A Lesson in Tops for a Market Getting Ready to Bottom

Nov. 17, 2000

I received an email from a reader the other day who wasn't happy with me. Seems he didn't like what I had to say about i2 (ITWO:Nasdaq - news - boards) last Friday . At the time, I said I thought i2 was vulnerable to a 50-point whack. I was wrong -- the whack was only about 40 points -- but after reading his email, it occurred to me that while I spend an awful lot of time discussing the process of building bases, I haven't spent much time on the process of building tops. And i2 is a chart that is building a top.

In the same way bottoming is a process, topping is a process as well. Just as a stock gets accumulated over time to form a base, a stock will be distributed over time to form a top. The forces behind both processes are the same: Bulls and bears are having a tug of war. In both cases, the bulls are buying when the stock is down, and the bears are selling when it's up.

Fund Junkie: Weigh Your Tech Exposure and Consider a Diet

David Gaffen: Tech Stocks Not Cheap Yet

Justin Lahart: Margin Debt at Worrisome Levels

Jim Cramer: Get Liquid

Brett Fromson: Get Ready For Fourth-Quarter Pre-Announcements

Technical View: A Lesson in Tops for a Market Ready to Bottom

Metrics View: A Dozen Stocks Still Defy Gravity

Taskmaster Chat: Take a Defensive Posture

Fund Junkie: Climate Is Changing for Net Bellwether Stocks

One of the first signs that a top is forming is when a stock rallies and fails to make a new high. You can see i2's failure at $200 in late September as it failed to surpass its March high of $220. The volume is also important. You may have to squint to see it on this chart, but that huge pick-up in volume occurred on that slide from $200 to $140, so that run to $200 didn't have good volume behind it. That's another sign of a failure.

But for i2, the real sign of a change in trend came when it broke that uptrend line dating back to last fall's lows. One of the best rules of thumb for trend lines comes from basic geometry: Two points make a line, and the more points on that line, the better the line. In i2's case, there are approximately seven points on that line (depending on how thick your pencil point is), and the line is not terribly steep, which adds more meaning to it. (Steep lines tend to be unsustainable and are frequently broken). In addition to the break of the uptrend line at $160, it was the first time since the spring lows that the stock broke a previous low -- another sign of weakness.

But this is where the process is still taking place. The decline came down to the $110 area, which turns out to be the low the stock made in early August, so it bounced off support. It has since rallied back to $148, which you can see on the chart is the resistance level it left behind when it broke those twin October lows. What will it do now? It'll probably trade between $110 and $160 while we have another slugfest between the bulls and the bears. I suspect the stock will eventually make its way to the 80s as the measurement of the top (200 - 140 = 60; 140 - 60 = 80), which turns out to be the spring lows. But just as base building is a process of backing and filling, so is topping -- so as usual, patience is needed.

The pattern I've just described is quite common in many of the stocks that held on tight until the end, like Juniper (JNPR:Nasdaq - news - boards) and Network Appliance (NTAP:Nasdaq - news - boards). Of course, those are the groups that are just collapsing now. The groups that have already collapsed, like the semis, are in a different place entirely. The SOX shows this quite clearly. The chart is showing a triangle pattern for the past six or eight weeks. We've got two lower highs and (connect the highs at 800, 775 and 725) and one higher low (connect the lows at 600 and 605). A triangle, as you might have guessed, is a period of uncertainty.

One of the first signs a stock is closer to the bottom is that it refuses to break on bad news. While we can't say for sure that the semis are in that camp, we can say they've begun to withstand some of the downgrades that have been thrown at them lately. I am also hard-pressed to come up with a brokerage firm that is recommending them these days. This group certainly has had its share of bearishness and yet has still not broken 600 on the SOX. But remember, this is a process. If we go back to the i2 chart and note how long the top took to form (about four months), it's easy to see that at six weeks it's still too early to say whether the SOX has formed a bottom yet.

The market remains boxed in, stuck in the middle. So much seems to be in a trading range these days. It's not just the indecision for the presidency; heck, even the utilities, after tacking on close to 40% this year, have gone sideways for two months. The NYSE is in much better shape than the Nasdaq Composite Index, but that's because the NYSE has been in a bear market for 2 1/2 years (I see the beginning of the bear market as April 1998 for the NYSE) so it's much further along in building those bases than the Nasdaq, which is only seven or eight months into its bear market. Patience, please.

Overbought/Oversold Oscillators

For an explanation of these indicators, check out The Chartist's primer .

---

Helene Meisler, based in Singapore, writes a technical analysis column on the U.S. equity markets on Tuesdays and Fridays, and updates her charts daily on TheStreet.com. Meisler trained at several Wall Street firms, including Goldman Sachs and SG Cowen, and has worked with the equity trading department at Cargill. At time of publication, she held no positions in any securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. She appreciates your feedback and invites you to send it to Helene Meisler .