Section 6:

Bearish Continuation Patterns

 

Double Distribution (Inverted Cup and Handle)

 

Definition:

The double distribution, or inverted cup and handle, is a somewhat rate bearish continuation pattern. It starts when a stock a stages a steady bearish trend. The stock then starts to rebound over several weeks or months, but then loses upward momentum and levels off. The stock then slides lower, back down to the point from which it first rebounded. The stock rebounds once more from the same level, creating horizontal support. The stock starts to level off again, after rebounding for a second time from support, but during this rebound the stock levels off at a relatively lower level. This creates a series of lower lows. The stock returns to the horizontal support once more and breaks down, continuing its bearish trend.

Nuance:

The double distribution is an extremely strong bearish continuation pattern. But unfortunately the pattern is rare. The strongest double distribution patterns are usually long-term in nature, taking months or even years to form. Generally the longer the pattern takes to form, the more convincing it is once broken.

Application:

A double distribution is confirmed when the stock breaks below horizontal support. Like other bearish continuation patterns with horizontal support, the double distribution horizontal support often acts as resistance after it’s broken.

A double distribution is violated if a stock rebounds from horizontal support and advances above the second high, creating a relatively higher high.

Figure 6.6

Example:

Shares of AirTran (AAI) traced a double distribution, starting with the termination of a strong bearish trend at $9 as shown in Figure 6.6. The stock then rebounded from several quarters, reaching as high as $13 before leveling off. The stock retested $9 about one year after first falling to that level. It then rebounded once more, but leveled off at the $11 level, which was $2 below the first high. The pattern of lower highs is a requirement for the double distribution.

AAI dropped lower after breaking below the $9 horizontal support level. There was no hesitation once support was broken. Observe how a clear action point was offered at the $9 horizontal support level.

Bearish Continuation Patterns Summary

Bearish triangles, wedges, flags, pennants, and double distributions are the most important price patterns for trading bearish trends in the stock market. Remember that bear markets are rare in the broad stock market as defined by the S&P 500, or other broad market gauge.

Bear markets are more common in sectors and individual stocks. Identification of these bear markets starts with a consistent approach to determining trends. Confirmation of bear markets comes with observing sectors and individual stocks that are at least ten percent off of recent highs. A more conservative approach to trading bearish continuation patterns is achieved by waiting for bearish sectors and individual stocks to fall by 20 percent, or more, from recent highs.

There will be periods in the market when it makes good trading sense to frequently trade bearish continuation patterns. Trading only bearish continuation patterns during broad-based bear markets, for example, is a smart and tactical way to approach such difficult periods.

The difficulty with all bearish trades is that the potential reward is finite; it’s limited to the stock falling to zero. The risk, meanwhile, is virtually unlimited due to the fact that a stock can go higher and higher. That’s why it is so very important to consistently manage risk whenever trading a bearish continuation pattern. In fact, erring on the side of being conservative makes a lot of sense when trading bearish continuation patterns.