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Three Bearish Stock Market Chart Patterns That Could Save Your Portfolio

Posted, by sara nunnally on August 31st, 2010

Every day was an exercise in symmetrical triangles and double tops, candlestick patterns and Fibonacci retracements, 200-day moving averages and RSI...

Stock market charting became both an art and an oracle.

Over the years, you start to see patterns everywhere. And some of the most recognizable ones are the best-performing formations, making simple stock market charting techniques easy to add to your analysis of any stock or investment vehicle.

With the market struggling for direction, it's important to recognize these patterns when they pop up.

So here are the top three bearish stock market chart patterns to be wary of in this recovery...

Head and Shoulders Top

This is the No. 1 performing bearish stock market chart pattern. It signals a reversal and an average decline of 22% and a failure rate of only 4%.

Here's what it looks like. Take this chart, for example. It's of the NYSE Euronext (NYX:NYSE).

NYSE Euronext Chart
View BYSE Euronext Chart

The red line indicates the Head and Shoulders pattern, characterized by three peaks with the middle peak higher than the other two, and the outside peaks at approximately the same level. The chart also shows the impeding decline.

In this case, the NYX dropped nearly 80% in less than a year.

You'll also note that just before the drop, this pattern had a slight pullback. This is also typical of the Head and Shoulders pattern, where the stock pulls back to the "neckline" of the pattern before falling off the cliff.

Double Top

Double Tops are the second-best performing bearish stock market chart pattern, but there are a couple variations of this formation. They involve the shape of the peaks. "Adam" peaks are pointy, and "Eve" peaks are round. Double Tops can have any combination of these two peaks, but according to Bulkowski, the Eve-Eve Double Tops are the best-performing combination.

With an average decline of 18% and a failure rate of 11%, here's what a Double Top looks like...

Apple, Inc. Chart
View Apple Chart

This is a chart of Apple, Inc. (AAPL:NASDAQ) from late 2006 to mid-2009. As you can see this pattern is an Eve-Eve Double Top.

One of the important features of a Double Top is that the peaks can't be more than 5% apart in height, and the peaks themselves must be increases of 10% or more.

This chart of Apple follows these rules, and we see an eventual decline of 34.5% after it breaks down.

Bump-and-Run Reversal Top

The third-best performing bearish stock market chart pattern is called the Bump and Run. This formation is characterized by a climb along a trend line that inclines between 30 and 45 degrees. The stock then begins climbing with a steeper incline, creating a bump with high volume. Once prices close below the original trend line, the pattern has a tendency to break down through that line, with an average decline of 19% and a failure rate of only 5%.

This chart of United States Oil (USO:NYSE) illustrates the formation.

United State Oil Chart
View U.S. Oil Chart

In this example, USO declines 70.5% in just a few short months. This is a very powerful pattern...

There's one question that these three charts bring up.

What Happens Next?

What happens once these formations are complete? In all three cases, we see the charts bounce back off their lows. But these bounces all occurred at the beginning of 2009, when talks of "green shoots" were spurring both the economy and the markets on to recovery.

Fundamental conditions still apply once a formation has run its course, which I'll illustrate for you on Friday with some bullish chart patterns.

In the meantime, keep an eye out for these bearish patterns in your investment portfolio assets. Knowing when to get out can be a powerful tool in preserving your wealth.

Viral Investing 101

If you'd like to learn more about reading charts to find the defined and playable patterns, there's no better analyst out there interpreting those charts than Editor Adam Lass.

And now Adam's put together a video guide that can help you decipher the apparent chaos of the stock market and turn those wild leaps and collapses into defined, readable playable patterns.

Are you sick and tired of getting whipsawed by today’s volatile market? Take a few minutes out of your day and learn how to turn that volatility into potential profits for your investment portfolio. It's all in Adam's new FREE video guide -- Viral Investing: Turning Market Chaos Into Cash.

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Authored by, sara nunnally
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