All day I scan the charts looking for technical patterns to trade. My Trending 123 Pattern Scan powered by Recognia is one useful tool I have to scan the markets quickly, and it is showing two polar opposite technical events in the intermediate term for these two business services stocks.
Bullish Flag in AOL
AOL (NYSE:AOL), as most people know, was one of the first internet companies to really gain mainstream attention, but nowadays they’re not doing so hot. That’s why I was interested to see a bullish flag develop in this stock over the past 10 days.
A bullish flag follows a steep, or nearly vertical rise in price, and consists of two parallel trendlines that form a rectangular flag shape. The flag can be horizontal (as though the wind is blowing it), however it often has a slight downtrend.
The vertical uptrend, that precedes a flag, may occur because of buyers’ reactions to a favorable company earnings announcement, or a new product launch. The sharp price increase is sometimes referred to as the “flagpole” or “mast”.
The rectangular flag shape is the product of what technical analysts refer to as consolidation. Consolidation occurs when the price seems to bounce between an upper and lower price limit. This might occur, for example, in the days following a positive product announcement, when the excitement is starting to subside, and fewer buyers are willing to pay the high price that was commanded just a few days before. But, at the same time, sellers are unwilling to sell below a lower support limit.
A bullish signal occurs when the price rebounds beyond the upper trendline of the flag formation, and continues the original upward price movement. This is considered a pattern confirmation.
As the flag develops, the volume tends to decrease. Following a positive product announcement, the price may have reached an unexpected high, and fewer buyers will be willing to buy. Interest in the stock may resume, however, as prices drop, and sellers begin to lower their price. The increased activity explains why you will often notice a sharp spike in volume at the end of a flag.
Recommendation: Go long AOL for a short-term trade with a target price range of $46.50 – $48.50.
Head and Shoulders Top
Evolving Systems (NASDAQ:EVOL) is a software company that has developed a bearish head and shoulders top pattern over the past 21 days.
The classic head and shoulders top looks like a human head with shoulders on either side of the head. A perfect example of the pattern has three sharp high points, created by three successive rallies in the price of the financial instrument.
The first point – the left shoulder – occurs as the price of the financial instrument in a rising market hits a high and then falls back. The second point – the head – happens when prices rise to an even higher high and then fall back again. The third point – the right shoulder – occurs when prices rise again but don’t hit the high of the head. Prices then fall back again once they have hit the high of the right shoulder. The shoulders are definitely lower than the head and, in a classic formation, are often roughly equal to one another.
A key element of the pattern is the neckline. The neckline is formed by drawing a line connecting two low price points of the formation. The first low point occurs at the end of the left shoulder and the beginning of the uptrend to the head. The second marks the end of the head and the beginning of the upturn to the right shoulder. The neckline can be horizontal or it can slope up or down. The pattern is complete when the support provided by the neckline is “broken.” This occurs when the price of the financial instrument, falling from the high point of the right shoulder, moves below the neckline. Technical analysts will often say that the pattern is not confirmed until the price closes below the neckline – it is not enough for it to trade below the neckline.
Volume is extremely important for this pattern.
For a head and shoulders top the volume pattern is as follows.
Volume is highest when the left shoulder is forming. In fact, volume is often expanding as the uptrend continues and more and more buyers want to get in.
Volume is lowest on the right shoulder as investors see a reversal happening. Experts say low volume levels on the right shoulder are a strong sign of a reversal.
In the head portion of the price pattern, volume falls somewhere between the strength of the left shoulder and weakness of the right shoulder. Volume often increases when the neckline is broken as the reversal is now complete and downside pressure begins in earnest. One of the key characteristics in a head and shoulders top is very high volume on the breakout.
Changes in the rate of trading are more important than the precise number of shares being traded.
Recommendation: Short EVOL for a target of $5.90-$6.05.
InvestorPlace advisor John Lansing tracks the charts all day and offers expert technical analysis in his day trading, options and trading services: Power Trading at the Open, Parabolic Options and Trending123. For more information on which service is for you click here.