Bulkowski's Bullish Top Trap

This is what the bullish top trap looks like.

Price rises into the pattern, starting at A. Price retraces to B before moving back up to a head-and-shoulders top at CDE, with C and E being the shoulders and D is the head. There can be many peaks before the head-and-shoulders top appears, but at least one is required.

Ideally, the head-and-shoulders appears within the same support (on the bottom) and resistance (on the top) as the AB move, but I allowed variations.

Price confirms the head-and-shoulders by dropping to F. This decline is usually in the 5% to 10% range. Price finds support at F and climbs to G.

The few statistics I have for this setup are based on 68 patterns on the weekly charts. I found price hits F and rises to G 75% of the time. For those patterns moving above the top of the head-and-shoulders (above point D), the bottom of point F will remain above B 67% of the time. In 18% of the cases, the stock will stop at or near the price of B. Together, it means price will remain at or above B 85% of the time. The remainder of the time, the stock drops below B and continues lower.

Here are the rules to find a working setup.

Price should rise into the first peak of the pattern (move A on the way to peak B). This isn't always the case, but you really want an upward price trend to be pushing the stock higher.

After price peaks at B, it drops and forms valley C. Additional peaks and valleys may lie between B and LS, the left shoulder of the head-and-shoulders top.

A head-and-shoulders top appears. Refer to the link if you're not familiar with this pattern.

The head-and-shoulders confirms, meaning price closes below the low between the head and right shoulder (which I call the right armpit).

Price drops to D, the low before it starts to climb and bust the head-and-shoulders (meaning price works its way higher to close above the head).

At or near the head, price completes the setup (at the start of the red segment). Price will often retrace and drop before recovering and continuing the upward climb.

If you step across the street and look at this setup, it appears like a rounded top with several peaks sharing similar prices and valleys sharing similar prices. Support on the bottom of the pattern is key because that's what halts the decline after the head-and-shoulders confirms. So you'll want to make sure underling support created by the prior valleys is numerous and potent.

This setup differs from the bearish top trap because the chart pattern is located at the top of the setup, not at the bottom, and the chart pattern is a head-and-shoulders top. In this setup, the head-and-shoulders top busts and that often results in a strong upward trend.

This is an example of the setup on the weekly chart. D is the first peak with a drop to C. The head-and-shoulders (S-H-S) is as marked. Price drops to A before rising to B.

Recognizing this setup can help you avoid making a trading mistake like shorting the head-and-shoulders top when price closes below the red line.

Notice that after price peaks at B, it drops to find support near the price of A.

This is a situation similar to the last chart. A is the first peak in the setup with a drop to C. A recovery follows and forms a head-and-shoulders top (S-H-S, weekly chart) with a drop to B. Notice that B remains above C, which it does 67% of the time. Price rises above the pattern at D. If you shorted the stock the bar after B, you'd likely have lost money.

Price also finds support at the price of B after the drop from D.

Another setup on the weekly chart with price climbing to A, dropping to D, and then forming a head-and-shoulders top. Price confirms the head-and-shoulders on the way down to C. After bottoming at C, price rises to E.

This is an example of a failure of the setup. Failures happen about 25% of the time based on a limited sample (weekly charts only).

Points A, B, and C are peaks before what appears to be a complex head-and-shoulders top but Patternz found it as a regular head-and-shoulders top.

The pattern confirms and price drops to find support at the red line (D). It looks like the setup is going to work but price only rises to E before heading lower to F.

The drop from G (far left, top) is unusual and may account for the failure. However, having a number of peaks (A, B, C) before the head-and-shoulders is typical. In fact, you might think that the support area setup by prior peaks to be reassuring, but it didn't help in this case.

Point B is the peak before the head-and-shoulder, like you would expect in the setup. Price drops to H, which is below I, the low between the first peak (B) and the chart pattern (S-H-S).

Price makes it down to C and recovers to D. All of this looks like a working setup, however, there's a catch. The price scale.

A close below the blue line is the entry signal to short the head-and-shoulders top (NOT trade this setup), which happens at H, the week (weekly scale, remember) after confirmation at that tall black bar. So the drop from entry (the open at bar H) to the low at C is 13%. That's higher than the 10% drop I allow for this setup. Maybe a polished short trader could make money trading this head-and-shoulders before the setup came into play and ripped his trade to shreds.

This chart should be a study of how far price will drop after this setup confirms. Price bottoms at C, near the prior valleys at E, F, and G. To put it another way, riches can be yours trading stocks if you know where support and resistance are likely to appear. In the examples accompanying this article, price will often find support above the low between peak B and the head-and-shoulders. In other words, 67% of the time price will bottom above I.

This chart shows how to trade this pattern. First, I feel this setup is more of a warning that the head-and-shoulders top will not send price down as far as expected. So it's a warning about trying to short the head-and-shoulders, but it's also a warning for long term holders selling prematurely. If you own the stock and are worried about price dropping when this setup appears, you can probably hold onto your position.

Having written that, can we use the setup to make money by anticipating a rise in the stock? Yes.

First, look for the setup. Peak C comes first followed by a drop to D. There may be many peaks between C and the left shoulder (S). Recall that most of the time, the stock will remain above D. If it closes below D, then close out the trade.

Find a head-and-shoulders top, like that shown here as S-H-S. Price should confirm the pattern by closing below the right armpit. That's the red line at A. Price drops to B and rebounds to form a small peak at G before dropping again (in this example).

Price makes it down to E which is still above D before recovering. When price tops the prior peak (G), which happens at H, buy the stock.

When to sell is up to you, but the next slide discusses what happens after price reaches the top of the setup.

When the stock reaches the price of the head, it'll often reverse near there (sometimes coasting above it, like that shown in this example with the black line representing price). Sometimes price will retrace for about a week, sometimes much longer. After that retrace completes, price resumes climbing. So patience is required when price rises to the top of the setup (H). Expect a retrace.

Here are the extent of the retraces, from the top down.

• 16% of the time the stock remains above the right shoulder.
• 28% of the time, the stock reverses at or near the top of the right shoulder.
• 23% of the time, the stock reverses between right shoulder peak and right armpit low. The armpit is the lowest valley between the head (H) and right shoulder (S).
• 5% of the time, the stock will reverse at or near the right armpit.
• The remainder of the time, 28%, the stock continues below the right armpit.

Knowing that price will retrace when reaching the top of the setup, you can wait for the retrace to finish before buying. For example, if the stock dropped below the right shoulder, I'd buy the price bar after it closed above the right shoulder.