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| Broadening
Top Pattern |
WHEN YOU SEE A
BROADENING TOP, THE MARKET WILL EVENTUALLY DROP
Major reversals in trend--those that mark the turn from a bull to a bear
market--can take the shape of many price patterns. Stocks or markets can
top by creating, for example, head and shoulders or descending
triangles. One of the most difficult patterns to predict, however, is
the broadening top.
A broadening top is hard for the swing trader to spot because it is seen
far less frequently than other important price patterns. It can be
visualized, however, as opposite to a symmetrical triangle. Whereas the
symmetrical triangle consists of two lines that converge, the trendlines
of the broadening top instead diverge. The shape that best captures this
pattern is that of a megaphone.
The classic technical analysis text by Edwards and Magee characterizes a
broadening top as a market that lacks intelligent sponsorship. It is one
in which the public is being whipped around and driven this way and that
by rumors. As such, volume during the broadening top pattern tends to be
irregular. During some rallies volume may expand, but during others it
tends to be tepid. The same pattern applies on pullbacks. Because it is
so unpredictable, the broadening top pattern is extremely difficult to
trade. There is no clear breakout to either the upside or downside edge
of the pattern.
Below is an example of a stock that is in a broadening top pattern,
Boise Cascade (BCC). I started the chart in December 2003, just before
the formation began in January 2004. Note the lower lows in February and
March, which mark the beginning of the formation. However, also note the
ability of BCC to continue to make marginal new highs. In fact, toward
the end of this chart it reached a new high peak of $37.80 (although as
the star candle shows, it quickly retreated from this level). Note the
erratic volume pattern, as the stock saw a pickup in volume on both
rallies and declines.
Below you will find a chart of the
S&P 500. I have included the 150-day moving average to show that
prices have gone below this key measure but have now popped back above
it. Within the context of a broadening top, the S&P could reach a
marginal new high of say 1170 without changing this pattern's
interpretation.
What would cause me to reject the
broadening top interpretation? First, the S&P would have to break
out above 1163. Second, it would have to hold the breakout level on a
pullback. And third, it would need to reestablish an uptrend by making a
series of highs lows and higher highs.
Such behavior would keep the index above
a rising 150-day moving average and would turn the March-May pattern of
lower lows into an aberration. Time will tell if the buying power
remains to re-ignite this kind of bull market. Until proven otherwise,
however, the broadening top explains the market's current choppy action.
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