, prices throw back tothe breakout point. However, prices continue moving down. Scrolling Figure12.4 to the left, you would see prices making a new low in September 1993 at31/8, below the February low of 34.Had you purchased this stock on the breakout and held on, you wouldhave lost money. I call this type of failure a 5% failure. Prices do not rise bymore than 5% above the breakout before heading lower. Fortunately, 5% failures are also rare; they occur only 17 times in this study. To put that statisticin perspective, it means that on 525 separate occasions prices continue upwardby more than 5%.Figure 12.5 shows an example of a second type of failure that perhaps you,too, have seen. Ted is a novice investor with an attitude. He looks at the stockchart, checks the identification guidelines, and believes that the stock is making a double bottom. When prices rise after the second bottom, Ted decides topull the trigger early and buys the stock, receiving a fill at 425/s. He reasons thatall the indications suggest the stock has completed a valid double bottom. Thatbeing the case, why not get in now while the price is still low instead of waiting for prices to rise above the confirmation point (461/*)? Ted makes a goodpoint. He is pleased with the stock's performance until it begins to round over.
Does he sell out now at a small profit or should he hold on and risk a downturnwhile waiting for additional gains? This is a recurring investor dilemma.He decides to hang on to his position. During May, the stock surgesupward again before beginning a downhill run. Ted watches in horror as his
profit vanishes and losses mount. Eventually, when prices spike downward, hesells at the opening the next day and closes out his position.
189
Air Products and Chemicals Inc. (Chemical (Diversified), NYSE, APD)
|an93
Feb
Figure 12.5 Example of second type of failure—failing to wait for breakout confirmation. Ted decided to get an early start on the double bottom but ended uplosing money.
What did he do wrong? He failed to wait for breakout confirmation.Prices must close above the confirmation point before a trade is placed. Otherwise your chances of success are only one in three. We discuss how to tradethis formation properly in the Trading Tactics section of this chapter.
Flightsafety Intl. Inc. (Aerospace/Defense, NYSE, FSI)
StatisticsThe statistics shown in the following tables only refer to formations that qualify as being true double bottoms. This means prices must close above the confirmation point (the highest price between the two bottoms). Table 12.2 showsthe general statistics for double bottoms. There are 542 formations in 2,500years of daily price data. Of these formations, 372 or 69% act as reversals of theprevailing trend.
Jan 93
Feb
Mar
Apr
May
Jun
jul
Aug
Sep
Figure 12.4 Example of a 5% failure. This rare occurrence happens when pricesplummet after rising less than 5%.
Nearly all the formations (97%), continue moving above the confirmation point after an upside breakout. The remainder fail to continue upward bymore than 5% before heading back down. This statistic suggests that youshould buy the stock after an upside breakout. In all likelihood, prices willcontinue rising.The average rise for formations with successful upside breakouts is 40%.However, the most likely rise is between 20% and 30%. Figure 12.6 shows agraph of the gains. The chart is built by sorting the gains into various bins andcounting the number of entries in each bin. The resulting frequency distribution
190
Statistics
Double BottomsTable 12.2General Statistics for Double Bottoms
Description
Statistic
Number of formations in 500 stocks from1991 to 1996
542
Reversal or consolidation
170 consolidations, 372 reversals
Failure rate
17 or 3%
Average rise of successful formations
40%
Most likely rise
20% to 30%
Of those succeeding, number meeting orexceeding price target (measure rule)
370 or 68%
Average formation length
2 months (70 days)
Average price difference between bottoms
2%
Average rise between bottoms
19%
Percentage of times left bottom price is lowerthan right
52%
Cains for lower left versus lower right bottom
39% versus 39%
shows the influence large gains have on the overall average. You can see in thechart that there are a significant number of large gains. If you consider anythingabove 50% a large gain, then almost a third of the formations fit into this category. The large gains tend to pull the overall average upward.
40
50
60
Percentage Gain
Figure 12.6 Frequency distribution of the gains for double bottoms. The mostlikely rise is between 20% and 30%.
