One of the most important aspects of learning to read stock charts and using Technical Analysis is to remember that the Market Structure is changing and evolving over bigo recharge. Sometimes these changes are very slow, other times the evolution is occurring at a rapid pace. In the past 5 years, the pace of change has been accelerating and continues to move at an ever increasing level. Therefore new and novice investors and traders need to be aware that all of the older books, articles, and information on the internet and in bookstores must be studied but also accepted as being outdated.
The topping formations that are developing now in the market reflect the fact that now 70-80% of all the market orders are automated. What this means is that most of the orders are triggered by a computer. Market Makers used to be humans that made the market by filling orders when there was no counter order. Now most of the market maker orders are fully automated.
Computer generated and matched orders create different technical patterns including topping formations, than human initiated and typed in orders. In addition the increased use of Alternative Trading Systems platforms by the giant institutions aka ATS, High Frequency Trading Firms Algorithmic trading HFTs, Electronic Communication Networks ECNs, and 16 different US stock Exchanges, create a far more dynamic stock market than what was present just a few years ago.
To start understanding topping action, a new or novice investor or trader must learn the original classic topping formations. Then they must learn the new topping formations of the automated marketplace. When both are learned, the investor or trader is prepared to use stock charts and technical analysis to the fullest advantage and success.
A topping formation occurs when a stock has been moving up for a long period of time and speculation has entered the price action. Often stock prices will go vertical with huge gains or shrinking price action just before a topping pattern begins. Tops often take a long time to form because most traders and investors don’t want to believe the uptrend is over. Late comers frequently buy a stock that is topping when it “dips” in price, because they are unaware of the fact that the stock has reached the end of its long term or intermediate term uptrend, needs to correct and move down.
This late buying causes tops to form over an extended period of time with a variety of topping patterns. Sometimes a top comes swiftly and the price collapses, but usually it takes a while. Regardless of your trading or investing style, being able to recognize topping formations early will help you keep more of your profits by exiting before the stock falls.
Inverted V is the opposite of a bottoming stock V. The inverted V occurs when a stock has been running up so fast that it doesn’t develop any viable support levels, suddenly peaks and forms a sheer cliff drop on the other side. These often have gap downs and the runs are so fast downward that they can be tough to catch. Inverted V tops are rarer now due to how High Frequency Trader activity controls most topping formations.
The Double Top is an inverted W or what is usually called an “M Top.” This is where the stock reaches a high, retraces and then moves up again but is unable to move beyond the original previous high to continue up. It then proceeds to move down again. The confirmation that a reversal of trend has occurred is when the price of the stock violates the lows of the M formation. Double tops are not topping formations until the reversal is signaled. Double tops can easily turn into a longer term sideways pattern that meanders up and down within that price range, so confirmation of price is critical. Also Double or M Tops are less common and rarely form on long term trends. With the automated market, most M Tops are seen only on the short term trend.
Triple Tops and Head & Shoulders are basically that the H&S formation is a variation of the Triple Top. Head & Shoulders Topping Formations are exceedingly rare nowadays. Triple Tops are also quite rare. The rule for H&S is that it must break the neckline, which is the lows between the shoulders. The neckline can be horizontal or angled and either makes no significant difference in the success of the downside formation. The head should be formed on upside weaker volume, the right shoulder should form on upside weaker volume still, and the break to the downside should form with strong red or downside volume.
These tops are very rare nowadays due to how the giant funds use ATS platforms to slowly sell out of a stock long before it runs up speculatively. The H&S formation peak fails to form often as HFTs trigger massive collapsing sell-offs on sudden news events. Since HFTs are mostly one day events the “Head” that used to form, no longer forms because there is no continuation after the huge one day volume surge and price speculative intraday action.