The Tower Top Pattern
The Tower Top pattern is the bearish version of the pattern that can appear in an established uptrend. The first candlestick in the Tower Top is a relatively large bullish candlestick with a large real body with little or no shadows. This candlestick is followed by a series of smaller candlesticks with relatively short real bodies that do not move the market higher in any significant way. These candlesticks are followed by another relatively large candlestick that is bearish and dark in color, forming the second tower of the pattern. The overall pattern forms a top with a tower on either side of the pattern. It can also form a rounding top.
What the Tower Top tells us
The Tower Top appears in an established uptrend where the bulls are in control of the market. The first candlestick in the pattern illustrates the continued strength and conviction of the bulls. However, it is followed by a few smaller candlesticks that do not drive the market much higher. These candlesticks imply weakness in the uptrend as the bulls are beginning to struggle in their efforts to move the market higher. The appearance of the bearish tower suggests that the bears are beginning to take control, with the size of the last candlestick reflecting the extent of their strength.
Essentially, the smaller candlesticks between the two towers indicates that the bullish market sentiment has started to wane. The second tower confirms that the market sentiment has shifted and a bearish trend reversal can now be anticipated.
Trading the Tower Top Pattern
The Tower Top warns that there is weakness in the current uptrend and forewarns of a possible transition to a trend reversal. This implies that the bullish uptrend coming to an end is more likely than it continuing. Traders that are holding open long positions should, therefore, look the exit their positions on the opening of the candlestick that follows the Tower Top.
Traders would now be anticipating the emergence of a downtrend and will be looking to be short, which means they will be preparing to place sell orders. However, the trader should wait for confirmation of the pattern before placing a sell order. This confirmation would be a price break below the low of the pattern or a candlestick that closes below the low of the Tower Top, after which the trader could place a sell order on the open of the following candlestick.
Since a short position would be taken against the current trend, a protective stop-loss order should be used to limit the risk of the pattern failing. This protective stop could be placed just above the highest high of this candlestick formation as a price break above this level would negate the pattern. If the placement of the protective stop-loss is too far from the entry to provide a favorable risk/reward ratio, the trader could wait for a possible pull-back towards the high of the pattern before entering the trade. This would place the entry much closer to the protective stop and would reduce the capital at risk on the trade, though there is no guarantee that a pull-back will occur. Remember that confirmation of the pattern must first be obtained before placing a sell order.
The Tower pattern does not provide a clear profit target. Instead, a trader could implement a profit target based on a defined risk/reward ratio, a measured move, or some other trading mechanism can be used to exit the trade. This could be a Fibonacci retracement level , the appearance of a bullish candlestick formation, or a simple trailing stop.
As with most trend reversal patterns, the Tower pattern becomes more reliable depending on where it appears on the price chart in relation to trendlines , pivot points , and support and resistance lines , etc. A Tower Top pattern at or near an upper trendline or resistance line can be used in anticipation that the test of the trendline or resistance line is not likely to break it. The resulting price decline following the failure to break the trendline or resistance line should give greater impetus to the pattern. Also, if the Tower Top pattern is formed at an all-time high, it becomes more significant as the market could be overbought. Here traders can use the Tower Top pattern in conjunction with an oscillating indicator , such as the RSI , that shows the security to be overbought.
