from it, simply because the word ascending is in the title. However, that is nothow the formation performs. It is a bearish reversal of the short-term price
trend. This is not a novel finding, as others have discussed the bearish behavior of ascending broadening formations. The word ascending in the title refers27
28
Broadening Formations, Right-Angled and Ascen-_..ig
Edwards, A. C. Inc. (Securities Brokerage, NYSE, ACE)
to the minor highs that rise over time. The base of this formation is flat but thetops widen out, generally following an up-sloping trendline.There are a few surprises highlighted by the Results Snapshot. The fail-
ure rate falls from 34% to 9% if you wait until after a downside breakoutbefore buying the stock. An improvement is not unusual but such a large oneis. The large gain is because I ignore all upside breakouts, and only a few downside breakouts fail, leaving a small failure rate.The other interesting statistic is the number of pullbacks to the formationbase. This number is due, in part, to the messy looking breakout that seems tobe quite common with this reversal. After a breakout, prices move horizontally
and bounce around a bit before continuing down. The decline is sometimesover quickly as a 10% to 20% decline is easy to erase, fostering a 72% pullbackrate.Apr 92
TourRight-angled ascending broadening formations: What does the name mean? Rightangle implies that it is a member of the triangle family. A horizontal base withan up-sloping hypotenuse forms a right triangle. The third side drops downfrom the hypotenuse to the base and intersects it at a 90 degree angle, formingthe so-called right angle. Ascending means that the hypotenuse ascends overtime as contrasted with descending broadening formations. Broadening formation means that prices make higher highs. Ascending and descending triangles,in contrast, have narrowing price movements.Figure 2.1 puts the formation in perspective. There are two formationsshown in the chart. The first one is somewhat ill-formed but better performing than the second. Both formations have a base outlined by a horizontaltrendline connecting the minor lows. The up-sloping trendline skirts the topsof the minor highs. The result is a triangle-appearing formation with pricesthat broaden out, but do not let the ascending price pattern fool you. Thisformation is bearish: Prices plummet through the base of the formation mostof the time.Why do right-angled ascending broadening formations form? ConsiderFigure 2.2. The rise began in mid-December 1991 on volume that was higherthan anything seen in almost 2 months. By late February, the stock had reacheda new high and was rounding over after meeting selling resistance at 14. Thestock returned to the 12'A level where it found support. At that point, itpaused for about 2 weeks and established the base on which a horizontal trendline appears.The reason for the horizontal trendline is one of perceived value. As thestock approached the $12 level, more investors and institutional holders purchased the stock. The desire to own the stock at what they believed a good
May
'un
)ul
A
"9
Sep
Oct
Nov
Dec
Figure 2.1 Two right-angled ascending broadening formations bounded by ahorizontal base and up-sloping trendline. Prices decline after a downside breakout.
Baker). Inc (Shoe, NASDAQ, JBAK)-IS
|an92
Figure 2.2 A pullback to the base of the formation. Pullbacks occur often inascending broadening formations.
29
30
Broadening Formations, Right-Angled and Ascen
value outweighed the reluctance of sellers to part with their shares. Thedemand halted the decline in the stock and eventually sent it skyward again.This happened in mid-April as volume spiked along with the price. The enthusiasm caused the stock to reach a new high. Momentum was high enough sothat the next day, prices rose even further before closing lower. With the second peak, a tentative trendline drawn along the tops of the formation slopedupward and gave character to the broadening formation.The stock moved rapidly back down even as volume increased. Thisdecline stopped before it reached the lower trendline, signaling continuedenthusiasm. Prices pushed higher and reached a new high, this one at 15l/2 onMay 6. The up-sloping trendline resistance area repelled any further advance.The stock simply did not have enough upward momentum to push through theselling pressure at the new level.The next day volume dried up, but there was enough momentum remaining for another try at the summit. When the attempt failed, the smart moneyheaded back for base camp and volume receded even further. As prices collapsed, other investors joined in the retreat and volume moved up. In less than2 weeks, prices were back at the lower trendline.Another feeble attempt at a new high floundered on unremarkable volume. The stock moved horizontally and stalled out—a partial rise that oftenspells trouble for a stock. On June 4, prices dropped on high volume andreturned to the horizontal trendline. The stock paused there for just over aweek before moving down and punching through the support level at 12'/4.A pullback is quite common for ascending broadening formations, so it isno surprise that the decline quickly faded. After a rapid 13% retreat, the stockturned around and pulled back to the base of the formation. Although it is notshown in Figure 2.2, the stock continued moving up until it began forminganother ascending broadening formation in late October with a base at 16'/2.The ascending broadening formation represents the desire of investorsand traders to own the stock at a fixed price, in this case about 12 '/4. Their buying enthusiasm pushes prices higher until mounting selling pressure causes ahalt to the rise and sends the stock tumbling. With each attempt, fewer peopleare left willing to sell their shares until they receive an even higher price, so abroadening range of prices appears at the top. Eventually, the buying enthusiasm at the base of the formation collapses and removes the support for thestock. When that happens, the stock punches through the support level anddeclines. It continues moving down until reaching a point where otherinvestors perceive significant value and buy the stock.
