|With all the talk of head and shoulders top patterns in the S&P 500, Nasdaq Composite and Dow Transportation Indices (see "When Will This Cruel Bear Market Be Over?" by Tim W. Wood, Working Money 07/23/2002) and subsequent market bottoms, the chart pattern that appeared with Microsoft (MSFT) on November fourth was an almost-perfect textbook example of a double bottom reversal chart formation. It also demonstrates how quickly market sentiment can change from bearish to bullish as investors pile back into the markets. Last but certainly not least, it gives traders and investors a minimum upside target price to look forward to (assuming no fundamental meltdown in the interim) .|
Since hitting a high of $117.75 on New Years Eve 1999, the stock moved down for the next nine months to then trade in a range between $43 and $70 for the next 14 months. The predominant downtrend returned when it began dropping from $70 on January 17, 2002 to an 18 month low of $41.41 in July. This move also marked the beginning of the double bottom. It hit a second low of $43.12 on September 30. On November 4, it gapped up above the double bottom neckline, thereby completing the pattern.
|Technimental traders (those relying on both fundamental and technical data) who saw the pattern forming must have reacted with added glee to the US court decision on November first, upholding the previous ruling that allowed Microsoft to continue with business as usual and avoid a breakup. It was a clear victory for Bill Gates and company. Investors also loved it, pushing the stock up more than five percent on Monday. The move by the bellwether technology company pulled up a number of industry rivals in the process.|
|Figure 1 - Daily chart of Microsoft between June 1 and November 4, 2002. Note the volume moving up as the price moves down earlier in the pattern and a reversal near the end.|
|Graphic provided by: StockCharts.com.|
|The first requirement of a trend reversal pattern is there must be a trend to reverse. In this case it was clearly down. To begin the process of a double bottom, the stock must hit a low, retrace and hit a low again (see blue line). They do not have to be equal. Next, a piercing of the (green) trendline is the third step and this occurred on October 15. Fourth, the neckline must be decisively broken as the stock moves up, which occurred on November 4 (blue arrow). |
An integral part of this pattern confirmation is volume. Generally with most trend reversal patterns, volume diminishes as the formation evolves and then moves dramatically higher with the price breakout. As we see from the chart, the blue circles mark volume spikes; volume first increases on price drops which occurs in bear markets but as prices begin to move higher, volume also increases, which is a sign that market sentiment has changed to bullish. Volume increases and spikes occurred exactly where they should have on this classic chart pattern by Microsoft.
|Also note the dramatic increase in money flow as investors pour money into the equity and the green arrow signaling a bullish momentum stochasticRSI buy signal as it moved out of oversold territory on October 30th. |
One final but crucial aspect of reversal patterns is the ability to provide insight into where the equity may be going. A technician is able to set a price target by measuring the change from the neckline down to the bottom (see blue dashed lines on chart). According to theory, the stock should move at least as much in the opposite direction. In this case, the difference between the neckline and the latest bottom ($53.45 - $43.12) is $10.33, giving us a minimum price target of $63.78 (give or take a few pennies).
Technically speaking, the gap up may provide some worry as it could portend the beginning of a possible island reversal pattern. More likely there will be price filling at lower levels, which would be healthy, but as long as the neckline holds, the price should eventually begin moving to our price target.
|However, as any technimental or fundamental trader/investor should know, all bets are off if the US coalition decides to invade Iraq or some other major event occurs.|
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