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Part III: Bollinger Bands on Their Own

Figure 13.2 Actual head-and-shoulders top, Vishay, 250 days. Head and shoulders are rarely picture perfect; look for the key elements to clarify the picture.

longer top formations. Typically the first push will be outside the upper band, and the second push will make a new high and touch the upper band. The third push may make a marginal new high- more often not-but will fail to tag the band. Volume will diminish steadily across the pattern. This is a portrait of failing momentum, a portrait many stocks paint as their tops form. The typical building blocks would be M15s or M16s.

The first part of a head-and-shoulders formation is an M formation that consists of the left shoulder and head. M14 and Ml 5 patterns or a blend of them would be typical. The next part is another M consisting of the head and right shoulder. M3 and M4 or M7 and M8 formations would be typical right-shoulder patterns. The final part is also an M consisting of the right shoulder and the throwback rally, typified by an Ml or M3. However, starting with the first trough after the head, you might wish to analyze the patterns as a series of Ws, as the formation now has a downside bias with a lower high and the potential for a



Chapter 13: M-Type Tops

Figure 13.4 Three pushes to a high, Juniper, 200 days. Note the preponderance of black candlesticks after the final high.



Part III: Bollinger Bands on Their Own

lower low. A Wl or W2 would be the pattern to look for on a throwback rally.1

Of course, you can get even more detailed, counting each M and W as it presents itself-there would be a total of five in a head-and-shoulders pattern-and testing each for relevance. But there isnt much need to do that, except perhaps for shorter-term traders looking for setups within the context of the formation. For position traders, observing the formations as they evolve and noting their bias is generally enough.

As was the case with bottoms, often top formations such as the head-and-shoulders pattern contain smaller formations within them, especially at the next higher level of magnification. So if one is examining a head-and-shoulders pattern forming on the daily chart, look for small-scale patterns forming on the hourly charts confirming the larger pattern on the daily charts.

When you have detected a formation you think qualifies, wait for a sign of weakness to confirm your diagnosis before acting. This can be defined as a day with greater-than-average volume and greater-than-average range. There is another aspect to successful trade entry that was not discussed in the prior chapter, patience. Often after the sign of weakness there will be a countertrend rally that will provide a perfect entry point. For example, the throwback rally after the neckline is broken often provides a perfect entry point (Figure 13.5). Of course, this is true of bottoms too, but it seems clearer in relation to tops. Many professional traders require this type of setup before entering a trade, as it lets them precisely define their risk-reward relationship by setting a stop just above the top of the pullback. Very good risk-reward ratios are achievable this way.

With tops, relativity is the key, just as it was with bottoms. In many cases your outlook will need to turn cautious even though an absolute new high has been made. Really the only device for doing this successfully is Bollinger Bands. A high made outside the bands followed by a new high made inside the bands is always suspect, especially if the second (new) high fails to tag the upper band. This is the only approach we know of that can consistently warn of danger at a new high or opportunity at a new low. A particularly clear sequence is a high made outside the upper band, a pullback, a tag of the upper band, a pullback, and then a final rally that fails to achieve the upper band at all. In Part IV well



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