Identification GuidelinesWhat are die characteristics of an ascending broadening formation? To answer
the question, peruse the selection guidelines outlined in Table 2.1. While con-
Identification Characteristics of RCharacteristicShape
Horizontal bottom support line
Up-sloping top trendline
VolumePremature breakoutsPrice action before breakout
Downside breakoutSupport and resistance
sidering the table, look at Figure 2weekly scale. The overall shape oone side horizontal. The bottomline, while an up-sloping trendlitouches at least two minor highs.clearly visible and well separatedtal trendline also shows two minoline. The phrase minor low referstroughs. The various touch pointsAs you can see from Figure 2tern is irregular. However, in a mbreakout. Although this formationrise in early 1993.I define premature breakoutsboundary but return before the foformation are rare enough that thIn some ascending broadeninform a solid, horizontal base at t
32
Broadening Formations, Right-Angled and Ascending
Focus on Failures
33
Focus on Failures
Parker Drilling Co. (Oilfield Svcs/Equipment, NYSE, PKD)-8
-6
What can we learn from a review of the failures of this formation? Figure 2.4shows two broadening formations, the one on the left fails to descend but theone on the right makes up for it. The figure makes one lesson clear: Alwayswait for a confirmed breakout before taking a position in a stock; that is, waitfor prices to fall below the lower trendline before selling your long positionor selling short. Even though most ascending broadening formations break outdownward, the failure rate is too high to hazard an investment before knowingthe outcome. Had you sold the stock short during the first formation, yourposition would not have made money for almost half a year. Look back atFigure 2.3. A short position in the stock at the low would have lost moneyfor years.
92 F M A M | | A S O N D 9 3 F M A M ) J A S O N D 9 4 F M A M J | A S O N D95 FM A M J
Figure 2.3 Support and resistance areas on a weekly time scale. They appearalong the trendline axis and can extend far into the future, as in this case.
months. Eventually, prices rise above the formation top or slide through thebottom trendline and stage a breakout. Once a breakout occurs, typicallydownward, expect a pullback. A pullback is when prices move lower, then turnaround and touch the bottom trendline. Prices may continue moving up butthey usually bounce off the trendline and continue back down. A pullback givesinvestors another opportunity to short the stock or add to their short position.Before investing, however, make sure the pullback is complete and prices aredeclining once again.I chose Figure 2.3 because it shows the two common areas of support andresistance. These areas follow the trendlines. Along the base of the formationprojected into the future, the support area repels the decline over 2 years afterthe formation ends. The rising trendline tells a similar tale; it repels pricesthree times nearly a year later. The implications of this observation can be profound. If you own a stock and it is breaking out to new highs, it would be niceto predict how high prices will rise. One way to do that is to search for formations such as this one. Many times, extending the trendline into the future willpredict areas of support and, in this case, resistance.Although the trendline did not predict the absolute high, it did suggestwhen prices would stall. The resistance area turned out to be a good opportunity to sell the stock.
Selling a stock prematurely is just as bad. If you held a long position inthe stock shown in Figure 2.4 but sold it during June, you would have regretted your trade until December when the footwear company slipped. Had youwaited for a downside breakout, you would have remained in the stock as itascended. Once the second broadening formation took shape, a sale afterprices pierced the horizontal trendline would have gotten you out at a betterprice.
Figure 2.4 Two broadening formations. The formation on the left fails to descendbelow the lower trendline. You should wait for the breakout before investing inascending broadening formations.
