30 www.activetradermag.

com • December 2001 • ACTIVE TRADER

 TRADING Strategies

Markets don’t ring bells when they’re about to change direction.

You have to keep your eyes open for the clues that sometimes
develop at tops and bottoms. This pattern is the perfect example.

M icro-M tops and Micro-W bottoms are chart patterns that graphically depict the bat-
tle between bulls and bears at many market turning points. A Micro-M top forms
when a price makes a new high in the current upswing, corrects briefly and then
rallies as the uptrend reasserts itself. At this point, the Micro-M top is three-fourths
complete: The new price high is the first leg of the M, the decline from the high is the sec-
ond leg and the resumption of the uptrend is the third leg.
Because a trend is more likely to continue than reverse, prices usually continue higher to
test the high of the M. When that happens, the Micro-M pattern is cancelled. However, on the
occasions when the resumption of the uptrend fails and prices fall below the low of the pat-
tern’s third leg, a Micro-M top is completed and a new downtrend begins. The logic behind
the Micro-W bottom is analogous.
Micro-M tops and Micro-W bottoms are essentially very short-term double tops and double
bottoms. For more information on double tops and bottoms, see Technical Tool Insight, p. 80.

Micro-M tops and Micro-W bottoms are effective patterns, but patterns alone do not constitute
trading strategies. Acomplete trading strategy includes three components: setup, entry and exit.
Setups alert you that market conditions are favorable for a trade, entries actually get you into a
trade and exits get you out of a trade — sometimes with a profit and other times with a loss.
continued on p. 32

BY THOMAS A. BIEROVIC

ACTIVE TRADER • December 2001 • www.activetradermag.com 31

 FIGURE 1 MICRO-M TOP set 10 cents above the first bar of a Micro-
M top and 10 cents below the first bar of
A Micro-M top setup resembles a very short-term (three-bar) double top. A a Micro-W bottom. (The 10-cent specifi-
short sale would be entered when price fell 10 cents below the low of bar C. cation is somewhat arbitrary; any small
amount will do.) The logic behind the
Autodesk Inc. (ADSK), daily
initial protective stop is that a penetra-
A C tion of a Micro-M top’s high or a Micro-
39
W bottom’s low negates the premise of
38 the trade. When the premise that got you
Sell short into a trade is no longer true, cut your
B 37 losses and look for another opportunity
elsewhere.
36
D
35
A trailing stop attempts to lock in an
34 increasing amount of a trade’s open prof-
its while still giving the trade some room
33 to run. For Micro-M tops and Micro-W
32 bottoms, the trailing stops are called
Risky Business (short) and Risky
31 Business (long). The short stop is used to
protect profits after you sell a stock short;
30 the long stop is used to protect profits
after you buy a stock. The stops are
29
named Risky Business because they are
20 27 9/2001 10 17 based on multiples of a trade’s initial
Source: TradeStation by TradeStation Group risk, which is the difference between a
trade’s entry price and its initial protec-
The setups for Micro-M tops and Micro-W bottoms are com- tive stop.
posed of the first three legs of the patterns. For an M, the setup For example, if you buy a stock at $20 and set your stop at
consists of the new high, the decline and the resumption of the $18, the risk on the trade is $2. The first Risky Business (long)
uptrend; for a W, the setup consists of the new low, the rally price target would be a close at or above $22 (the $20 purchase
and the resumption of the downtrend. When a setup is in price plus the amount of the initial risk). When the first target
place, attention turns to the entry component. is reached, a trailing stop set at $20 takes over for the initial
protective stop that was set at $18. The second price target is a
close at or above $24. When that target is reached, the trailing
stop is raised to $22. The trailing stop continues to rise until the
Patterns alone do not trade is eventually stopped out. (In the case of a short position,
the trailing stop would decline along with prices until the trade
constitute trading strategies. was stopped out.)

A complete trading strategy Here are the rules for trading Micro-M tops. Invert the rules for
trading Micro-W bottoms.
includes three components: Setup
setup, entry and exit. 1. Bar A makes the highest high of the last 13 bars, the close
is greater than yesterday’s close, and the close is greater
than the open.
2. Bar B makes a lower low and a lower close than bar A,
The entry trigger for a Micro-M top is a decline below the and the close is less than the open.
low of the M pattern’s third bar; a Micro-W bottom’s entry trig- 3. Bar C makes a higher low and a higher close than bar B,
ger is a rally above the high of the W’s third bar. and the close is greater than the open.
The exit component for Ms and Ws covers two scenarios:
exiting with a loss and exiting with a profit. The former is an Entry
initial protective stop, the latter a trailing stop. 1. Sell short on bar D or bar E 10 cents below the low of
The initial protective stop, which limits the risk on a trade, is bar C.