191
The measure rule, discussed at length in the Trading Tactics section ofmis chapter, is a method used to predict the minimum price rise for a stock.One simply computes the formation height and adds the value to the confirmation point. The result is the price level to which it is hoped the stock willrise at a minimum. Using this method, two-thirds (68%) of the formationsmeet or exceed their predicted price targets. This 68% value is low, as I consider values above 80% to be reliable.The average formation length is just over 2 months (70 days) as measuredfrom bottom to bottom. The minimum length is arbitrarily limited to 10 daysas a selection guideline. Although I formally established no maximum length,there were a few formations well over a year long. I removed them from consideration. As a result, the formation length ranges from 15 to 374 days.The average price variation measured between the two bottoms is 2%,half the 4% guideline maximum. The intent of this statistic is to show that thewo bottoms appear to be on or near the same price level.The rise between the two bottoms averages 19%, with a 10% minimum
set as a guideline. The confirmation point is the highest price reached betweenthe two bottoms. It is used to compute the formation height and to confirm an
upside breakout.The two bottoms are at nearly the same price level, with slightly more leftbottoms at a lower price (52%) than right bottoms (48%). I checked the gainsfor formations with either a lower left or lower right bottom and both typesperform equally well (in other words, formations with a lower left bottom havegains of 39%, the same as those with a lower right bottom).Do bottoms spaced closer together show larger gains than those spacedfarther apart? Yes. Consider Figure 12.7, a chart of the gains mapped onto afrequency distribution of the distance between the two bottoms. The chart saysthat if you have a bottom separation of 3 weeks, the average gain is 42%. Alarger separation, say about 4 months, gives an average gain of just 23% forthose formations in this study.Table 12.3 shows breakout statistics for double bottoms. There is a timedelay between the second bottom and the actual breakout. The reason for thedelay is that it takes time for prices to rise from the second bottom to the confirmation point. For the formations in this study, the delay is about a monthand a half (43 days).Since this study only considers true double bottoms, those with prices rising above the confirmation point, all 542 formations have upside breakouts.Once an upside breakout occurs, 17 formations initially move higher but throwback to the formation and continue down. In these cases, prices did not rise bymore than 5% before returning to the formation. This 5% failure, like thatshown in Figure 12.4, is quite rare and should not be of major concern.There are a significant number of throwbacks to the breakout price(68%). Such a high throwback rate suggests an investment strategy: Wait for
192
Statistics
Double Bottoms
193
Once an upside breakout occurs, how long does it take to reach the ultimate high? Although the average time is about 7 months (204 days), oneshould temper this value by realizing it is an average. Should your particularformation rise by only 10% or 15%, the time to reach the ultimate high likelywill be shorter—probably about 2 months.Where in the yearly price range do double bottoms occur? Surprisingly,
most (46%) occur in the center third of the range. Mapping the percentagegain into the yearly price range shows the average gain is about equal for allthree ranges. The result suggests that most double bottoms occur after a runup in prices. Once prices back off their yearly high and trend down for a while,they form a double bottom and begin climbing again.You might expect that formations falling furthest (those in the lowestthird of the yearly price range) rebound higher. That appears to be the case,with a 42% gain. You might also expect that those double bottoms occurringnear the yearly high would get caught in upward momentum and soar evenhigher. Those formations with breakouts in the upper third of their price range35
49
63
77
91
Trough Separation (days)
Figure 12.7 Price rise versus trough separation. Do bottoms closer together resultin the larger gains? The graph suggests the answer is yes.
the throwback, then invest after prices recover. The Trading Tactics section ofthis chapter discusses this strategy further.The average time for prices to return to the breakout price is 11 days,which is about the same value for many formation types. No throwbacks occurover 30 days. Throwbacks occurring beyond a month are not throwbacks at all,just normal price fluctuations.
