The theory behind this reversal pattern is when you get five small reversals they are usually followed by a more substantial change. So in the example below, you have:
| Reversal 1: change from rise to fall |
| Reversal 2: change from fall to rise |
| Reversal 3: change from rise to fall |
| Reversal 4: change from fall to rise |
| Reversal 5: change from rise to substantial fall |
In a Broadening Top, reversal 3 must occur at a higher level than reversal 1, and reversal 5 must be higher than reversal 3. Reversal 4 must occur at a lower level than reversal 2.
The underlying idea behind this reversal pattern is that the market is almost out of control and lacking support from well-informed investors. The smart money is bearish on the stock, but it keeps on getting bounced upwards by other investors. Volume is also erratic during this period and does not help with the interpretation of the charts.
Perhaps the best way to view this formation is as if the market is gradually becoming more and more unstable. As the swings get wilder and wilder something is going to break!
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