Thomas N. Bulkowski - Encyclopedia of Chart Patterns

For example, Figure 1.7shows double bottom AB acting as a reversal because price drops into the pattern and leaves it going upward. The downtrend reverses. The rectangle at C in Figure 1.2is a continuation pattern. Price rises into the start of the rectangle (from B) and exits out the top. That is, price continues in the direction of the prevailing price trend.

Table 1.1 Reversals (R) versus Continuations (C)

Winner. Table 1.1tells us that reversals work best after upward breakouts and continuations work best after downward breakouts. For example, I found 55% of chart patterns acting as reversals outperformed continuation patterns in bull markets after upward breakouts. Almost all (87%) of the chart patterns after downward breakouts in bull markets showed patterns acting as continuations beating those which acted as reversals.

Performance.This line in the table shows the average gain or loss for the contests. For example, reversals in bull markets after upward breakouts gained 43%. Continuation patterns saw price rise 42%. Notice that the differences between the contests are often narrow. Continuations, for example, lead by one or two percentage points. The narrow lead is a warning that the indicator is weak as a predictor of future performance.

Table 1.2: Height.Do tall patterns outperform short ones? Tall or short is a measure of the height of the chart pattern divided by the breakout price.

Winner.This line shows how chart pattern performance varies with height. I contend that tall patterns outperform short ones, and we find that belief is true in all market conditions and breakout directions. For example, tall patterns win all of the contests (100%) after downward breakouts in bull markets.

Performance.The performance averages are wide, too, with tall patterns gaining an average of 46% and short ones gaining just 39% (bull market, up breakout). I believe height is a key indicator of future performance, so you'll want to trade tall patterns and avoid short ones.

Table 1.3: Width.Do wide patterns outperform short ones? I measure width from the start to the end of the pattern.

Winner.The numbers in the table tell how well width works as an indicator of chart pattern performance. Contests from patterns in bull markets perform better when they are wide. Bear market patterns show a tie.

Performance.Most performance differences are marginal (one or two percentage points). For example, after downward breakouts in bear markets, wide patterns see price drop 23% on the way to the ultimate low, but narrow ones see price drop an average of 22%. Thus, width is not a strong predictor of performance, but it can give you an edge in bull markets (where performance differences are wider).

Table 1.2 Height: Tall (T) versus Short (S)

Table 1.3 Width: Wide (W) versus Narrow (N)

Table 1.4 Breakout Day Gap (G) versus No Gap (N)

Table 1.4: Breakout day gap.Do gaps that occur on the day of breakout help performance?

Winner, Performance.After downward breakouts in bull markets, I found that 85% of the chart pattern types showed a gap helping performance. The chart patterns dropped an average of 16% versus 15% for those not showing a breakout gap.

Notice that the percentages on the performance line are close, suggesting gaps are not a strong performance indicator, either. Because I measure performance using the opening price the day after the breakout day gap, you can participate in the better performance that a gap may provide.

Table 1.5: Throwbacks and pullbacks.Throwbacks and pullbacks are features I love. When they appear, they invariably hurt performance. The table shows the blood. A throwback happens after an upward breakout from a chart pattern when price soars but then returns to the breakout price (or comes close to it) within a month. Pullbacks are the same except the breakout is downward.

Winner, Performance.For example, 97% of the time I found that throwbacks hurt performance after upward breakouts in bull markets. In contests of patterns with downward breakouts in bear markets, all of them (100%) showed that pullbacks hurt performance. The average decline of those contests was 26% for those patterns not showing a pullback (N) and 20% for those that did pull back (P). For a downward breakout, that's a wide difference.

Table 1.5 Throwbacks (T) and Pullbacks (P) versus None (N)

Occurrence.The Occurrence line in the table shows how often a throwback or pullback occurred, on average. Throwbacks and pullbacks happen almost two out of three times (63% to 65%).

Table 1.6: Rising or falling volume.The table shows how patterns behave if volume is rising or falling from the start of the pattern to the end, found using linear regression.

Winner.For upward breakouts, performance improves just over 60% of the time if volume is rising. Downward breakouts are mixed with bull markets in patterns showing falling volume doing best but bear markets show a tie.

Performance.The performance numbers are close, though, especially for downward breakouts. For example, patterns with rising volume (R) saw price climb 44% to the ultimate high (bull market, up breakout). Patterns with falling volume (F) showed gains averaging 42%. The volume trend is not a good predictor of future performance.