Encyclopedia of Chart Patterns. Thomas N. Bulkowski

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Encyclopedia of Chart Patterns - Thomas N. Bulkowski


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Horizontal top resistance line A horizontal line of resistance joins the minor highs, shown by drawing a trendline connecting the peaks. Down‐sloping trendline The expanding price series is bounded on the bottom by a down‐sloping trendline. Touches Look for at least five trendline touches, three on one trendline and two on the other. They need not be alternating touches. Price slicing through a trendline doesn't count as a touch. Whitespace Price should bounce from trendline to trendline, erasing most whitespace in the pattern. Breakout direction Price can break out in either direction, usually accompanied by a rise in volume that soon tapers off. Partial rise or decline For an established pattern, when price climbs toward the top trendline or declines toward the lower one but fails to touch it, price often reverses direction and breaks out of the broadening pattern. Volume Trends upward most often (but almost random). Don't discard a pattern with a downward volume trend. Support and resistance Follows the two trendlines into the future but is sporadic.

      Down‐sloping trendline. The same applies to the down‐sloping trendline: It requires at least two distinct touches before drawing the trendline (more touches are better).

      Touches. I prefer to see at least five trendline touches, three on one trendline and two on the other, with all five being minor highs or minor lows (peaks or valleys). Fewer than five touches make correct identification more difficult.

      Whitespace. Figure 10.4 shows an identification problem at AB. There are two trendline touches along the top (as minor highs) and four touches as minor lows along the bottom. The pattern looks like a descending broadening pattern.

      It's not.

      See that chunk of whitespace at B? Price doesn't cross the pattern often enough to qualify it as a valid broadening pattern. The inset at C shows that the pattern is better drawn as a down‐sloping channel. This chart is an example of cutting off a turn and calling it a descending broadening pattern. Do not tell anyone that you found a broadening pattern after you cut off a turn. What you found was a mistake.

      Breakout direction. A breakout occurs when price closes outside the trendline boundary. Breakouts can occur in either direction.

      Partial rise or decline. A partial rise, as shown in Figure 10.3, or a partial decline (not shown), is often a clue to the ultimate breakout direction. When price curls around on a partial rise or decline and returns to the trendline, the stock will usually break out immediately (that is, without crossing the chart pattern again).

Graph depicts the AB is not a descending broadening formation.

      Figure 10.4 AB is not a descending broadening formation.

      Since descending broadening formations can break out either up or down, I show both views of failed breakouts. The first one, Figure 10.5, is characterized by the telltale partial decline in late November. From there, the stock climbs and eventually pierces the top trendline, as predicted.

      Once price closes above the trendline, you would expect it to throw back to the formation top and resume the upward trend. In this situation, price reverses at 45 and returns to the formation proper—a classic throwback. Unfortunately, instead of rebounding and heading higher like a typical throwback, the stock continues down. It does more work inside the chart pattern before shooting out the other side in a straight‐line run.

Graph depicts 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. Graph depicts the descending broadening pattern (left) results in a 5% failure. A broadening top formed in early November.

      Figure 10.6 shows 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 10.2 shows general statistics for right‐angled and descending broadening formations.

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