulders, is a reversal pattern that shares many common characteristics with the Head and Shoulders Top, but relies more heavily on volume patterns for confirmation.

As a major reversal pattern, the Head and Shoulders Bottom forms after a downtrend, with its completion marking a change in trend. The pattern contains three successive troughs with the middle trough (head) being the deepest and the two outside troughs (shoulders) being shallower. Ideally, the two shoulders would be equal in height and width. The reaction highs in the middle of the pattern can be connected to form resistance, or a neckline.

The price action that forms the Head and Shoulders Bottom is roughly the same as that which forms the Head and Shoulders Top, but reversed. The role of volume marks the biggest difference between the two. Generally speaking, volume plays a larger role in bottom formations than top formations. While an increase in volume on the neckline breakout for a Head and Shoulders Top is welcomed, it is absolutely required for a bottom. We will look at each part of the pattern individually, keeping volume in mind, and then put the parts together with some examples.

Prior Trend: It is important to establish the existence of a prior downtrend for this to be a reversal pattern. Without a prior downtrend to reverse, there cannot be a Head and Shoulders Bottom formation.

Left Shoulder: While in a downtrend, the left shoulder forms a trough that marks a new reaction low in the current trend. After forming this trough, an advance ensues to complete the formation of the left shoulder (1). The high of the decline usually remains below any longer trend line, thus keeping the downtrend intact.

Head: From the high of the left shoulder, a decline begins that exceeds the previous low and forms the low point of the head. After making a bottom, the high of the subsequent advance forms the second point of the neckline (2). The high of the advance sometimes breaks a downtrend line, which calls into question the robustness of the downtrend.

Right Shoulder: The decline from the high of the head (neckline) begins to form the right shoulder. This low is always higher than the head, and it is usually in line with the low of the left shoulder. While symmetry is preferred, sometimes the shoulders can be out of whack, and the right shoulder will be higher, lower, wider, or narrower. When the advance from the low of the right shoulder breaks the neckline, the Head and Shoulders Bottom reversal is complete.

Neckline: The neckline forms by connecting reaction highs 1 and 2. Reaction High 1 marks the end of the left shoulder and the beginning of the head. Reaction High 2 marks the end of the head and the beginning of the right shoulder. Depending on the relationship between the two reaction highs, the neckline can slope up, slope down, or be horizontal. The slope of the neckline will affect the pattern's degree of bullishness: an upward slope is more bullish than a downward slope.

Volume: While volume plays an important role in the Head and Shoulders Top, it plays a crucial role in the Head and Shoulders Bottom. Without the proper expansion of volume, the validity of any breakout becomes suspect. Volume can be measured as an indicator (OBV, Chaikin Money Flow) or simply by analyzing the absolute levels associated with each peak and trough.

Volume levels during the first half of the pattern are less important than in the second half. Volume on the decline of the left shoulder is usually pretty heavy and selling pressure quite intense. The intensity of selling can even continue during the decline that forms the low of the head. After this low, subsequent volume patterns should be watched carefully to look for expansion during the advances.

The advance from the low of the head should show an increase in volume and/or better indicator readings, e.g., CMF > 0 or rise in OBV. After the reaction high forms the second neckline point, the right shoulder's decline should be accompanied with light volume. It is normal to experience profit-taking after an advance. Volume analysis helps distinguish between normal profit-taking and heavy selling pressure. With light volume on the pullback, indicators like CMF and OBV should remain strong. The most important moment for volume occurs on the advance from the low of the right shoulder. For a breakout to be considered valid, there needs to be an expansion of volume on the advance and during the breakout.

Neckline Break: The Head and Shoulders Bottom pattern is not complete (and the downtrend is not reversed) until neckline resistance is broken. For a Head and Shoulders Bottom, this must occur in a convincing manner, with an expansion of volume.

Resistance Turned Support: Once resistance is broken, it is common for this same resistance
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Double Top Reversal

The Double Top Reversal is a bearish reversal pattern typically found on bar charts, line charts, and candlestick charts. As its name implies, the pattern is made up of two consecutive peaks that are roughly equal, with a moderate trough in-between.

Note that a Double Top Reversal on a bar or line chart is completely different from a Double Top Breakout on a P&F chart. Namely, Double Top Breakouts on P&F charts are bullish patterns that mark an upside resistance breakout.

Gillette Co. (G) Double Top Reversal example chart from StockCharts.com

Although there can be variations, the classic Double Top Reversal marks at least an intermediate-term, if not long-term, change in trend from bullish to bearish. Many potential Double Top Reversals can form along the way up, but until key support is broken, a reversal cannot be confirmed. For clarification, we will look at the key points in the formation and then walk through an example.

Prior Trend: With any reversal pattern, there must be an existing trend to reverse. In the case of the Double Top Reversal, a significant uptrend of several months should be in place.