Table 12.3Breakout Statistics for Double BottomsDescription
Statistic
Average days after right bottom to breakout
43 days
Upside breakout
542 or 100%
Upside breakout but failure
17 or 3%
Throwbacks
366 or 68%
Average time to throwback completion
11 days
For successful formations, days to ultimate high
show gains of 41%.Table 12.4 contains volume statistics for double bottoms. The first bottom has higher volume 58% of the time, whereas the right bottom has highervolume 42% of the time. About two-thirds of the time (65%), the volumetrend throughout the formation is downward. I computed this by finding theslope of the linear regression line of volume over the formation from the leftto right bottom. Excluded from the calculation is the run-up from the rightbottom to the breakout point because it often results in above average volume.After a breakout, volume usually surges for a few days but quickly returns
to normal. Table 12.4 shows the average volume for the day of the breakoutuntil a week later. You can see how quickly the volume drops, from 165% ofthe prior day's value to 18% below a week later.Are low volume breakouts more likely to throw back to the breakout price?No. Both high and low volume breakouts throw back to the breakout price 65%of the time.Table 12.4Volume Statistics for Double BottomsDescription
Statistic
Percentage of left bottoms having highervolumeNumber showing downward volume trend
58%
7 months (204 days)
Percentage of breakouts occurring near 12-month low (L),center (C), or high (H)
Volume for breakout day and next 5 dayscompared with day before breakout
165%, 133%, 105%, 92%, 89%, 82%
128%, C46%, H25%
Percentage gain for each 12-month lookback period
L42%, C38%, H41 %
Percentage of high and low volume breakoutssubject to throwback
65%
351 or 65%
194
Double Bottoms
Trading Tactics
195
Bane One Corp. (Bank, NYSE, ONE)
Trading TacticsTable 12.5 shows trading tactics for double bottoms. The measure rule predicts die minimum price move expected once a double bottom experiences anupside breakout. Consider the chart pictured in Figure 12.8. To calculate thepredicted price, first determine the formation height by subtracting the lowestlow from the highest high in the formation. Tn Figure 12.8, the lowest lowoccurs at the right bottom, with a price of 27.57. The highest high, marked onthe figure by point A, is 31.09. Add the difference, 3.52, to the confirmationpoint, or the highest high between the two bottoms (that is, 31.09 + 3.52).Again, the highest high is point A. The result, 34.61, is the expected minimumtarget. You can see in the chart that prices meet the target in late December.A few days after meeting the target, prices momentarily descend before resuming their climb. During mid-April, the stock reaches its ultimate high price of
40.26 before declining.After you locate a potential double bottom, review the selection guidelines before placing a trade. Figure 12.8 shows a declining price trend leadingto the first bottom. The rise between the two bottoms is about 13%, just abovethe 10% threshold. The two bottoms are at nearly the same price level and several months apart.Very high volume appears on the left bottom with substantially reduced
Apr 92
May
Figure 12.8 Double bottom trading dilemma. How do you trade this doublebottom? Do you buy just after the second bottom or wait for prices to rise abovethe confirmation point? You wait for prices to recover after the throwback, thenbuy. A rounding bottom appears from point A to the breakout.
volume on the right bottom, which is typical. The overall volume trend slopesdownward from the left bottom to the right, as expected.
Once the second bottom of a double bottom occurs, you can use the measure rule to estimate the minimum price move. If the potential profit is largeenough, then wait for the breakout. This cannot be overemphasized. With a
dismal failure rate of 64%, you must wait for an upside breakout. Figure 12.5is an example of what happens if you do not.
A close above the confirmation point signals a breakout. The confirmationpoint is simply a fancy way of saying the highest high reached between the twobottoms. Shown is the confirmation point, marked point A in Figure 12.8, anda line extending to the breakout point.Once prices close above the breakout point, should you buy the stock?Probably not. Since two-thirds of the formations rise up, then quickly return
Table 12.5
Trading Tactics for Double BottomsTrading Tactic
Explanation
Measure rule
Compute the formation height by subtracting the lowest lowfrom the highest high in the formation. Add the difference tothe highest high between the two bottoms (the confirmationpoint). The result is the expected minimum price move.
Wait for breakout
Since only 36% of the formations break out upward, youmust wait for an upside breakout before placing a trade.
Wait for throw/back
Two-thirds of the formations throw back to the breakoutprice. Therefore, consider waiting for the throwback and forprices to head upward again.
to the breakout price, it is wise to wait. Once prices complete the throwback tothe breakout point, they may continue moving down. Usually, however, theyturn around and start heading higher. In either case, wait for prices to stopdescending and begin climbing again. When that happens, buy the stock.However, following this guideline means that you will miss some potentiallyprofitable opportunities.
For short-term gains, sell as prices near the target price. Only 68% of theformations meet their price targets, so be ready to take profits as the targetnears or if weakness intervenes.For intermediate- and long-term investors, you can hold on to the stockand hope for an extended upward move. Of course, a review of the fundamental factors supporting the price rise is often a key to large gains. Use the double bottom formation to time your entry and the fundamentals to justify acontinued presence in the stock.
