Price structure as found in charts of historical prices of financial instruments records where people have changed their minds, peaks represent spots where buyers decided to stop paying more for the instrument and low points represent spots where sellers decided to stop accepting less. The reversal analysis of such a price structure entails the reading of all the turning points to establish whether they were part of a trend or whether they actually marked a change in control.
The shapes matter little. It is the failure of the second attempt to rise to the prior high price and the behavior of the price at the low price between the two peaks that matter. A double top is an ‘M’ shaped formation. But a failed double top has no signal value whatsoever until the price has fallen below the low point between the peaks.
Similarly, formations such as head & shoulders, rounded tops, triple bottoms, wedges and others may represent different kinds of exhaustion and so demand different standards of confirmation. Each is a way of identifying supply and demand imbalances and once a particular one has been recognized on a chart, then that chart can be treated as if it were of a completely different instrument.
Reading peaks and troughs as evidence of participation
A swing high, in and of itself, is nothing. The high degree of pain to record it is considerable. However, in recording marginally new higher swing highs on lower volume than the prior swing, with decreasing range and speed of retracement, a market is displaying decreasing numbers of participants doing poorly.
What to measure at each turning point
- Range expansion or contraction relative to the previous three to five swings
- Volume on the thrust into the extreme versus volume on the move away from it
- Time spent above or below the prior extreme before rejection
- The depth of the corrective leg as a proportion of the impulse that preceded it
- Whether subsequent lows hold above the last higher low
Sequence is far more important than a single reading. Trends are sequences of highs and lows, so in terms of first evidence of a reversal, that always starts with the failure to make a new extreme followed by a break of the most recent counter-trend structure (or pivot point), a sequence worth working through in this practical guide to trading the M pattern.
Support and resistance as reference levels, not barriers
Market structure is reflected in price’s relationship to specific levels. A concentration of orders at particular prices and points leads to stop loss placement around these same levels. Thus, a level tested several times without a break deteriorates with each subsequent test. The late test will most likely resolve against the trader’s current expectation.
However, it’s far more important to understand how price behaves when leaving a level as opposed to touching a level. For example, a wick down through resistance may be absorbed back inside the body of the candle. Conversely, a close above a level and then a retest of that same level which only manages a shallow penetration and then closes above it again means that level has changed function and can now be used as an actionable formation.
Weighing the quality of a level
A level defined at the start of strong price action or a large volume node is more relevant than a minor intraday price level connected by lines. Agreement with the higher time frame price is a filter to timing of entries. Agreement with the levels of a higher time frame does not mean that a reaction is a trading opportunity.
Confirmation standards and their trade-offs
There is a trade-off between timeliness and reliability when choosing confirmation methods. They need to be validated against a range of portfolio factors, including position size, holding period and cost of wrongness. Hence they are generally portfolio decisions rather than chart decisions.
| Confirmation approach | Typical entry timing | Main trade-off | Best suited to |
| Neckline or pivot break on close | Immediate on the breaking bar | Higher rate of failed breaks | Liquid instruments with tight spreads |
| Retest of the broken level | One to several bars later | Misses fast-moving reversals entirely | Larger positions needing defined risk |
| Momentum divergence plus structure break | Often later than price alone | Divergence can persist for long periods | Swing and position timeframes |
| Volume confirmation on the break | Same bar, assessed after close | Unreliable where volume data is fragmented | Exchange-traded markets |
| Multi-timeframe alignment | Latest of the options | Gives up much of the initial move | Lower-frequency, higher-conviction trading |
Where reversal reads commonly fail
- Treating a formation as complete before the confirming break, which turns a hypothesis into a position too early
- Drawing the structure after the fact, selecting the pivots that make the shape work
- Ignoring the trend one timeframe up, where the apparent reversal is a routine pullback
- Applying a single confirmation rule across instruments with very different volatility and liquidity profiles
- Placing stops at the obvious structural extreme, where clustered orders invite a sweep
Building a repeatable process
For each pattern identify the formation, the confirmation for entry, the price for invalidation and the maximum loss for the trade. Then log every occurrence of that pattern and compare the result to your rules rather than how you wished the trade had turned out. It takes a sample size of fifty or more logged trades of each pattern type to know your edge in that trade rather than relying on some obscure chart that supports your preconceived notion.
A formation does not predict the future, it’s merely a way of organizing past evidence to form a testable proposition that can be entered at the appropriate size and subsequently closed at the appropriate price, or lost.