Broadening top

Let's look at the "broadening top" chart pattern evident on the daily chart of the S&P/ASX200 from mid 2006. Identified by a gentlman called Schabacker back in the thirties, the Broadening Top is a large reversal pattern. It can often be confused as a consolidation pattern which is characterised by investor consensus and a general lack of volatility, where as time passes and more information is disseminated, investors come to a collective decision and volatility slows. The opposite is true of broadening tops: as time passes broadening tops feature increasing wide ranges and greater volatility caused by increasing market indecision.

Broadening tops are characterised by three distinct stages;

1) a rally to a new high on increasing volume. Normally, this rally will be the result of better than expected earnings, product or sales news and/or a plethora of broker recommendations, as the stock surges to new highs more sellers appear, taking profits and it is not long before the stock settles back to a prior support level.

2)After a period of consolidation more positive news pushes the stock to yet another new high on increased volume (2nd top) which should be a sign that the stock is very bullish but once again the stock falters, falling to a relative new low.

3)Although the original positive news is still valid, the rumour mill grinds out the predictable stories that the 'big boys' are selling out, taking profit and liquidating their positions. Bullish investors rally to defence of the stock and the Media continues to put a positive spin on the stock. Brokerage firms’ recommendations contain high price targets and once again, the stock begins to move higher. Although volume is strong, It is less than in the previous rallies. Nevertheless, the stock moves to third new high (3rd top) in as many attempts. Whilst the stock is making a new high, there is still a case of the jitters among some investors. Soon afterwards the stock begins to top out on increased volume but no specific news. Several days later the stock is collapsing and support at the most recent low is in jeopardy. Panic set in and the stock sinks back to the longer-term support level.

Broadening top

The theory suggests that the break out of the pattern will result in the share price falling approximately the same as the height between point “A” and Point “B”. Applying this theory to the S&P/ASX200 chart above (also known as the XJO) it suggests that if the XJO does break the medium term up-trend shown, then a index target of "C" is possible.