34
Broadening Formations, Right-Angled and Asce
StatisticsTable 2.2 shows general statistics. Just like other broadening formations in thisbook, I did not feel comfortable basing the statistics on my 5-year databasealone, so I incorporated my more recent database for 35 additional formations. This gives a total of 216 formations, making ascending broadening formations one of a rare breed. An examination of the formation reveals that 81are consolidations of the prevailing trend, but the vast majority are reversals,with 135 falling into that category.I measure the failure rate in two ways. Since I expect a downward breakout, I counted the number of formations in which that is not the case. Thereare 74, giving a failure rate of 34%. What if the investor waits for a downsidebreakout? This is called breakout confirmation. It lowers the failure rate to just9%, well below the 20% maximum I consider reliable formations to possess.That is how I suggest you trade this formation: Wait for a confirmed downsidebreakout before selling short.
Statistics
35
What is the average decline for formations with downside breakouts?The average is 18%, but the most likely decline is less than 10%. I measure thisby sorting the percentage losses into 10 bins and counting the results. Theresulting frequency distribution reveals that the most likely loss is narrower
than the average, due to a few large declines and several in the 15% to 20%range. Together, they skew the average upward.
I use a similar method for rises from failed formations. A failed formationis one with an upside breakout or downside breakout that fails to continuemoving down by more than 5%. The average gain is 32%, with the most likelyrise being about 20%. Over a quarter of the formations with upside breakouts
(27%) rise over 50%.The measure rale, which predicts a target price, is disappointing for
ascending broadening formations. With only 43% of the formations meetingor exceeding the target, I decided to compute a new measure rule that gives ahigher success rate. I computed the formation height by subtracting the lowest low from the highest high and then dividing by two. The target price is the
height subtracted from the breakout price. Dividing the height by two is theonly change in the formula, and it results in 91% of the formations meeting
their price targets.The average formation length is just under 3 months, long enough to beTable 2.2General Statistics for Right-Angled Ascending Broadening FormationsDescription
Statistic
Number of formations in 500 stocks from1991 to 1996
181
Number of formations in 296 stocks from
1996 to 1998
35
Reversal or consolidation
81 consolidations, 135 reversals
Failure rate
74/216 or 34%
Failure rate if waited for downsidebreakout
13/151 or 9%
Average decline of successful formationsMost likely decline
18%10%
Most likely rise for failed formations
32%20%
Of those succeeding, number meetingor exceeding price target (measure rule)
60 or 43%
Use measure rule based on half height
125 or 91%
Average formation length
3 months (86 days)
Days to ultimate low
3 months (81 days)
Average rise for failed formations
Note: Only two out of three ascending broadening formations work as expected and themost likely decline is meager at 10%.
visible on weekly charts. I also computed the average duration from the end of
the formation to the ultimate low. This turns out to be about 3 months.Table 2.3 shows statistics related to the breakout. There are only 13 formations that break out downward but fail to continue moving down by more
than 5% (the so-called 5% failure). This statistic coupled with only three formations breaking out upward and then moving lower suggests that once theformation breaks out, it will likely continue in the breakout direction. Forinvestors, this is worth knowing. Simply trade with the trend.Almost a quarter (24%) of the formations break out upward, 6% havehorizontal breakouts, and the remainder are downside ones (70%). I define abreakout either as prices closing below the lower trendline and moving downor as rising above the highest high in the formation and continuing up. Oftenprices just meander between the two points for several months before finallystaging a breakout.Throwbacks are prices that break out upward and return to the top trendline. They occur 44% of the time for those formations with upside breakouts.The average time to complete a throwback is less than 2 weeks (11 days). Thatis die time it takes to flip around and touch the top trendline. I exclude anythrowback taking longer than 30 days. If it takes over a month for prices toreturn, I consider it normal price action and not due to a throwback.Fullbacks are more prevalent. A pullback is when prices break out downward and quickly return to the formation base. Seventy-two percent of the formations with downside breakouts experience pullbacks. The average time to
36
Broadening Formations, Right-Angled and AscendTable 2.3Breakout Statistics for Right-Angled Ascending Broadening Formations
Description
Statistic
Downside breakout but failure
1 3 or 9%
Upside breakout but failure
3 or 6%
Upside breakout
52 or 24%
Horizontal breakout
1 3 or 6%
Downside breakout
1 51 or 70%
Throwbacks
23/52 or 44%
Average time to throwback completion
11 days
FullbacksAverage time to pullback completion
109/151 or 72%
For successful formations, days to ultimate low
2 months (69 days)
For failed formations, days to ultimate high
3 months (96 days)
Percentage of downside breakouts occurring nearthe 12-month price low (L), center (C), or high (H)
L22%, C42%, H36%
Percentage loss for each 12-month lookback period
L17%, C18%, HI 8%
Volume for breakout day and next 5 dayscompared with day before breakout:Percentage of successful breakouts occurring onhigh (H) or low (L) volume
Trading Tactics
12 days
157%, 170%, 122%,107%, 99%, 102%H74%, L26%
Percentage of failed breakouts occurring onhigh (H) or low (L) volume
the largest volume. It measures 70week wears on. This pattern is notrealize a confirmed breakout is undI next wanted to know if thebreakout volume and the success ordownside breakouts, high volumeis not a key to the success or failurejust because you see a low-volumeprices will soon recover.
