Telltale Signs of Tops and Bottoms

09/21/2011 3:30 pm EST

Focus: STRATEGIES

Toni Turner

Author, Short-Term Trading in the New Stock Market

Technician Toni Turner explains how to monitor price action on the charts and spot the warning signals whenever a market top or bottom is potentially being formed.

How can a trader identify tops and bottoms? Let’s ask Toni Turner. Toni, what are the characteristics of a top and a bottom? How do you identify them?

Well, in a stock market, we have short-term tops. When a market is coming up, say a market has traded in an uptrend—higher highs and higher lows—maybe for six months, maybe for two years, the longer it’s moved higher, of course, the more we have to watch it.

That’s the move up, the markup period, and an uptrend. Nothing moves up forever, and at some point, people are going to take profits, and it’s going to start to come down.

So, we watch many, many things. Something I think a lot of traders don’t think about is when we’re watching a big market like the S&P on a chart, it’s very wise sometimes to back up, look at a weekly chart and a monthly chart, establish what we call price support and resistance zones on that, and then we see on a weekly or monthly chart whether the S&P 500 can continue to make higher highs and higher lows.

At the point where it can’t and it starts to roll over, of course, we have to look around us at global events and conditions. Has it gone up for a long, long time? Those global events and conditions, are they going to give it enough belly punches to roll it over and make buyers put their hands behind their backs and say, “I’m not willing to pay any more for this market right now?”

So, we watch for perhaps a top to come in where if it goes straight down, and then we watch for the next top to come in. Can it go higher than the high before?

If it can’t go higher than the high before, especially on a longer-term chart like a weekly or a monthly chart, then we have to say buyers are no longer willing to buy at a higher and higher price.

Perhaps this is a time when we should take profits or at least tighten our stops.

NEXT: How to Spot Potential Market Bottoms

|pagebreak|

Toni, does it take a long time for a top to form?

It can take a very long time, and it can take a matter of not long at all.

If you look back at the year 2000 when we had the Nasdaq, the Internet highs, that bubble was formed by a very steep uptrend to the upside, so the top of that was very, very short lived.

If our ascent is more gradual, sometimes a top will take longer to form, but we can identify it because the candles or bars in between will get wider and wider. As the bulls say, “No, this market needs to go higher,” the bears say, “No, we’re going to push it lower.”

These big, long bars just contribute tremendous confusion. At this point it’s very smart of us to raise our stops or take some profits.

If it is a top, tops can be very volatile and take a little while to form. Then we see a break of support where we can draw a line as a place where we definitely should take our profits and either sell short or wait on the sidelines.

Toni, is the same true for bottoms?

Bottoms can be different. They can be quicker. Not always, but many times.

Especially if we look back, the bottom of 2001 and 2002 took longer to form. It formed—I can see a weekly chart in my head, or a monthly chart; it was a double bottom—the bottom came down, and that’s actually the best one. It made a low, came back up, looked like a “W,” came back down, retested, and started up.

It was a very nice uptrend higher. It wasn’t the “hoorah” uptrend that we had since the lows of 2009.

Now, if you go to the lows of 2009, of course, it was again a very steep drop down. When things are steep, then the reaction is…the move is steep either up or down. If the move is steep, then the reaction tends to be equally, you can’t say steep…equally sharp.

So, in 2009, in March, the market came down, but that Lehman Brothers drop was horrific, scared the devil out of all of us, and then started up. I thought it would come back down and retest those lows, but it never did.

It actually fooled around there in April, and then said, “No, I’m going up, and for now, this is it, at least for the time being.” That’s all we had to go on. So, that was a very steep drop; very fast bottom. Maybe we could legally say it took a day or so.

And then, up it went. So, they’re all different. If they weren’t all different, trading would be easy. But because for each and every top and each and every bottom, the characteristics are so very different, that’s why trading can be quite a challenge at times.

Related Reading:

Related Articles on STRATEGIES