Encyclopedia of Chart Patterns. Thomas N. Bulkowski
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Trading Tactics
Table 7.10 shows 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 7.7 to 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
| Trading Tactic | Explanation |
|---|---|
| Measure rule | Measure the height of the pattern from the lower of the two bottoms to the high between the two bottoms. Add the height to the high price between the two bottoms. The result is the target price. Large percentage moves will be unlikely. The bottom portion of the table shows how often the measure rule works. |
| Stop location | Place a stop at the location of your choice, using the results in Table 7.7 as guidance. |
| Launch price | Determine where the launch price is and use that as a target. |
| Higher second bottom volume | If the right bottom shows higher volume than the left one, expect better performance (in bull markets). |
| Description | Bull Market | Bear Market |
|---|---|---|
| Percentage reaching half height target | 88% | 77% |
| Percentage reaching full height target | 74% | 55% |
| Percentage reaching 2× height | 53% | 31% |
| Percentage reaching 3× height | 39% | 17% |
| Return to launch price | 70% | 51% |
Table 7.11 Special Features
| Description | Bull Market | Bear Market |
|---|---|---|
| Lower left bottom, performance | 46% | 29% |
| Lower right bottom, performance | 47% | 30% |
| Even bottom, performance | 38% | 34%* |
| Higher left volume, performance | 45% | 31% |
| Higher right volume, performance | 49% | 27% |
| Median days from launch price to left bottom | 22 | 21 |
| Median days from right bottom to ultimate high | 92 | 51 |
| Large rise between valleys, performance | 48% | 30% |
| Small rise between valleys, performance | 44% | 29% |
| Median rise between valleys | 14% | 26% |
* 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 7.2 shows 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 7.3 says that almost half (46%) will fail to see price rise more than 25%.
Table 7.11 shows 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