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Friday September 03, 2010 |
Triple
Bottom
A triple bottom formation is the mirror image of
the triple top. After an extended decline to new lows a stock puts-in a
bottom on massive volume and a moderate rally ensues. After several
sessions (sometimes weeks) the stock drifts back to test the first bottom and
once again buyers push the stock higher. This process is repeated a third
time before buyers finally overwhelm sellers and the stock moves significantly
higher.
Why Does It Happen?
Whereas triple tops are all about distribution, the triple bottom is about
accumulation. After an extended decline characterized by aggressive
short-selling and valuation concerns, value-oriented investors with longer-term
time horizons begin to take positions in the stock. They understand that
the only way to build a large position in a stock that they like is to do so
when selling predominates. It is their willingness to buy the stock when
all of the news is bad that creates a clear support level, the first bottom (bottom#1). This
presence of large buyers in the face of bad fundamental news will normally be sufficient to force many
professional short sellers (bears) to cover positions. This coupled with
buying from longer-term value investors may be enough to rejuvenate investors
that recently purchased the stock at higher levels -- they may even rationalize that the
"market" is finally beginning to realize that the current weakness is without merit
and a few bullish speculators may be enticed to take new long positions.
Unfortunately, after several sessions of positive price action buying
pressures are exhausted and the stock once again begins to falter. The
positive price reaction to the decline that formed bottom#1 is complete. Technical
traders call this the reaction high. Amid continued negative
fundamental news, short
sellers return and bullish speculators decide to take profits. What begins
as modest selling quickly becomes a route. As the stock approaches bottom#1
volumes remains light and in many cases the stock will actually fall through
the previous low on very light volume. It is at this point in time that
pessimism is greatest, there seems to be no legitimate reason to continue
holding the stock. Novice short sellers add new short positions and beleaguered
bulls who purchased the stock at much higher levels begin to surrender in
anticipation of a new leg lower. However the expected big decline does
materialize because longer-term investors continue to buy the dips in price. A
new rally begins as short sellers are forced to buy stock to cover short
positions. As a second bottom (bottom#2)
begins to take shape the pace of short covering accelerates and the stock
quickly rallies toward the reaction high. Although the rally is sharp,
volume remains light. It is at this point that a new wave of bad news hits
the stock price. Bearish investors feel vindicated and the stock slumps
back toward bottoms #1 and #2. It is at this point in time that
pessimism is greatest, there seems to be no legitimate reason to continue
holding the stock. New short sellers add short positions and beleaguered
bulls that purchased the stock at much higher levels finally capitulate, volume
swells but oddly, support at bottoms #1 and #2 holds. Professional short
sellers start to sense that the "jig is
up", the stock is not going down. The price begins to stabilize and a
third bottom (bottom#3) becomes apparent. Suddenly, the flow
of news becomes less pessimistic, short sellers begin to panic and a massive
rally ensues. The stock rallies through the peak set between bottoms #2
and #3. On the chart three equal bottoms are created, the triple bottom is in place. In many
cases triple bottoms lead to important rallies because a vital support level has
been established at both the bottoms and the reaction high.
How are Technical Targets
Derived?
The technical target for a triple bottom
formation is derived by adding the difference between bottom #1and the reaction
high to the new breakout
level. After the third bottom has been created, the new breakout level is the
peak achieved between bottoms #2 and #3. No double bottom formation is complete until the stock
rallies through this level.
Vital Signs
-
For triple bottoms volume must increase as the
stock moves toward the bottom of the pattern. Increased volume at the
bottom of the pattern suggests that accumulation is taking
place.
-
No triple bottom pattern is truly valid until
the stock moves above the peak established between bottoms #2 and #3.
-
Upside breakouts through the reaction high
often lead to small 2-3% advances followed by an immediate test of the
breakout level. If the stock closes below this level (now support) for
any reason the pattern becomes invalid.
-
Technical targets are implied but they are by
no means assured. Targets are guideposts only.
Now that we have some of the basic multiple phase reversal
patterns under our belt let's tackle the more complex reversal patterns.
The broadening top is our starting point.
triple
top 
broadening
top
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