Chart Patterns: Pipe Tops And Pipe Bottoms

Two of the most common chart patterns used by traders are the pipe bottom and pipe top. First identified by technical analyst and investor Thomas Bulkowski,^[1] the pipe bottom and pipe top can be classified as either reversal or continuation patterns. A reversal pattern signals the end of a trend, or an exhaustion of directional price action. Conversely, a continuation pattern is one that suggests that price is likely to extend in concert with the initial trend.

Often referred to simply as "pipes," pipe bottoms and pipe tops provide the trader an indication that a prevailing trend may continue or may be coming to end. Depending upon market conditions and the location of the pipe itself, the pattern can support either a contrarian or trend-friendly market view.

Pipes can be found on open-high-low-close (OHLC) charts or candlestick charts, with practical applications ranging from long term investment to swing and intraday trading. According to research conducted by Bulkowski, the optimal statistical reliability of the pipe pattern is related to its application upon weekly data sets.^[2] Although much of the research on the validity of pipes was focused on their predictive value concerning equities, they have been adapted to numerous products in nearly every marketplace.

Recognition Of Pipes

Pipes represent a pending market correction and the end to a periodic directional move in price. It's important to remember that a pipe can signal the end to a broader trend or the end to a retracement of that trend. Through early recognition of a pipe pattern, the trader is able to capitalise on a long-term change in market direction or join the prevailing trend.

A pipe top occurs in a bullish market, signaling the potential exhaustion of buying pressure. Conversely, a pipe bottom is found in a bearish market and is a sign that selling pressure is subsiding. No matter which of the two formations is being referenced, several basic characteristics must be present in order for a pipe to exist.

The following components are necessary for a pipe top or a pipe bottom formation to occur:

• Spikes: A spike refers to a large periodic move in price relative to previous price action included in the data set. Spikes are illustrated by elongated price bars much larger than preceding price bars. In the case of a pipe pattern, the pipe itself consists of two consecutive spikes or two consecutive elongated price bars.
• Overlap: To be considered a pipe, the two adjacent spikes must share a substantial portion of their ranges. The overlap refers to how much of the initial bar's range is shared by the second elongated price bar. It is not required for both price bars to bottom or top at the exact same price. However, the greater the overlap, the more credence is given to the formation as a whole.
• Volume: This is a measurement of market participation. Above-average volume is optimal for each price bar in the pipe and lends validity to the pattern's predictive capability.
• Confirmation: A pipe is not complete until price closes above or below the extreme high or low of both spikes that constitute the formation. Confirmation is crucial to the completion of the pipe, because it affords the trader an entry point to the market. IT also affords a firm indication that the buying or selling pressure of the initial trend has subsided.

Pros And Cons

Pipes are versatile technical indicators and can be applied within the context of nearly any trading approach. However, in order to apply a trading strategy based on pipe chart patterns, each trader must evaluate if use of the indicator is feasible given the product and market being traded.

Advantages provided by pipes:

• Provides long- and short-term context for market direction
• Specific confirmation points ensure exact market entry
• Concrete stop losses can be defined by the high or low of the pipe, ensuring limited risk

Disadvantages of using pipes:

• Inadequate volume in pattern formation can lead to a lack of market follow through
• Although concrete, stop losses associated with pipes can often be expensive
• Trades can be missed by sudden market moves pending pattern confirmation

Summary

In order to apply a strategy based upon pipe chart patterns, the individual must decide if use of the indicator fits in with the overall trading plan. Ultimately, it is up to each trader or investor to evaluate if the use of pipes is suitable given the objectives and inputs available for the trading operation as a whole.

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