32 www.activetradermag.com • December 2001 • ACTIVE TRADER

 Exit FIGURE 2 MICRO-W BOTTOM
1. Set an initial protective stop 10 A Micro-W bottom is the mirror image of a Micro-M top. Here, a Micro-W
cents above the high of the pattern marks a bottom and upside reversal in Boeing.
Micro-M pattern and trail a
Risky Business (short) stop. Boeing Co. (BA), daily
59.5
59

The daily chart in Figure 1 (opposite 58.5

page) shows a Micro-M top. Bar A 58
makes a new 13-day high, closes above 57.5
the previous day’s close and closes
57
above its open. Bar B makes a lower low
and lower close than bar A, and closes 56.5
below its open. Bar C makes a higher 56
low and higher close than bar B, and 55.5
closes above its open. Sell short on bar D
10 cents below the low of bar C. D 55
B
Figure 2 (right, top) shows a Micro-W Buy 54.5
bottom. Bar A makes a new 13-day low, 54
closes below the previous day’s close 53.5
and closes below its open. Bar B makes a
53
higher high and higher close than bar A,
C 52.5
and closes above its open. Bar C makes A
a lower high and lower close than bar B,
7/2001 9 16 23 30
and closes below its open. Buy on bar D
Source: TradeStation by TradeStation Group
10 cents above the high of bar C.

FIGURE 3 STOPS AND PROFIT TARGETS

Figure 3 (right, bottom) illustrates a suc-
A Micro-M top triggers a short trade on a move 10 cents below bar C. The
cessful Micro-M top trade. Bar A, the
initial protective stop is 10 cents above the high of the pattern. Profit
highest high of the past 13 days, closes
targets are established at multiples of the initial risk, which is the difference
above the previous day’s close and clos-
between the entry price and the initial protective stop.
es above its open. Bar B trades lower
than bar A, closes below bar A’s close Check Point Software (CHKP), daily
and closes below its open. Bar C makes 120
a higher low and higher close than bar A Initial protective stop
B, and closes above its open. Sell short
110
on bar D at 99.60, 10 cents below bar C’s C
low (99.70).
Sell short 100
The initial protective stop is set at B
113.43, 10 cents above the high of bar A
D 90
(113.33). The risk on this trade, 13.83, is
calculated by subtracting the entry price 1
(99.60) from the stop (113.43). The first 80
E
profit target is 85.77, which is calculated
by subtracting the initial risk amount 2 70
(13.83) from the entry price (99.60).
I
Target one is reached (on a closing basis) F 60
3
on bar E, and the stop is lowered to 99.60
(the entry price). 50
The second profit target (a close at or G
4
below 71.94) is calculated by subtracting
40
the initial risk (13.83) from target one H
(85.77); thus, target two is 71.94. Bar F
2/2001 3/2001 4/2001
closes below target two, so the stop is
Source: TradeStation by TradeStation Group
continued on p. 34

ACTIVE TRADER • December 2001 • www.activetradermag.com 33

 FIGURE 4 SHORT SALE lowered to target one (85.77). Target
three (58.11) is calculated by subtracting
In this example, bar A is an up day, bar B is a down day and bar C is an up
13.83 (the initial risk) from target two
day. Sell short on bar D 10 cents below the low of bar C.
(71.94). Bar G closes below target three,
Dime Bancorp Inc. (DME), daily so the stop is lowered to target two
(71.94). Target four (44.28) is calculated
A C by subtracting 13.83 from target three
30 (58.11). Bar H closes below target four,
so the stop is lowered to target three
Sell short (58.11). Bar I trades above 58.11, and the
29 trade is stopped out with a profit of
B D 41.49 per share (99.60 minus 58.11).
1 Because the gain on the trade was 41.49
28 and the risk was 13.83, the reward-to-
E
risk ratio is a respectable 3:1.
2
The daily chart of Dime Bancorp
H 27 (DME) in Figure 4 (left, top) illustrates
3 another profitable Micro-M top trade.
Bar A, the highest high of the last 13
26 days, closes above the previous day’s
4 F
close and closes above its open. Bar B
G
trades lower than bar A, closes below
5 25 bar A’s close and closes below its open.
Bar C makes a higher low and higher
18 2001 8 22
close than bar B, and its close is above its
open. Sell short on bar D at 29.27, 10
Source: TradeStation by TradeStation Group
cents below bar C’s low (29.37).
The initial protective stop is 30.10, 10
cents above the high of bar A (30). The
FIGURE 5 CATCHING A BOTTOM risk on this trade is only .83. The first
Here, a Micro-W bottom catches a rally in Barnes & Noble. The trailing stop profit target is 28.44, which is reached
approach allows the trade to continue to run while protecting profits. (on a closing basis) on bar E, and the
stop is lowered to 29.27. The second
Barnes & Noble Inc. (BKS), daily profit target (a close at or below 27.61) is
reached on bar F and the stop is lowered
4 36
to target one (28.44). On bar G, the stock
plunges throughout the trading session,
35
G eventually closing not only below target
34 three (26.78) but also below target four
3
33 (25.95). Because target four has been
F reached, the stop is lowered to target
32
three (26.78). Bar H trades above 26.78,
2 31 and the trade is stopped out with a prof-
H 30 it of 2.49 per share (29.27 minus 26.78).
E 29 The gain on the trade was 2.49 and the
1 risk was .83, so the reward-to-risk ratio
28
is 3:1.
27
B D
Buy 26
25 The daily chart of Barnes & Noble (BKS)
C in Figure 5, (left, bottom) provides an
24
example of a profitable Micro-W bottom
A 23 trade. Bar A, the lowest low of the last 13
26 4/2001 9 16 23 30 5/2001 7 14 21 days, closes below the previous day’s
Source: TradeStation by TradeStation Group close and closes below its open. Bar B
trades higher than bar A, closes above

