Thomas N. Bulkowski - Encyclopedia of Chart Patterns

Table 6.6Volume Statistics

Table 6.7 How Often Stops Hit

Table 6.7shows a table new to this edition: how often price hits a stop.

I split the pattern into three pieces: top, middle, and bottom. The top is the higher of the two peaks (B in Figure 6.3). The bottom of the pattern is the low at the valley between the two peaks (point C). The middle is, well, midway between the top and bottom.

In bull markets, price reached the top of the pattern just 2% of the time on the way to the ultimate low (after the breakout). Although bear markets show 0%, I actually found two samples where price reached the top.

If you wish to place a stop, then price will rise up to the middle of the pattern 16% of the time in bull markets, or recover (perhaps during a pullback) to the bottom of the pattern 70% of the time. Bear markets show similar performance.

In Table 6.8I mapped the breakout date into one of three decades, which the table shows, split into performance in the top portion of the table and failures in the bottom portion. Because bear markets only happened in the 2000s, they are not included in the statistics.

Performance over time.The 1990s showed the best performance from big Ms, but not so's you'd notice unless you traded a lot of them.

Failures over time.Failures happened at about the same rate over all decades studied, with the 2000s showing the most and the 1990s showing the least. These “failures” are breakeven failures, that is, failure of the stock to drop more than 5% after the breakout.

Table 6.8 Performance and Failures Over Time for Bull Markets

Table 6.9 Busted Patterns

Table 6.9shows how busted patterns performed. As you will recall, a busted big M happens when price breaks out downward, drops less than 10% (an arbitrary amount), reverses, and closes above the top of the big M (above the higher of the two peaks). The new, upward breakout busts the downward one. Multiple busts can follow.

Busted patterns count.Because the sample count for big Ms was high, I found quite a number of busted ones, from a sprinkling in bear markets (18%) to over a third in bull markets (38%). That makes intuitive sense because the bear market trend will help take price lower. It reminds me of watching a barge move down river. The water level drops near shore and gets all churned up. As a kid, I was afraid I'd be pulled under while swimming or even canoeing (even though the barge was across the river, about a quarter mile away).

Busted occurrence.Single busts happened most often followed by triple busts. While you may find that odd (that double busts don't come in second), you join me in my confusion. I've seen this trend in other pattern types and don't have an explanation for why it happens. A double bust would send price lower (that is, the first bust sends price upward and the second bust turns price downward), if that is any help.

Busted and non‐busted performance.Grouping single, double, and three or more busts together sees price rise 38% after busted downward breakouts in bull markets. Separating out single busts, we see price rise an average of 55% in bull markets (that's measured from the top of the big M to the ultimate high). That's a nice return if you can capture most of it.

I used big Ws as a proxy for a non‐busted big M. They don't see price perform as well as their busted sisters.

If you can find a busted big M, buy it and pray that price continues rising for a long time (a single bust). The 55% rise compares to a 46% average gain for big Ws (which break out upward). See the table for bear market results.

Table 6.10shows trading tactics for the big M pattern.

Measure rule, targets.I'll give an example of how to use the measure rule for big Ms in the sample trade. Use the measure rule to help gauge how far price will drop after the breakout. The rule is no guarantee that price will reach the target.

The bottom portion of Table 6.10shows how often price drops to various pattern heights. For example, using the full height in the measure rule calculation in bull markets, price drops to the target 55% of the time. If you use half the height, the hit rate rises to 80%.

Want to live dangerously? Price reaches a target farther away (twice or three times the height) less often, as the table shows. Bear markets show similar hit rates, slightly outperforming their bull market counterparts.

If you wish to buy the stock (long), you can use the measure rule numbers to help determine the probability of a stock dropping to half, one, two, or three times the pattern's height below the breakout. Just remember that anything can happen. Look for underlying support where the stock might turn and decide if it's worth selling now before it drops that far.

Table 6.10 Trading Tactics

Another way to trade a big M is to wait for price to find support after the breakout. Consider buying then and riding the recovery. Don't be fooled into buying the stock during a pullback. After a pullback completes, the stock resumes the plunge 55% to 60% of the time (see Table 6.4).