Thomas N. Bulkowski - Encyclopedia of Chart Patterns

Figure 10.5 A descending broadening formation appears with price that fails to continue moving up. The partial decline suggests the ultimate breakout will be upward, but the rise falters and price moves down instead.

Figure 10.6 This descending broadening pattern (left) results in a 5% failure. A broadening top formed in early November.

Figure 10.6shows a more harrowing tale because it involves a short sale. Investors watching the sharp 2‐day decline beginning 14 October 1994 would be tempted to short the stock the next day. Had they done so, or even waited a few days, they would have opened the trade near the low. From that point on the stock moved higher, back into the formation before ultimately soaring out the top. If you were a novice trader and had not placed a stop on your short sale, your loss would have taken you from a low of 24.38 to 53, where it peaked near the end of the study.

The figure represents a failure type I call a 5% failure . That happens when price breaks out in a given direction and moves no more than 5% before crossing the pattern and breaking out in the new direction. This type of failure can turn a small profit into a large loss if stops are not used.

Table 10.2shows general statistics for right‐angled and descending broadening formations.

Number found.I found 1,150 patterns in 668 stocks from August 1991 to October 2019. However, that included bear market patterns, and there were not enough of those to include in the statistics. Not all of the stocks covered the entire period, and some no longer trade. Notice that the pattern favors upward breakouts, judging only by the numbers.

Table 10.2 General Statistics

Reversal (R), continuation (C) occurrence.Upward breakouts act as continuation patterns most often, but downward breakouts act as reversals. Recall that a reversal has price leaving the chart pattern in a direction opposite the way it entered. Continuation patterns have price exit in the same direction as the prevailing price trend.

Reversal/continuation performance.Upward breakouts show better performance from reversal patterns, but downward breakouts favor continuations.

Average rise or decline.Shown in the table is the average rise or decline. Nothing spectacular here.

Standard & Poor's 500 change.I compared the date of the breakout to the ultimate high or low posted by the chart pattern and compared those to the index. The index shows it didn't perform nearly as well as the broadening pattern over the same holding period.

Days to ultimate high or low.Upward breakouts take an average of about 8 months to reach the ultimate high, but downward breakouts end faster, in about 2 months. The yardage traveled is different, though, because upward breakouts rise 43% and downward breakouts drop 15%. If you do the math, we find that the downward breakout should have reached bottom in 85 days, not 51. So, price dropped faster than it climbed.

How many change trend?I added this measure to help decide which chart patterns lead to outsized gains (a gain or loss of more than 20%). The results shown in the table are mid‐list numbers. The upward breakout number is good (more than half the patterns see decent gains), but downward breakouts fall well short of a 20% loss (just 27% drop that far).

Table 10.3shows various failure rates for the two breakout directions. How do you make sense of the table? It is easier to understand by example. I found that 21% of the patterns with upward breakouts failed to see price rise more than 5%. Over half (51%) of the patterns failed to see price rise more than 25% after an upward breakout.

Table 10.3 Cumulative Failure Rates

Table 10.4 Breakout and Post‐Breakout Statistics

You read downward breakouts in a similar manner. Almost a quarter of the patterns (23%) saw price drop no more than 5%. Half (59%) didn't see price drop more than 15%.

Table 10.4shows breakout‐related statistics.

Breakout direction.Price breaks out of the pattern upward almost twice as often as downward.

Yearly position, performance.I sorted the breakout price into one of three buckets, each a third of the yearly high–low range. Then I checked performance for patterns in those three buckets. The table shows that there's not a big performance difference for upward breakouts. Clearly, though, you'll want to avoid trading patterns within a third of the yearly high (price rises 41%).

Downward breakouts also show those near the yearly high underperforming those in the other two buckets. It suggests people should avoid momentum trading this chart pattern and focus on bottom fishing for candidates.

Throwbacks and pullbacks.Throwbacks and pullbacks occur almost two‐thirds of the time, and it takes stocks less than 2 weeks to return to the breakout price.