34 www.activetradermag.com • December 2001 • ACTIVE TRADER

 FIGURE 6 LETTING PROFITS RUN
is calculated by adding the initial risk
Despite corrections within the uptrend after the Micro-W bottom reversal,
(2.56) to target one (28.57).
the progressive stop levels allowed the trade to accumulate profits.
Bar F closes above target two, so the
Amdocs Ltd. (DOX), daily stop is raised to target one (28.57). Target
three (33.69) is calculated by adding 2.56
68
I (the initial risk) to target two (31.13). Bar
66
4 G closes above target three, so the stop is
64 raised to target two (31.13). Target four
H 62 (36.25) is calculated by adding 2.56 (the
3 60 initial risk) to target three (33.69). The
J 10th bar after G narrowly misses closing
G 58
above target four, and three days later
56 bar H stops out the trade with a profit of
2
54 5.12 per share (31.13 minus 26.01). With a
F 52 profit of 5.12 and initial risk of 2.56, the
1 50 reward-to-risk ratio on this trade was 2:1.
E Figure 6 (left) shows the final exam-
48
B D ple: a Micro-W bottom trade in Amdocs
46 (DOX). Bar A, the lowest low of the last
44 13 days, closes below the previous day’s
42 close and closes below its open. Bar B
C trades higher than bar A, closes above
A 40
bar A’s close and closes above its open.
26 4/2001 9 16 23 30 5/2001 7 14 21 Bar C makes a lower high and lower
Source: TradeStation by TradeStation Group close than bar B, and closes below its
open. Bar D fails to penetrate the high of
bar A’s close and closes above its open. Bar C makes a lower bar C, but bar E succeeds; a long position
high and lower close than bar B, and its close is below its open. is entered at 45.46, 10 cents above bar C’s high (45.36).
Buy on bar D at 26.01, 10 cents above bar C’s high (25.91). The initial protective stop is 40.50, 10 cents below the high of
The initial protective stop is 23.45, 10 cents below the low of bar A (40.60). The risk on this trade is 4.96 per share. The first
bar A(23.55). The risk on this trade, 2.56 per share, is calculated profit target is 50.42, which is reached (on a closing basis) on
bar F, and the stop is raised to 45.46. The second profit target (a
close at or above 55.38) is reached on bar G and the stop is
Effective price patterns raised to target one (50.42).
On bar H, DOX closes above target three (60.34) and the stop
is raised to target two (55.38). Bar H closes above target three
reflect the repetitive, (60.34) and the stop is raised to target two (55.38). Bar I closes
above target four (65.30) and the stop is raised to target three
(60.34). Finally, bar J falls below 60.34 and the trade is stopped
real-world behavior of traders out with a gain of 14.88 (60.34 minus 45.46). The risk on this
trade was 4.96 and the gain was 14.88 for a reward-to-risk ratio

and investors interacting in of 3:1.

a constantly changing arena Effective price patterns reflect the repetitive, real-world behav-
ior of traders and investors interacting in a constantly chang-
ing arena of hope, fear and greed. Micro-M tops and Micro-W
of hope, fear and greed. bottoms identify a brief sequence (four or five bars) of price
action that regularly leads to a tradable price swing in the
opposite direction of the underlying trend.
Ms and Ws can be traded successfully in both stocks and
by subtracting the stop price (23.45) from the entry price (26.01). futures and in time frames ranging from five-minute bars to
The first profit target is 28.57, which is calculated by adding the weekly bars. Like all other chart formations, Micro-M tops and
amount of the initial risk (2.56) to the entry price (26.01). Target Micro-W bottoms aren’t perfect, but they are simple, reliable
one is reached (on a closing basis) on bar E and the stop is raised patterns that can contribute to your trading success. Ý
to 26.01 (the trade’s entry price). The second profit target (31.13)

ACTIVE TRADER • December 2001 • www.activetradermag.com 35