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What to Do with Topped Out Patterns in Penny Stocks

When penny stock shares enjoy a long and gradual price uptrend, the trading chart may show a topping out pattern. Such a pattern indicates that that the prices won’t go any higher from here and are about to start falling lower.

When you spot a topping out pattern, it may be a good time to take profits. Further upward moves in price will be hard to come by, and the probability of shares sinking is high.

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A topping out pattern can be indicated when all the following situations play out:

  • Prices gradually increase. An upward price trend is a necessary part of any topping out pattern. Ideally, you will see several months of gradually increasing prices; the longer the uptrend, the more likely a topping out pattern will form.

  • The upward trend turns sideways. The shares next need to turn into a sideways trend. Shares have stopped their gradual advance, and now they close with very minimal gains or losses from day to day. For example, if the shares were generally up about 2 percent every week during the uptrend, they may now close up or down about 0.5 percent on a week-by-week basis.

  • The number of down days increases. As the shares near the topping out point, you will see a higher closing price about as often as a lower closing price. Right before shares start falling lower, the number of trading days in which the shares close lower will reach about two or three for every day that the shares closed higher.

  • Volume decreases. The number of shares trading hands will fall to a fraction of what it had been during the uptrend. This lower trading volume is one of the most important aspects of a topping out pattern and will be the best indicator of when the shares are about to fall.

    Investor buying drove the upward trend, and as soon as that buying dries up, there is nothing to hold the shares at the higher levels.

Treat a technical analysis (TA) indicator as a topping out pattern only if it meets all four of the criteria listed above. Many situations resemble topping out patterns, but unless they meet all four criteria, you can’t expect them to play out like one.

Penny stocks often rise in share price over time, then “take a breather,” or slow down for a while. The shares may trade sideways or even fall off under the weight of profit takers who are selling into these new higher prices. This activity isn’t the same as topping out, and the share price weakness may be temporary or not at all indicative of what to expect next.

You won’t see topping out patterns very frequently; however, you might see them quite a bit among penny stocks that have had months of upward trending prices.

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