Thomas N. Bulkowski - Encyclopedia of Chart Patterns

Performance over time.The 2000s were the outstanding decade for performance with gains averaging 51%. The worst performance came in the 1990s with the 2010s nestled comfortably between those two.

Failures over time.I would expect to see low failure rates in the 2000s because that was the best performing decade, and yet the table shows it's tied at 8% with the 1990s. The 2010s showed a slight uptick in failures. The failures I'm reporting on, by the way, are 5% failures. They count how many big Ws fail to see price rise more than 5% after the breakout.

Table 7.9shows statistics related to busted patterns.

Busted patterns count.Big Ws rarely bust, as the table shows (compared to other patterns, which see busts in the 40% range). What does this mean? Up to 20% of the time, on average, price will fail to rise more than 10% after the breakout before reversing and closing below the bottom of the big W. So if you want to make a lot of money, then one in five trades won't exceed 10% profit, on average, and that's if you trade it perfectly.

Busted occurrence.For those patterns that busted, I sorted them into one of three bins: single, double, and three or more busts (triple+). The table shows single busts happening most often followed by double and triple busts. In some other pattern types, we see triple busts coming in second place, so big Ws behave themselves.

Busted and non‐busted performance.Compare the performance for all busted patterns (drops of 15% in bull markets) with the performance of big Ms (not Ws). Big Ms see price drop an average of 17% after a downward breakout, and they act as the proxy for a non‐busted big W.

Busted pattern performance for big Ws is not as good as trading a big M chart pattern. However, if you are lucky enough to trade a single busted big W, then price drops an average of 23% (in bull markets). That's exceptional for a bearish pattern; of course, your mileage may vary.

How can you tell if the big W will single bust (as opposed to double or triple bust)? I'll leave that as an exercise for the reader (translation: I have no idea, but focus on nearby overhead resistance that might turn price down or the timing of an earnings announcement).

Table 7.9Busted Patterns

Table 7.10shows trading tactics.

Measure rule, targets.Use the measure rule to help determine how far price may rise after the breakout. The lower portion of the table shows the numbers. Before I get there, let me explain how to use the measure rule.

Measure the height of the big W by subtracting the lower price of the two bottoms from the price of the highest peak between the two bottoms. Add the height to the peak between the two bottoms to get a full‐height target. The table says that price will reach that target 74% of the time in bull markets.

If you use different multiples of the height (half, 2×, or 3×), you will see different hit rates. For example, if you like to hold onto a stock and target three times the height, compute the height as already described, multiply it by three, and add it to the breakout price. Price will reach the target 39% in bull markets but only 17% in bear markets.

Stop location.Use Table 7.7to help determine where to place a stop. You can use a volatility stop, which is based on how volatile a stock is, to locate your stop. Often I'll stick a stop below a nearby minor low and double‐check that with a volatility stop. See the Glossary for details on volatility stops.

Return to launch price.Look back at Figure 7.1. Point A is the launch price. It's the price where the stock begins the decline in earnest, leading down to the big W. Unfortunately, the launch price can be hard to determine in some cases, so I use the measure rule to give better targeting guidance.

Table 7.10 Trading Tactics

Table 7.11 Special Features

*From 18 samples.

However, the stock can return to the launch price after a big W breaks out. Keep that in mind when setting targets. Look for price to stall just short of the launch price. Figure 7.2shows an example of that. The launch price is point A and price climbs to F, which is just below the price of A.

The last line in the table shows the stock returns to the launch price 70% of the time, on average, in bull markets. To use this finding, convert into a percentage the distance from the current price to the launch price. If it's a high percentage, then it'll probably be unrealistic.

You can run the potential gain by Table 7.3. For example, if the current price is 40 and the launch price is 50, that means a gain of 25% or ((50 – 40)/40 × 100). Table 7.3says that almost half (46%) will fail to see price rise more than 25%.