Thomas N. Bulkowski - Encyclopedia of Chart Patterns

Set realistic goals and realize that you'll have to make more on winning trades to compensate for losing ones. Trading perfectly also helps… (that's a joke, but focusing on improving technique often leads to making more profit).

Table 7.4shows breakout and post‐breakout statistics.

Breakout direction.All big Ws break out upward. If they don't, then they are not big Ws.

Yearly position, performance.I sorted patterns according to the breakout price and checked performance of the three ranges.

The best performance for both bull and bear markets comes from big Ws near the yearly low. The worst performance comes from those near the yearly high. It suggests that bottom fishing (buy low, sell high) works better for big Ws than momentum trading (buy high, sell higher).

Throwbacks.A throwback happens after the breakout when price rises but quickly returns to the breakout price (within 30 days). Often price resumes the rise thereafter. In Figure 7.1, for example, the throwback peaks at E before returning to the breakout price. Figure 7.2shows a throwback after point E.

Throwbacks occur about twice every three trades. Price peaks in 6 days after rising between 8% and 11%, on average, before completing the trip back to the breakout price (or nearly so) in 12 days (that's the roundtrip total).

Notice that price does better if a throwback is absent. We've seen this behavior in other chart patterns, too. How can you tell if a throwback will happen? Look for nearby overhead resistance, such as prior peaks, round numbers (10, 20, 30, and so on), or sideways price movement between the breakout price and about 10% higher. If you see some, then expect a throwback. In my trading, I always expect a throwback will happen, and I party when they don't.

The vast majority of the time, between 60% (bear market) and 76% (bull market), price will resume the upward move after a throwback completes. Few things are more aggravating than placing a buy stop a penny above the breakout price, getting into the trade perfectly, only to see a throwback take price lower. Sometimes, the stock continues down below the bottom of the pattern and you're stopped out. Then you sit on the sidelines as the stock recovers and soars like an eagle. Fortunately, this type of behavior is rare for big Ws ( Table 7.9says it happens 20% or less).

You can always wait for a throwback to complete before making a trade. However, if you wait, you'll miss investment opportunities where a throwback doesn't occur (that is, you'll miss the best performers).

Gaps.Breakout day gaps push price higher, meaning performance is better if a gap appears. However, in bull markets, the extra push probably won't be enough to wake you from a sound sleep. In bear markets, it's more of a jolt.

How can you tell if price will gap higher? I've no idea. However, I measured performance from the opening price the day after the gap to the ultimate high. So if you see a gap, you can buy into the situation and maybe score extra performance points for doing so.

Table 7.5shows how the sizes of big Ws perform.

Height.Tall big Ws perform better than do short ones. To use this finding, measure the height of the big W from the peak between the two bottoms to the lower of the two bottoms. Divide the result by the breakout price (the price of the peak between the two bottoms). If the result is bigger than that shown in the table, then you have a tall pattern.

Table 7.5 Size Statistics

Table 7.6Volume Statistics

Width.Bear markets don't see a performance difference, but in bull markets, wide patterns perform slightly better than narrow ones. The median width between narrow and wide is about 3 weeks (see the table). The width is the time between the two bottoms.

Height and width combinations.Patterns that are tall and wide outperform the other combinations of height and width. You might want to avoid short patterns (either narrow or wide). They underperform in bull markets and don't do that well in bear markets.

Table 7.6shows volume statistics for the big W pattern.

Volume trend.Volume trends downward most of the time, as measured using linear regression between (and including) the two bottoms of the big W. As I mentioned, don't discard a big W because it has an unusual volume trend. Remember, the trend is your friend.

Rising/Falling volume.Patterns with falling volume, as measured from bottom to bottom in the big W, perform best in both bull and bear markets. The bear market shows the biggest difference between the two values (31% versus 25%). The 25% number comes from 136 samples, so additional samples will likely narrow the gap.

Breakout day volume.Bull markets don't see a performance difference, but bear markets do with heavy breakout volume helping performance. The difference seems unusually wide, though, so additional samples will likely narrow the spread.

Table 7.7is one of my favorite tables because this kind of trading information can pay for the price of this book.

How often are stops hit? I placed a stop‐loss order at the peak between the two bottoms and price touched this (after the breakout and on the way to the ultimate high) over 70% of the time. Scoot the stop a bit lower (the middle of the big W, measured from the peak to lowest valley) and the stop triggers less often, between 13% and 20% of the time. Place it at the lower of the two bottoms and it'll hardly trigger at all.

The safe place to locate a stop‐loss order is below the bottom of the big W, but the distance between the stop and the buy price may entail a large potential loss. The rumors are true: Positioning a stop is an art you need to master to become a successful trader.

Once you decide where to place the stop, convert the potential loss into a percentage of the current price. If you gasp at the result, then the stop is too far below the current price. Either adjust the stop location, abandon the trade altogether, or hope the trade succeeds.

Table 7.8shows how big W performance has changed over three decades. Because bear markets only occurred in the 2000s, they were excluded from consideration.

Table 7.7 How Often Stops Hit

Table 7.8 Performance and Failures Over Time for Bull Markets