196
Double Bottoms
13
Sample TradeLauren is a school teacher. Although she loves teaching kids, she would muchprefer raking in the dough by day trading stocks over die Internet. Until thattime, she shoehorns her investment activities into the few hours of free timeshe has each week.When she spotted the double bottom shown in Figure 12.8, she knew it
Double Tops
was love at first sight. The rounding bottom pattern (from point A to thebreakout) suggested higher highs were in store. However, she resisted thetemptation to get in early because she could not guarantee prices would continue moving up. She justified her action by pretending that she was teachingher students how to trade. If she could not do it properly, how could they?
When prices reached the high between the two bottoms, Lauren decidedto buy. Just before she placed her order, the broker read off the current quotation. It was well above the confirmation point. So she decided to wait and prayfor a throwback.
About 4 weeks after the breakout, prices dipped to the buy point, but wouldthey continue down? She had to wait until she felt confident that prices wouldrise. To her, this occurred a day later, on November 27. That day prices made ahigher low and she felt comfortable buying the stock. It was a gamble, because 2days of rising prices hardly make a trend. Still, she was getting antsy and did notwant to wait too long and watch prices rise above the level that she could havebought a month before. So, she bought the stock and received a fill at 313/s.The following day, volume spiked to over three million shares and pricesjumped over 3/4 of a point. The spike made her nervous as it reminded her of a
R E S U L T S SNAPSHOTAppearance
Two well-defined peaks, separated in time but atnearly the same price level
Reversal or consolidation
Short-term (up to 3 months) bearish reversal
Failure rate
65%
Failure rate if waitedfor breakout
17%
of 307/s, about % below the recent minor lows, an area of prior support.
Average decline
20%, with most likely decline between 10% and 15%
The following day prices moved down but succeeding days saw themrebound. In mid-December, the stock went ballistic and fulfilled the measurerule. She could not make up her mind if it was worth selling at that point. Bythe time she decided to sell, the stock had returned to the up-sloping trendline
Average volume trend
Downward until breakout
Fullbacks
69%
Percentage meetingpredicted price target
39%
one-day reversal, but the stock closed at the high for the day, which is odd for
the formation. That is when she remembered to place a stop. She chose a price
(drawn connecting the lows in September through January), so she held on.
The stock moved up. In late March, the stock jumped sharply, climbingalmost 1 1 /2 in 1 day. That was a big move for the stock and she wondered whatwas going on. She followed the stock closely and it became obvious the stockhad entered the bump phase of a bump-and-run reversal. Periodically, as the
Surprising findings
Tops closer together, deep troughs, and high volumebreakouts all show larger losses.
See also
Head-and-Shoulders Tops, Complex; Horn Tops
stock climbed, she penciled in the sell lines parallel to the original bump-and-
run reversal trendline. As she looked at the chart, she saw the narrow peakappear and knew the end was near. When the stock dropped below the nearestsell line, she placed an order to sell her holdings and received a fill at 385/s.She cleared 22% on the trade, but on an annualized basis, she made 60%.She smiled, knowing that annualized numbers were something her math classneeded to learn. Now she had the perfect example.
The study of double tops results in several surprises. The failure rate at 65% isworse than just tossing a coin. If you blindly sell your holdings before the
breakout, you will likely miss out on some handsome upside gains. If, instead,you wait for the breakout, then you will be correct in dumping your shares
83% of the time. However, almost half the formations decline less than 15%,and nearly two out of three formations fall shy of their predicted price targets.197
198
Double Tops
V
jic Scientific (Precision Instrument, NYSE, PSX)Second Top
Such poor performance statistics might make you think seriously about hanging onto your shares.
Fullbacks to the breakout point are high at 69% . Once a breakout occurs,you can probably safely wait for the pullback to complete and prices to headdown again before selling.Double tops spaced closer together have larger losses than those withpeaks spaced farther apart. With peaks close together, investors are more likelyto recognize a double top and try to take advantage of it.There is also a relationship between the size of the decline between thetwo peaks and the resulting percentage loss. Formations with large peak-totrough declines also have large losses when compared to small trough declines.High volume breakouts result in statistically significant performance differences than those with low volume breakouts. In other words, formationswith high volume breakouts decline further. The Statistics section of this chapter explores these findings.
