Thomas N. Bulkowski - Encyclopedia of Chart Patterns

Table 7.11shows features that might improve trading a big W.

Lower valley performance.I checked the performance of big Ws where the price of the left bottom was above, below, or equal to the right bottom. There wasn't much of a performance difference except for big Ws where the price of both bottoms was the same. When that happened, performance suffered, and quite substantially.

Higher bottom volume.I found that if the right bottom of the big W has volume higher than the left bottom, patterns outperform in bull markets and underperform in bear markets. Because the bull and bear market values show opposite performance results, it concerns me that this finding won't be reliable. Use it with caution.

Time to launch.I measured the time from the launch price to the first bottom and compared it to the time from the second bottom to the ultimate high. The numbers show that the drop into the big W is short, about three weeks, but the recovery is long. In bull markets, the median is about four times as long.

Rise between valleys.I compared the height of the peak between the two bottoms of the big W to performance. If the rise was taller than the median (measured as the height from peak between the two bottoms to the lower of the two bottoms divided by the price of the lower of the two bottoms), then performance improved. In bull markets, the differences are pronounced compared to bear markets.

I have traded the big W a number of times, but all from the buy side so the lessons learned aren't as important as those on the sale side. To put it another way, it doesn't matter at what price you buy. It only matters at what price you sell.

Let me tell you about what I found in my trade review.

Abercrombie & Fitch Co. (ANF) in 2017 had been trending lower for almost a year after peaking in March 2016. I saw a big W forming and thought this would make for a good bottom‐fishing trade.

Here's what I wrote in my trading notebook. “Buy reason: Extra cash. I'm hoping that this will be the start of a rebound, a fallen angel–type play. Earnings were good and the stock shot up and then threw back, as expected. It should recover from here, based on a good earnings surprise. If not, then sell when it gets in the 10+ range to keep the [dollar] loss small. The odds don't favor this trade, but I'm betting the stock has bottomed and will recover from here.”

The earnings announcement saw price climb from 11.69 to a high of 13.75 the next day, or almost 18%, but it retraced most of that gain by the time I bought on 10 March. I received a fill at 11.68. The position size was small, about one‐fourth of what I normally trade, and that told me I was concerned about the stock.

I sold the stock (at 10.92) after the report of weak same‐store‐sales numbers less than 2 weeks after I bought, taking a 7% loss.

This was one of those trades where the smart money is just waiting to trap you. I sold the day price bottomed. The stock recovered but only to 12.46 before dropping again. The stock bobbed up and down, eventually making another big W in August and September 2017, which was the real bottom. From there, the stock climbed from its confirmation price of 10.49 to peak at 29.20, or 178% higher.

My instincts were good. I picked a stock that almost tripled except the timing was wrong. I missed entering a winning trade by 6 months.

I made a perfect entry, buying after a throwback completed, and sold on the day price dropped (but didn't close) below the bottom of the big W. If I had waited for price to close below the bottom of the big W, I would have stayed in the trade longer but would have taken a slightly bigger loss.

The big question comes from a curious mention in my notebook: “The odds don't favor this trade.”

Lesson: If the odds don't favor the trade, then don't make it.

Lesson: Keep the position size small if you believe a trade is risky.

I made a trade in Teradyne Inc. (TER) as the stock emerged from the 2007–2009 bear market. A big W confirmed and I bought in at 5.94 on 1 May 2009. The stock threw back but then cooperated and climbed.

Later in the year it moved sideways until August 2010, when it resumed its upward move. Here's what I wrote in my notebook: “Sell reason: Hit stop. This sold on reaction to market weakness, so my guess is I sold too soon. I expect a rebound, but you can't be too sure.”

I sold within a week of the stock peaking and before it dove by more than 40%. I made 194% on the trade (I almost tripled my money!).

This is one of those trades you want to climb up on the roof of your house with a megaphone and shout at your neighbors that you're rich. Of course, you'd be gunned down by the rednecks surrounding your house like a moat, so don't do that.

There is no lesson to share with this trade. A perfect entry and perfect exit led to a nice reward for holding onto the stock for 1.8 years.

In Ann Taylor (ANN), the stock made a big dive, forming the left side of the big W in late 2006. I bought on 1 February 2007, at a price of 35.19. This was a late entry by about 2 weeks, and yet if I had bought at a penny above the confirmation price, I would have entered the trade at a lower price: 33.82. My preferred entry method is to place a buy stop a penny above the breakout price.

On the sale, here's what I wrote: “21 March 2007. I decided to sell this using a trailing stop set between today's close and the low +.01 as the cents margin (11 cents) [I think this has to do with setting an automated trailing stop with my broker]. Hopefully, this will move up in the morning and I can get out at a higher price than just selling at the open. The market was up big today, and this stock was one of the few to close lower. It's running up against SAR [support and resistance] at 39–40, as predicted. My guess is it'll form a handle and backtrack. I don't want to wait around, though. I think the company sucks because SSS [same‐store‐sales] are soft despite positive comments from the company.”

I received a fill at 39.09. Four trading days later, the stock peaked at 39.92, before entering the bear market and seeing the stock bottom at 2.41, or 94% below where I sold. I made 11% on the trade.

Lesson: Buying as soon as the stock breaks out of a chart pattern is often better than waiting.

With Energy East Corp. (EAS), I saw a big W forming and price didn't confirm the pattern before heading back down to the price of the first bottom, where I bought. I received a fill at 23.12.

The stock cooperated, for a time, by rising but eased lower and looked to be heading down about 3 weeks after I bought. I sold it for a 2% loss so I could deduct it on my taxes.

From my notebook: “Sell reason: End‐of‐year tax‐loss selling. This is going down, I predict, so it's time to dump it and lower my cap gains taxes. This H&S [head‐and‐shoulders] bottom didn't work as expected.”

The head‐and‐shoulders became apparent after I bought (which happened at the right shoulder low), and it never confirmed by the time I sold on 30 December 2005, at 22.69.

This trade contradicts the prior lesson. If I had placed a buy stop a penny above the top of the big W, I would have entered the trade at 24.06, well above my 23.12 purchase price. The big W didn't confirm until 10 January 2006, where the stock continued up to make a vertical run for 8 days (peaking at 25.57). Then it moved sideways to down for 1.5 years.

I sold on the day the stock started to climb in that vertical rise. Bad exiting timing, that's for sure. But I would have collected dividends from the electric utility only if I had continued to hold the stock, so selling was a good choice.