H80%, L20%
Table 2.4 lists trading tactics. The mstock will decline. Compute the dihorizontal trendline in the formatiohorizontal trendline, and the resultas a minimum price move to expetions, prices usually miss the targetFor a more conservative apprand dividing by 2, then subtract thereach the nearer target almost all thserves as a wake-up call indicatingtrading—at least on the downside.
Note: Downside breakouts experience pullbacks 72% of the time.
TTrading Tactics for Right-Angle
complete a pullback to the formation base is 12 days. Again, I remove any pullback over 30 days.Ascending broadening formations reach their ultimate low or highquickly, in about 2 or 3 months, respectively. The abruptness of the decline isdue in part because these formations do not decline very far (the most likelydecline is just 10%), so it takes less time to reach the ultimate low.Most ascending broadening formations occur near the middle of the 12month price range, as measured from the base of the formation. The largestdeclines split evenly at either 17 % or 18 % throughout the various yearly priceranges. In essence, it does not matter where in the yearly price range the formation occurs; the performance is the same (unlike some other formationsthat show definite trends).Although volume appears irregular throughout the formation, I didexamine the volume surrounding the breakout day. When compared with theday before the downside breakout, the day after the breakout typically shows
Trading Tactic
Expl
Measure rule
Comthe hvaluetargeheigh
Wait for confirmation
Sincerate (to droabov
Buy upside breakouts
Oncedirectand e
Ignore downside breakouts
Mostloss isworth
Note: The best approach is to buy after an
38
Broadening Formations, Right-Angled and
Sample Trade
39
Sample Trade
Figure 2.5 Ascending broadening formation. Predicted price targets using halfand full formation heights. A broadening top formation appears in late October.
Figure 2.5 makes the measure rule clear. The height of the formation isthe difference between the highest high (34H) and the trendline price (29^4), or47/s. Subtract the result from the trendline price, giving a target price of 243/s.Since prices only reach the target 43 % of the time, I show a second one. Thenearer target uses half the formation height, or 2.44, to give a price targetof 26.81. Prices reach the closer target 91% of the time after a downsidebreakout.With an overall failure rate of 34%, there is a high likelihood of anadverse breakout from this formation. Therefore, an investor should alwayswait for a breakout before making a trade.Although die formation usually breaks out downward, you can try buying
the stock on an upside breakout. This approach allows you to go with the usualtrend in prices (up), and the most likely gain is about 20%. Again, be sure towait for the upside breakout (when prices close above the up-sloping trendline)since only one in three breakouts is upward.I do not suggest trying to capitalize on a downward breakout by shortingthe stock. Although the likelihood of a decline is good, the most likely declineis only 10%, hardly enough to warrant the extra risk of a short sale. If youalready own the stock and do not want to experience a 10% or perhaps largerdecline, then you can either wait for a confirmed downward breakout (wait forprices to close below the lower trendline) or sell the stock as it nears or touchesthe upper trendline and begins heading down.