First Peak: The first peak should mark the highest point of the current trend. As such, the first peak is fairly normal and the uptrend is not in jeopardy (or in question) at this time.

Trough: After the first peak, there is generally a decline of 10-20%. Volume on the decline from the first peak is usually inconsequential. The lows are sometimes rounded or drawn out a bit, which can be a sign of tepid demand.

Second Peak: The advance off the lows usually occurs with low volume and meets resistance from the previous high. Resistance from the previous high should be expected. Even after meeting resistance, only the possibility of a Double Top Reversal exists. The pattern still needs to be confirmed. The time period between peaks can vary from a few weeks to many months, with the norm being 1-3 months. While exact peaks are preferable, there is some leeway. Usually, a peak within 3% of the previous high is adequate.

Decline from Peak: The subsequent decline from the second peak should witness an expansion in volume and/or an accelerated descent, perhaps marked with a gap or two. Such a decline shows that the forces of demand are weaker than supply and a support test is imminent.

Support Break: Even after trading down to support, the Double Top Reversal and trend reversal are still not complete. Breaking support from the lowest point between the peaks completes the Double Top Reversal. This too should occur with an increase in volume and/or an accelerated descent.

Support Turned Resistance: Broken support becomes potential resistance and there is sometimes a test of this newfound resistance level with a reaction rally. Such a test can offer a second chance to exit a position or initiate a short.

Price Target: The distance from support break to peak can be subtracted from the support break for a price target. This would infer that the bigger the formation is, the larger the potential decline.
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Ultimate Oscillator

Interpretation
Buying Pressure and its relationship to the True Range forms the base for the Ultimate Oscillator. Williams believes that the best way to measure Buying Pressure is simply subtracting the Close from the Low or the Prior Close, whichever of the two is the lowest. This will reflect the true magnitude of the advance, and hence, buying pressure. The Ultimate Oscillator rises when Buying Pressure is strong and falls when Buying Pressure is weak.
The Ultimate Oscillator measures momentum for three distinct timeframes. Notice that the second timeframe is double that of the first, and the third timeframe is double that of the second. Even though the shortest timeframe carries the most weight, the longest timeframe is not ignored, which should reduce the number of false divergences. This is important because the basic buy signal is based on a bullish divergence and the basic sell signal is based on a bearish divergence.

Buy Signal
There are three steps to a buy signal. First, a bullish divergence forms between the indicator and security price. This means the Ultimate Oscillator forms a higher low as price forges a lower low. The higher low in the oscillator shows less downside momentum. Second, the low of the bullish divergence should be below 30. This is to ensure that prices are somewhat oversold or at a relative extremity. Third, the oscillator rises above the high of the bullish divergence.

Sell Signal
There are three steps to a sell signal. First, a bearish divergence forms between the indicator and security price. This means the Ultimate Oscillator forms a lower high as price forges a higher high. The lower high in the oscillator shows less upside momentum. Second, the high of the bearish divergence should be above 70. This is to ensure that prices are somewhat overbought or at a relative extremity. Third, the oscillator falls below the low of the bearish divergence to confirm a reversal.

Conclusion
The Ultimate Oscillator is a momentum oscillator that incorporates three different timeframes. Traditional signals are derived from bullish and bearish divergence, but chartists can also look at actual levels for a trading bias. This usually works better with longer parameters and longer trends. For example, the Ultimate Oscillator (20,40,80) and price trend favors the bulls when above 50 and the bears when below 50. As with all indicators, the Ultimate Oscillator should not be used alone. Complementary indicators, chart patterns and other analysis tools should be employed to confirm signals.
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Introduction of Williams %R
Developed by Larry Williams, Williams %R is a momentum indicator that is the inverse of the Fast Stochastic Oscillator. Also referred to as %R, Williams %R reflects the level of the close relative to the highest high for the look-back period. In contrast, the Stochastic Oscillator reflects the level of the close relative to the lowest low. %R corrects for the inversion by multiplying the raw value by -100. As a result, the Fast Stochastic Oscillator and Williams %R produce the exact same lines, but with different scaling. Williams %R oscillates from 0 to -100; readings from 0 to -20 are considered overbought, while readings from -80 to -100 are considered oversold. Unsurprisingly, signals derived from the Stochastic Oscillator are also applicable to Williams %R.

Conclusion
Williams %R is a momentum oscillator that measures the level of the close relative to the high-low range over a given period of time. In addition to the signals mentioned above, chartists can use %R to gauge the six-month trend for a security. 125-day %R covers around 6 months. Prices are above their 6-month average when %R is above -50, which is consistent with an uptrend. Readings below -50 are consistent with a downtrend. In this regard, %R can be used to help define the bigger trend (six months). Like all technical indicators, it is important to use the Williams %R in conjunction with other technical analysis tools. Volume, chart patterns and breakouts can be used to confirm or refute signals produced by Williams %R.
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