Tour
Sep 94
Oct
Nov
Dec
}an 95
Feb
Mar
Apr
May
Jun
Figure 13.1 A double top has twin peaks that are usually several months apartbut quite near in price. Only when prices decline below the valley floor is a doubletop confirmed as a valid formation.
Along with the head-and-shoulders formation, double tops are perhaps the
most popular. Many novice investors see a dual peak on the stock chart andproclaim it to be a double top. It probably is not. There are a number of characteristics that compose a true double top and I discuss them in a moment, but,first, what does a double top look like?Consider Figure 13.1, a double top in Pacific Scientific. The first thingone notices are the twin peaks. They are near the same price level and widelyspaced. The price trend leading to the first peak is upward and prices fall awayafter die second peak.
Table 13.1Identification Characteristics of Double TopsCharacteristic
Discussion
Upward price trend
Leading to the formation, prices trend upward over theshort to intermediate term (3 to 6 months) and usuallydo not rise above the left top.
Decline between tops
There should be at least a 10% decline between the twotops, measured from high to low. Some analysts require a20% decline with peaks spaced a month or more apart(the deeper the trough the better the performance). Thevalley is usually rounded looking but can be irregular.Two distinct tops with a price variation between peaks of3% or less. This is not crucial except that the two topsshould appear near the same price level and not be partof the same consolidation pattern.Tops should be a few weeks to a year apart. For widelyspaced peaks, use weekly charts.After the second top, prices must dose below the confirmation point without rising above the right top high.
The intervening valley is just that: a valley that sees prices decline by 10%
or 20%, sometimes more. The valley floor forms the confirmation level or point.The confirmation point is the lowest price between the two peaks and signals adownside breakout once prices close below it. A twin peak formation can onlyclassify as a true double top once prices close below the confirmation point.There is usually a pullback such as that shown in Figure 1 3 . 1 . A pullbackallows investors another opportunity to exit their position before the declineresumes. For more adventurous traders, the pullback is a chance to make ashort sale in the hope that prices will continue falling.
Identification Guidelines
Dual tops
Top distance
Prices decline after right topVolumeBreakout volume
Table 13.1 contains a host of guidelines that assist in correctly identifying double tops. The general price trend is the first guideline. Prices should be trending upward on their way to the first summit. The price trend should not be a
retrace in an extended decline but generally has the stair-step appearance such
Confirmation point
Usually higher on the left top than the right. Overall
volume trend is downward.Volume is usually high but need not be. High volumebreakouts decline further.The confirmation point is the lowest low between the twotops. Prices closing below the confirmation point confirma double top and the breakout.
199
200
v
Double Tops
as that shown in Figure 13.2. Of course, rapid rises occur. The guideline is thatthe rise should happen over several months and culminate in a top.Figure 13.2 shows a rise that begins in October 1993 and peaks during thefollowing March. The climb takes prices from a low of 25l/2 to a high of 40.Then prices descend for a few months before climbing to the second peak. Thesecond peak tops out at 39, just 2.5% below the first peak.The time between the two peaks is about 5 months, far enough apart toform two distinct peaks with an intervening rounded, valley. The valley floorbottoms out at 32'/z, far below the highest peak of 40. The decline, at 19%, iswell above the 10% minimum.After the second peak tops out, prices decline away from it at a steadyrate. Soon prices close below the confirmation point, which is the lowest lowin the valley, and continue moving down. When that happens, it confirms boththe downside breakout and the formation as a double top. Prices must close belowthe confirmation point before the formation becomes a true double top. This qualification cannot be overemphasized.Prices often will decline below the second peak then turn around and
continue rising. Sometimes a third peak forms and sometimes prices just sailaway. In two out of three instances, prices will not descend to the confirmationpoint at all—they just rise above the twin peaks and continue moving higher.The Focus on Failures section discusses this behavior in more detail.The volume pattern is what you would expect. It is usually higher on theleft peak, diminished on the second peak, and above average on the breakout.
