Thomas N. Bulkowski - Encyclopedia of Chart Patterns

How many change trend?As a measure of how well the chart pattern works (trends), I counted how many big Ms saw price drop more than 20% after the breakout. The thinking here is that a 20% move represents a trend change. For example, if the markets are bullish, a drop of 20% turns the market bearish. I applied the same measure to chart patterns.

Table 6.2 General Statistics

Table 6.3 Cumulative Failure Rates

As the table shows, higher numbers of big Ms see price drop more than 20% in bear markets as opposed to bull ones. This makes intuitive sense (it's like a receding tide will lower all boats). I consider values above 50% to be exhilarating.

Table 6.3shows how failure rates climb for small drops after the breakout. For example, 298 big Ms or 14% of the patterns in bull markets failed to see price drop more than 5% after the breakout. Over a third (37%) failed to see price drop more than 10%. In bear markets, the pattern performs better, with 37% failing to see price drop more than 15%.

You can use this table to help determine the chance of price making an extended decline. Want to make 50% after shorting your big M? Good luck with that. Only 2% in bull markets see price drop that far (that is, 98% fail to see price drop that far).

Table 6.4provides breakout and post‐breakout statistics.

Breakout direction.As I mentioned, if a big M breaks out upward, then you have a case of mistaken identity. Valid big Ms only break out downward.

Yearly position, performance.You will see the big M pattern appear anywhere in the yearly price range. Bull markets seem to find them hiding near the yearly high almost half the time. Bear markets see the breakout price hibernating in the middle of the yearly price range most often.

Mapping performance over the yearly price range doesn't see any statistically significant differences.

Pullbacks.A pullback occurs after a downward breakout. Price must return to the breakout price within a month by definition. The table says that price drops 7% to 10% in 6 days and then returns to the breakout price in a round‐trip total of 12 days.

Table 6.4 Breakout and Post‐Breakout Statistics

Patterns without pullbacks perform better than do those with pullbacks. That behavior is not unique to big Ms; we've seen it in other species of chart patterns. After a pullback completes, it resumes dropping 55% to 60% of the time on average.

Gaps.Breakout day gaps don't help or hurt performance much. Notice that the gap size in bull markets is almost twice the size of bear market gaps. Hmm . That's a surprise.

I measured the median gap size (19 cents in bull markets and 21 cents in bear markets) and used those as the difference between tall and short gaps. I found that in bull markets, gaps taller than the median saw price drop an average of 19% after the breakout. Short gaps lost just 16%.

In bear markets, the results were 25% decline for tall gaps and 21% decline for short gaps.

Table 6.5shows size statistics for the big M.

Height.We see that regardless of the market condition (bull or bear), tall patterns outperform short ones, but not by much. To compute this, measure the height of the pattern from the highest peak to the lowest valley between the two peaks and divide the result by the price of the lowest valley. If the result is larger than the percentage shown in the table, then you have a tall big M.

Width.Width doesn't offer any helpful performance improvement, although narrow patterns' performance is slightly better (but probably statistically insignificant). Measure the width of the pattern from peak to peak and compare it to the 26‐day median. If the result exceeds the median, then you have a wide pattern.

Table 6.5 Size Statistics

Height and width combinations.Upward breakouts show better performance if the big M is tall (regardless of width). Tall and narrow patterns outperform in bear markets.

Table 6.6shows that volume doesn't play a key role in performance of big Ms.

Volume trend.Volume trends downward every two out of three trades on average.

Rising/Falling volume.There's no performance difference between big Ms with a rising or falling volume trend (as measured from peak to peak using linear regression).

Breakout day volume.Only bear markets show better performance after heavy breakout volume. Heavy breakout volume typically leads to better performance for other chart patterns (not so much with downward breakouts, though, so it's weird that big Ms are different).