CHARTING The double top

Press, 13 November 1985, Page 51

CHARTING The double top

Charting is an important approach to investing in shares and futures overseas, and there is growing interest in New Zealand. This is the first in a series o] articles on charting by GEORGE PRICE, futures broker with Egden Wignall and Company, of Christchurch.

Most traders or investors have more or less definitive rules for entering and exiting positions in share or futures markets. Some use very simple rules, such as brokers’ or advisers’ opinions. Others are content to build up a case for buying or selling a share or entering into a futures contract from whatever information is available nearby. (Often they build the case, then get the information to support it) This series on charting is being written to help you: • Formulate your own strategy on how best to invest or risk your own money. • Learn the art and discipline of allowing the market to signal when it should be bought or sold. • Become familiar with techniques now being used extensively in most financial capitals of the world. © Initiate a valuable source of reference material. Our charts this week illustrate the formation known as double tops. The rareness of the formation in no way diminishes its importance. Double tops can be classified as such only at the end of a long and sustained bull market. The signal is now for a long and sustained bear market. We will study two classic double tops and analyse of their unique characteristics.

1: The first peak, as in our examples of the pound and gold, is always made on very heavy volume. Cast your minds back to the run up in gold, when there was frenzied buying as analysts began predicting higher and higher levels. Public participation to become part of the action caused these heavy volumes. The United States dollar was being dumped and consequently all currencies were being run up to these unrealistic levels. This is phase one.

2: The market without much warning will proceed to correct from what normally appears to be an overbought position. In the pound chart it went down for seven weeks and in the gold example for four months. The result is shown in phase two of our charts. Until then we have no conclusive proof that the markets are forming a top. It could be another correction in the ongoing bull market.

3: The market then begins to move higher. At this point the astute investor would note that activity and volume is no longer at fever pitch. Volume is more subdued. This concept is of the utmost importance. In the pound chart we see a rise for six weeks but the highs fail quite to attain their previous levels. In gold, we see the second peak just fails to attain its former level after a rise. This is phase three. The V formation separating phase

two and three is called a valley. 4: Until the end of phase three in our examples there was virtually no way of telling whether the market would break above its previous peak and just continue on its upward path, or if the resistance level at its first peak would bring out enough sellers to check its advance.

Do not try to outguess the market or tell it what it should be doing; let it tell you. You will not have to wait long to find out. In the pound chart it only took three weeks for the market to point its new trend.

Note how in phase two the market touched $2.30 before moving higher. That price of $2.30 became our pivot point. When that point was broken on the third week on the downside in phase four, it was the absolute and final signal that the market was now entering a major bear trend. In such a case, liquidate all long positions and go short. (A long is a buying position in futures; a short is a selling position.) The third phase in gold lasted four months before it too ran again into selling resistance. The pivot point is at $503. This level was broken on the fifth month in phase four and again was an immediate signal to liquidate all longs and go short.

5: The bear markets that followed from these two examples were fairly dramatic. After our sell signal in the pound it crashed to $1.05 on April 5, 1985. The little double top in

our example resulted in a horrendous five-year fall of the pound. At the time of writing gold has fallen to a low of $282 since our sell signal during the same time span and there is no evidence that these bear markets are yet complete. Double tops are extremely reliable, if watched judiciously, as has been shown. They do have one minor drawback, however. They do not have any measuring formula, indicating how far the market will fall.

In the next article we will be taking a look at the head and shoulders top.