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Tuesday February 09, 2010 |
Broadening
Top
Technically speaking, a broadening top is a rally to a new high, weakness to an
intermediate support level, a second rally to a higher high on increased volume
and decline through the intermediate support level, a third rally to a higher
high on strong volume followed by a eventual
collapse.
Why Does It Happen?
Whereas some technical patterns are characterized
by consensus and a general lack of volatility, the same cannot be said about the
broadening top. These patterns always feature indecision and extreme
volatility. When one looks at the pattern the resemblance to a megaphone
is striking. The stock makes a series of higher highs and lower
lows. Normally as time passes and more information is disseminated,
investors come to consensus and volatility slows but just the opposite is true
of broadening tops. There are distinct parts of every broadening top
formation. The first of three small tops (top#1) occurs after a
spectacular run to new high on increasing volume. Generally, this advance
will be the result of better than expected earnings, a new product and/or a
barrage of Wall Street recommendations. However, as the stock surges to
new highs sellers also step-up selling efforts and it is not long before the
stock settles back to a prior support level (a). After several sessions of
slower trade more positive news pushes the stock to yet another new high on
increased volume (top#2). The increased volume should be a sign that
bullish consensus is building but once again the stock falters, falling to a
relative new low (b) just days after making a new high. Although the news
flow is still very positive, rumors begin to circulate that some institutions
and insiders are beginning to liquidate positions. It is at this time that
there is a full scale defense of the stock by bullish investors. Wall Street firms make new recommendations with lofty price targets and once again,
the stock begins to move higher. Although volume is strong, it is
noticeably less than the prior rallies. The stock moves to third new high
(top#3) in as many attempts. All of the news is positive. The
company may be raising guidance, setting a stock split or talking about the
outlook for new products. The prospects seem bright but even as the stock
is making a new high, there is skepticism among some investors. Days later
the stock begins to falter on increased volume but no specific news.
Several days later the stock is collapsing and support at the most recent low is
in jeopardy. There is news that a large shareholder has filed to sell
stock, bullish investors panic. Weeks later the stock sinks back to the
longer-term support level.
How Are Technical Targets Derived?
Because broadening tops are very large reversal patterns, the technical
implications are usually extreme. The measured target is derived by
subtracting the height of the pattern from the eventual breakout level.
Broadening Top for XO Communications
Like so many telecommunications issues, XO Communications (XOXO) was once
afforded a valuation so rich it defied logic. XO Communications was the
product of two very "hot" telecommunication upstarts, Nextlink
Communications and Concentric Networks. Together these firms promised to deliver
a wide range of new products that would forever change the telecommunications
industry. Although products needed to facilitate this change did not come
cheap, upstart telecommunications firms found no shortage of willing venture
capitalist investors in the winter of 1999 because stock prices were surging.
From December 1, 1999 through February 23, 2000 XO Communications surged from
$24.40 to $59.50 (top#1), a gain of 107-percent! During that time frame
the company recorded a loss of $1.57 versus a loss of $1.03 during the prior
period. This was "offset" by a two-for-one stock split
announcement. By March 9 the stock had settled back to $52.93 (a) in light
profit taking. The very next day Wall Street broker Donaldson, Lufkin
upgraded the stock to "top pick" from "buy" in response to
the "improved" fundamental outlook. Once again the stock shot
higher, reaching a new high at $62.26 by March 13 (top#2) but that rally proved
very short-lived. By March 16, XO Communications was trading back to
$49.48 on no specific news. Once again, the Wall Street analyst community
came to the aid of telecommunications issues, making several bullish
recommendations in the sector. Days later XO Communications was pushing
higher again, this time reaching a record high on respectable volume at $66.25
on March 24 but just three days later Eagle River Trust filed to sell 350,000
shares of common stock. The stock began to plummet, falling as low as
$47.93 by March 5 (downside breakout). On March 14 XO Communications
authorized a boost in common shares from 460 million to 1.12 billion and the
stock continued to fall precipitously, reaching $42.50 amid surprisingly slow
trade.
Vital Signs
-
Unlike most consolidation patterns, broadening
tops feature increasing wide ranges and greater volatility as time passes.
-
Volume increases as the share prices
rises. Normally this is bullish but rallies prove very short-lived and
declines "take-out" previous support levels.
-
Broadening formations are only found in
topping formations because they are the product of unrealistic expectations
on the part of bullish investors.
-
Downside breakouts often lead to small 2-3%
declines followed by an immediate test of the breakout level. If the
stock closes above this level (now resistance) for any reason the pattern
becomes invalid.
triple
bottom 
head and shoulders
bottom
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