Palmer is a wiry sort of guy, one who acts as if he has swallowed too much caffeine. I am sure you have met the type. Faced with the situation shown in Figure 2.5, he took swift, decisive action. At point A, where the stock touched thetop trendline, he quickly sold it short and received a fill at 333/8. He placed astop at 34 in case the trade went against him. Then he waited.It did not take long for the stock to cross the formation and reach the horizontal trendline. Unfortunately, Palmer did not use an order to automaticallycover his short at 293/s (the value of the trendline). So when prices bounced offthe low, he covered his short the following day, shown as point B, at 30'/2.Immediately, he went long and bought the stock at the same price.Palmer placed a stop-loss order just below the horizontal trendline, at291/4, just in case. Then he extended the top trendline but worried that thestock might not reach its predicted high. He opted to put a target price at !/8below the old high at point A. In less than a week, the stock reached his targetand sold at 33'/2 (point C). Since the stock was still showing an upward bias, helaid back for a bit and waited for the trend to reverse. Three days later he soldthe stock short again at 33. This time, he put a sell order at '/s above the lowertrendline at 29'/2. The trade went against him. It rose to 34 and oscillated upand down for nearly 3 weeks, never quite reaching his stop-loss point of 343/8.Then the stock plunged and zipped across the formation. It hit his target priceat point D, and he covered his short.
Sensing a shift in the investment winds, he went long on the stock at thesame price but put a stop loss '/8 below the lower trendline. The following dayprices hit his stop at 29'/4 and he took a small loss. For some unexplained reason, Palmer walked away from the stock at this point. Perhaps it was the smallloss he incurred on his last trade, or perhaps he was just running low on caffeine.
(
3Broadening Formations,Right-Angled andDescending
RESULTS SNAPSHOTAppearance
Horizontal top with lower lows following a downsloping trendline
Reversal orconsolidation
Short-term (up to 3 months) reversal
Failure rate if waitedfor downsidebreakouts
3%
Failure rate if waitedfor upsidebreakouts
19%
Average rise
27%, but most likely rise is between 20% and 30%
Average decline
19%, but most likely decline is about 10% to 15%
Volume trend
Irregular
Fullbacks
33%
Throwbacks
23%
Percentage meetingpredicted pricetarget
69% for successful downside breakouts, 89% forsuccessful upside breakouts
40
Tour
41
Before I begin studying a particular formation, I review the available literatureand determine in which direction the breakout is likely to occur. For the general class of broadening formations, the breakout pattern is said to be down:Broadening formations are apparently bearish. After I completed the statisticsfor this formation, however, I surprisingly found that more right-angleddescending broadening formations broke out upward than downward. At first
I logged the upside breakouts as failures since I expected the correct breakoutto be down. I was wrong. I reexamined the literature and discovered thatdescending broadening formations could break out either way. So I reworked
the statistics and scanned all the formations again to make sure that they agreedwith the new methodology.The first thing you may notice in the Results Snapshot is that the reversal or consolidation line does not say whether the formation is bullish or bearish. That is because it depends on the breakout direction. If the breakoutdirection is up, which it is 57% of the time, the formation is bullish. For downside breakouts, which occur 37% of the time, the formation is bearish. Thebalance have horizontal breakouts or no specific breakout direction.Only those formations that break out and continue in the opposite direction classify as failures (the so-called 5% failures). I consider failure rates below20% acceptable, so the rates for both breakout directions score well.The average rise (27%) or decline (19%) are both below par. Bullish formations usually have gains of about 40% and bearish ones decline about 20%,on average. However, the most likely rise for upside breakouts is reassuring, at20% to 30%. Since the tabulation uses a frequency distribution of gains, thenumbers imply that the returns distribute evenly. In other words, there are few
large gains to skew the average upward. Unfortunately, with a small samplesize, the numbers are suspect. I believe the most likely rise is probably in the10% to 15% range, as it is for most other bullish formations.The measure rule works out better for this formation than for the ascending broadening formation. For downside breakouts, almost 7 in 10 (69%) meetor exceed their price targets, whereas 89% of upside breakouts reach theirs.The first statistic is borderline, but the second is reassuring. The meaning isalso clear: Wait for the breakout, then place a trade in the direction of the
breakout.
TourWhat do descending broadening formations look like and why do they form?Figure 3.1 is an example of the chart pattern. The characteristic flat top anddown-sloping bottom are apparent in the figure. These are the two key ingredients. Prices at the top of the formation reach the same price level beforedeclining. Over time, a horizontal trendline can be drawn connecting them.
