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41 CHAPTER M-TYPE TOPS Tops are quite different from bottoms, and Ms are different from Ws. Speed, volatility, volume, and definition-all are apt to be different. Thus tops and bottoms of similar importance will not necessarily be mirrors of one another. Their patterns are a function of psychology. Panic is a much sharper, more forceful emotion than greed, so panics portrayal on the chart is much clearer. Where the most typical bottoming pattern is a double bottom, or W, tops are typically more complex, with the most typical formation being the triple top. Just as in the case of panic bottoms, cases of spike tops do occur where an uptrend is sharply reversed, but they are relatively rare. Far more common are M-type tops, or double tops, that consist of a rally, a pullback, a subsequent failed test of resistance in the neighborhood of the prior highs, followed by the start of a downtrend. Most common of all, however, is the triple top, and a common variation of this is the head-and-shoulders top
Part III: Bollinger Bands on Their Own (this is perhaps the technical term recognized by the widest range of investors). The head-and-shoulders pattern (see Figure 13.1) consists of a rally followed by a shallow pullback that forms the left shoulder. Then the head is formed by a rally to a new high followed by a steeper pullback that typically ends near the low established by the first pullback. An Ml 5 pattern would be typical of this phase. Finally a failure rally that is unable to make a new high-ideally ending near the first peak-followed by a decline that falls beneath the levels established by the first and second declines-a level known as the neckline-forms the right shoulder. The new pattern could be the M15 morphing into an M12 or M7 after two more price swings. The last part of the formation is a throwback rally which carries prices back into the neighborhood of the neckline. After the final two swings, we now have an Ml or M3 pattern. From there the decline begins in earnest. Volume in a head-and-shoulders rally also has a typical pattern-strongest on the left side of the formation, waning across the middle, and picking up as the decline gets under way.  Figure 13.1 Idealized head-and-shoulders top. The most commonly known chart pattern.
Chapter 13: M-Type Tops Both the price pattern and the accompanying volume are closely linked to the underlying psychology. Euphoria and greed characterize the left side of the formation, with rumor often the dominant informational vehicle. Volume is high and activity heavy. The head is often accompanied by the release of the news that the rumors anticipated. Although we are at a new high, volume does not confirm. Here the old saw "sell on the news" comes into play, as those who bought in anticipation of the news, or due to the rumor, move to take profits. Their selling, accompanied by some short selling by the pessimists, forms the right side of the head and sets the stage for a last, weak bout of optimism that forms the right shoulder. Action is desultory and volume low. Now the decline sets in for real, the neckline is broken, and volume picks up again and fear surges. Finally, the covering of short sales by those who anticipated the decline and sold short near the highs is often said to be a factor in the throwback rally to the neckline. (Short sellers have to buy their shares back to close their positions.) The throwback rally is the last good chance to get out; ahead lie lower prices. See Figure 13.2 for a real-world example. Fortunately, the diagnosis of all this is greatly helped by Bollinger Bands. The easiest way to tackle tops is to break them down into their component parts and treat them as a series of Ms and Ws. These smaller pattern components are much easier to cope with than the big pattern, but first lets look at the big pattern in an ideal sense. The classic pattern would be a left shoulder outside the upper Bollinger Band, a head that tagged the upper band, and a right shoulder that failed well short of the upper band (Figure 13.3). In an ideal world the neckline would coincide with the middle band at the right shoulder, and the first decline would stop at the lower band. The throwback rally would stop at the middle band, and, finally, dramatically, the first leg down would break the lower band. Thats the ideal, but the odds of seeing such a pattern, perfect in every respect, are not high. Much more common would be a pattern that obeyed most of those rules, offering general guidance as the pattern unfolded. There is one very common variation of the head-and-shoulders pattern you should be aware of, three pushes to a high (Figure 13.4). This pattern often develops as the leading edge of larger,
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