Some of the most important resources in a technical analyst's arsenal are indicators that can help identify reversal in chart patterns. Double-top and the rarer triple-top are two such indicators.
These are pattern formations that typically lead to severe price corrections during bull markets. In bear markets, double-bottoms and triple-bottoms reverse downtrends and are followed by a price surge.
The BusinessLine newspaper is something I like to read regularly. They provide fairly unbiased and balanced opinions. In a recent issue, there was a 'buy' call given for Elgi Equipments.
This company wasn't on my 'watch' list so I decided to take a quick look at the price chart pattern. This is what I saw on the longer-term price chart:-
In April 2006, the stock made a high of 97. Shortly thereafter, it collapsed to 52 in July 2006 and then, after a brief sideways consolidation, dropped to 48 in Mar 2007.
Another sideways consolidation was followed by a sharp rise, this time to 95 in Jan 2008. That was a 'test' of the previous top that failed. Once again, the stock collapsed down to 44 in March 2008, going below the previous low of 48.
A quick upward bounce to 70 in April 2008, then a drop to 43 before the bear market took the stock all the way down to multiple bottoms at 27. A classic example of a double-top chart pattern formation.
First, the second top was almost the same as the first. Second, the volumes preceding and during the first top of 97 were higher than the volumes preceding and during the second top. Third, the low between the first and second tops could not support the fall from the second top as the stock dropped much lower.
Unfortunately, the double top can't be confirmed till the low between the two tops gets broken after the second top gets formed. On occasion, the stock price may continue to move upwards after falling briefly from the second top. Now you know why I keep mentioning that technical analysis is more an art than a science!
Next, have a look at another interesting chart pattern formation during the current bull rally. The stock had a sharp up move to 98 in Jan 2010 - almost the exact same level it hit in 2006 and 2008. The correction started immediately, and we may be witness to the much less frequent triple-top chart pattern formation.
Can we conclude that the stock is going to drop steeply once more? There are a couple of indications that suggest so. Except for a single, very large spike in Oct '09, volumes have been just as meager as it was during the formation of the second top.
Also, have a look at the 50 day EMA. Each time that the stock price moved 25-30 points above the medium-term moving average, the stock came crashing down. It could happen again.
If I was a gambling man, I would lay a wager that this is a triple-top reversal chart pattern. But I have lost enough money trying to predict what a chart pattern is going to do next.
A triple-top can't be confirmed till the 48 level is broken on the down side. But for existing holders, this can be as good a time as any to book some profits.
I'm afraid I can't agree with the BusinessLine 'buy' call from a technical perspective, even though the company may be doing fine fundamentally.
This is a good example to support my argument that investors should learn both fundamental and technical analysis. Only when the technicals and fundamentals are in synch should a stock be bought.
(A question: Why do you think the double-top or triple-top patterns get formed? Are there some logic behind them, or are these random patterns that defy logic?)