Identification Guidelines
201
Higher volume on the left peak and lower volume on the right peak help support the overall receding volume trend of the formation. Figure 13.2 showshigher volume on the left top and very low volume on the right one. Breakoutvolume is at about the same rate as the first peak—high but not as enthusiasticas it could be. Breakout volume is not a crucial factor in the validity of the formation, but formations with high volume breakouts tend to decline further.Why do double tops form? Consider Figure 13.3, a well-shaped doubletop that satisfies all the identification guidelines. The stock essentially beginsrising in October 1992 at a price of 97/s. At the start, volume is unremarkablebut does have its moments. On spurts, like that shown during March and again
in April, volume spikes upward and helps propel the stock higher.Many unfortunate investors bought near the left top hoping prices would
continue higher—a momentum play. However, astute technical investors recognized the price pattern for what it really was: a measured move up. The firstup-leg occurs in just 3 days. It is followed by horizontal movement for severalweeks and another swift rise to the first top.
Once the measured move completes, volume dries up and the upwardmovement stalls. Prices move down and form a base in early May that sees alow of 153/4. The consolidation lasts almost 2 months on light turnover.The price decline from peak to trough is not much in dollars, but it represents a 20% decline. Comparatively few investors take advantage of the pricelull to add to their position or place new trades. Those investors that buy in atthe top swear they will sell just as soon as they get their money back. When
Trinova Corp. (Machinery, NYSE, TNV)USF & G Corp. (Insurance (Prop./Casualty), NYSE, FG)First TopFirst Top
O
N
SecondTop
95
Feb 93
Figure 13.2 Double top on the weekly scale. Prices in this double top rise from afloor of 25^ to 40 in about 5 months. Prices closing below the confirmation levelconfirm a downside breakout and the formation itself.
Mar
Figure 13.3 Well-shaped double top. Prices do not push above this double topfor over 3 years. A measured move up formation forms the rise to the left top.
202
Double Tops
Focus on Failures
prices start to rise again, many of them pull the trigger and sell their shares.The volume pattern, which up to this point has been flat, bumps up and takeson a more rugged appearance (during late June and into July). Other investors,believing that the consolidation is over, buy for the first time.As prices round over and form the second peak during July some investorscorrectly assume that a double top is forming. They sell their shares near thetop, content with the profits they have locked in. Other intrepid traders sellshort and hope prices fall. Prices do fall but stop at the top of the consolidationarea formed between the peaks a few months earlier.After a prolonged attempt at creating a third peak in late August and intoSeptember, prices gap below the confirmation point at 15%. A downsidebreakout begins. The smart money sells their shares immediately and lickstheir wounds. Others hope the selling is overdone while still others sell short.
The stock attempts a pullback in mid-October but gives up. For the next3 years, until the end of this study, prices fail to rise above the high establishedby the double top.
203
First, the volume pattern is suspect. Volume on formation of the left top is highbut lasts only 1 day. The right top volume is dense, high, and remains high forabout a week as the top forms. However, in defense of the formation, the volume pattern often varies from the norm and offers little clue to the eventual
outcome.The second guideline violated is the more important of the two. Pricesfail to close below the confirmation point. When considering all twin peakchart patterns in this study, two out of three (65%) perform as the one shownin Figure 13.4. In other words, they move higher. Why?Expect top reversals (such as the double top) to perform poorly in a bull
market, whereas bottom reversals should excel. That appears to be the casewith many of the formations covered in this book. The key point to rememberabout Figure 13.4 is that you must wait for prices to drop below the confirmation point before placing a trade. Otherwise, you stand a good chance of cashing out too soon or getting taken to the cleaners if you sell short.If you do wait for confirmation, then the probability rises to 83% thatprices will continue moving down. Of course, that is small comfort if you happen to run into a 5% failure. Consider Figure 13.5, a double top that obeys the
Focus on Failures
identification guidelines including closing below die confirmation level.
What does a double top failure look like and can anything be learned from it?Consider Figure 13.4, a common failure of a double top. The twin peaks satisfy all the identification guidelines outlined in Table 13.1 with two exceptions.
March 1993, representing a rise of over 60%. Prices retreat for a month beforegathering steam and trying for a new high. They succeed at the beginning of
The uphill run starts in May 1992 and culminates in the top during
Sep 95
Oct
Apr
May
June, when prices crest the old high by 5/8.
|un
Figure 13.4 A common double top failure. Prices decline after the second peakthen rise before reaching the confirmation point.
Figure 13.5 A double top formation that suffers a 5% failure. Prices fail to continue moving down by more than 5% before rebounding.
204
Statistics
Double Tops
However,