42
Broadening Formations, Right-Angled and DescerT
Valero Energy Corp. (Petroleum (Integrated), NYSE, VLO)
.d
Applebees (Restaurant, NASDAQ, APPB)
Jun 95
Figure 3.1 Descending broadening formation. A horizontal trendline along thetop and a down-sloping trendline connecting the minor lows is characteristic ofthis chart pattern. The extended, down-sloping trendline shows future support andresistance zones. A one-day reversal appears on November 3 when prices pushedabove the formation top on high volume, but closed at the low for the day.
Along the bottom of the formation, the minor lows touch a down-slopingtrendline before prices rebound. Eventually, prices break out of the formationby either closing above the top trendline or below the bottom one.In Figure 3.1, the breakout is downward since prices close below the lowertrendline. I require prices to close outside the trendline so that is why the peakon November 3 does not classify as an upside breakout. On that day, prices closeat 19, the low for the day, and below the top trendline value of about 191/2.I mentioned in the Results Snapshot discussion that most descendingbroadening formations have upside breakouts. Figure 3.2 shows an example.The top of the formation is well formed with several minor peaks reaching thesame price level. However, three one-day touches compose the lower trendline. A trendline touch is a trendline touch regardless of whether it is composedof one-day spikes or many days of consecutive touches.Figure 3.2 shows a broadening formation with an upside breakout providing a 10% rise in just over 2 weeks. During May 1996, the stock reached 29, fora 25% gain. The figure also shows one of the few throwbacks to the top of theformation. This one occurs almost 4 weeks after the breakout. I consider throwbacks or pullbacks that occur later than 30 days to be just normal price action,not due to the throwback or pullback. This one just makes the cut at 27 days.
Figure 3.2 Another descending broadening formation but this time the breakoutis upward. Almost 4 weeks after the breakout, prices throw back to the formationbefore ultimately moving higher.
Figure 3.3 Two descending broadening formations. The first formation shows atrendline rebound resulting from an earlier support zone. The second formationshows a partial rise that often precedes the ultimate breakout. Shown are two resistance areas that parallel the trendlines.
43
44
Identification Guidelines
Broadening Formations, Right-Angled and DesceC ;g
Why do these chart patterns form? Look at Figure 3.3. During 1993, thestock entered the first formation in early April and moved higher on moderatevolume until it reached about 35. There, investors selling the stock matchedbuyers eager to own the security and the rise stalled. It traveled sideways untilMay 10 when it moved below the prior minor low. As the stock approached the31 level, it entered a support zone set up by the retracement in mid-March.The decline stalled and moved sideways for several days. Due to the supportlevel, many investors believed that the decline was at an end and the stockwould move higher. It did. As volume climbed, the price gapped upward andquickly soared back to the old high.The stock ran into selling pressure from institutions and others trying tosell a block of shares at a fixed price. The available supply halted the advance.Prices hung on for a few days, moved a bit lower, and paused before beginninga rapid decline to a new minor low.As volume climbed, the stock declined until it touched the lower trendline, a region of support. Suspecting an oversold stock, investors bought andforced it higher again. When the stock reached the old high, there were fewershares available for purchase. Apparently, those investors and institutions whowere trying to get 35 a share for their stock sold most of their shares in the preceding months. Soaking up the available supply, the stock gapped upward andclosed above the old high. An upside breakout was at hand.The stock moved higher but soon formed another descending broadening formation. This one was compact and tight but had bearish implications.
45
Table 3.1Identification Characteristics of Right-Angled Descending Broadening FormationsCharacteristic
Discussion
Shape
Looks like a megaphone, tilted down, with the top ofthe formation horizontal and bounded on the bottomby a down-sloping trendline.
Horizontal top resistance line
A horizontal line of resistance joins the tops as atrendline. Must have at least two distinct touches(minor highs) before drawing a trendline.
Down-sloping trendline
The expanding price series is bounded on the bottomby a down-sloping trendline. Must have at least twodistinct minor lows to create a trendline.
VolumePremature breakouts
Irregular with no consistent pattern.Very rare. A close outside the trendline is most likely agenuine breakout.
Breakout
Prices can break out in either direction, usuallyaccompanied by a rise in volume that soon tapers off.
Partial rise or