all uses the medianheight already described. Narrow means narrower than the 42day median (upward breakouts) or 39-day median (downwardbreakouts). Tall and narrow symmetricals with upward breakoutsrise an average of 41%. Short and narrow triangles, by contrast,show price rising just 25% after the breakout.• Symmetricals with breakouts within a third of the yearly low perform better than do those with breakouts in the other ranges.Those near the yearly high perform worst. This reinforces whatothers have found about symmetricals doing well at the start oftrends.Measuring Success
The measure rule is the same as what we’ve seen before, but we can add atwist. First, let’s discuss the standard model. Consider the inset in Figure7.19. It shows another version of the August symmetrical triangle. Themeasure rule gauges the height from F to G and adds/subtracts the resultto the breakout price at H (where price closes above/below the trendline).For ascending triangles, the height is the difference between thelowest valley in the chart pattern and the price of the horizontal trendline. Add or subtract the result from the breakout price for upward anddownward breakouts, respectively.Another method to predict a price target is to draw a line parallel tothe upsloping (for upward breakouts) or downsloping (for downwardbreakouts) trendline, beginning from the start of the pattern. I show thisin the inset as line D which is parallel to line E, starting at F. Where pricebreaks out of the triangle, the value of line D directly above is the target price.For downward breakouts, draw a line parallel to the downslopingtrendline (starting from G), and where price breaks out of the symmetricaltriangle, the value of the parallel trendline on that day is the target price.This method works for ascending and descending triangles as well.If prices break out in the direction of the sloping trendline, just draw aparallel line beginning from the start of the pattern until the day of thebreakout.
Ascending and Symmetrical Triangles
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Questar Corp. (Natural Gas (Diversified), NYSE, STR)51504948
DF
4746H
G
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FIGURE 7.19 Two symmetrical triangles presented trading opportunities.The black circles are the locations and prices of stop-loss orders.
If you use both methods to determine a target price, choose the onethat is closest to support or resistance (where price is likely to reverse), orone that is closest to the chart pattern. It doesn’t hurt to be conservativein your target.For ascending triangles, the standard measure rule works 75% ofthe time for upward breakouts and 68% for downward breakouts. Forsymmetricals, upward breakouts hit the target 66% of the time anddownward breakouts score 48% of the time. The numbers are below the80% hit rate that I like to see, so be conservative in your target selection.Case Study
Jake’s grin was a large as a watermelon slice. He seemed positively buoyant. “I see you’re looking at Questar. Let me tell you about two triangletrades I made in that.”Figure 7.19 shows two symmetrical triangles, both with downwardbreakouts, and both are busted patterns.“A busted pattern provides an excellent trading opportunity becauseeveryone is so upset with losing money, it gives traders an easy entry,”
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Jake said. “Two days after the breakout, I bought the first time.” Hebought 400 shares at 36.85. Then he put a stop at 34.19, just below thebreakout low where prices stopped declining in early May. The triangleapex is a support zone, but he wanted the stop farther away, just in case.As prices rose, he raised the stop as the black circles on the chartshows. Each circle represents the price and day at which he raised his stop.The circles generally correspond to price peaks—new highs that signal it’stime to raise the stop.“When price started going exponential [climbing steeply], I tightened the stop to 40.75. Those steep rises never last. In fact, I was stoppedout the next day.”The price target he was shooting for was 39.26, which is the heightof the triangle added to the breakout price, so he did better than that. “Imade just over $1,500 or 10%.”“I was taken to the cleaners on the second trade.” He bought 400shares at 40.91. He expected the symmetrical triangle to break out upward as the stock was higher when the S&P 500 index was down as heplaced the trade. That showed strength, but natural gas prices were trending lower—“not good for a company with gas,” he said and smiled, thensniffed the air and crinkled his nose as if smelling something unpleasant.He anticipated the stock completing a measured move up pattern to48 (34.26 at point A to 42.06, point B, projected upward from 40.50point C, the apex of the triangle then rounded down to 48).For support, the round number 40 would help, he reasoned, keeping any loss to a minimum. On the weekly scale, a downward breakoutcould take the stock back to the consolidation region at 36—the site ofthe prior symmetrical triangle.“A symmetrical triangle in an uptrend usually breaks out upward, sothat’s the bet I made. Later I found out that the uptrend-upbreakoutscenario happens only 55% of the time. That’s about random.”Just after he bought the stock, he placed a stop at 39.43, for a potential loss of 3.6%. He selected 39.43 because it was below the triangleand below the 39.50 round number (everyone else would place their orders at the even 50 cents).“When price closed outside the lower boundary of the symmetricaltriangle, I decided to sell. Other stocks in the industry were soaring gangbusters while this one moved horizontally. Yes, a region of consolidationis expected after a run-up, but this stock didn’t do what I expected.” Hesold the stock at 40.20, for a loss of 2% or $300.
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A chart pattern not acting as expected is always a good reason forselling. Imagine the stock backtracking to 36 or even lower. You can seewhat happened to the stock. It bottomed a day later, and then shot outthe top of the triangle and continued higher. Nevertheless, Jake cut hisloss short as soon as the trade went against him.
Triple TopsMany know triple tops yet few have actually caught one in the bush.Why? Because they are a rare breed, coming out most often in a bearmarket. While it’s common for prices to make a second top at the sameprice, adding a third one is unusual. A third top shows formidable overhead resistance and a chance to make money or get out of an existingtrade before the smart money catches you trespassing.Identification
Figure 7.20 shows a triple top at peaks 1, 2, and 3, with a horizontal confirmation line joining the lowest valley in the pattern. When price closesbelow the line, it confirms the three-peak pattern as a valid triple top andpredicts the price raft is about to tumble over the falls. If unconfirmed,then you don’t have a triple top, just more squiggles on the price chart.Triple tops are rare, so don’t expect them to appear often. In yourtrading, if you think a triple top is going to form because you have twopeaks at the same price and price is climbing to the third, don’t bet on it.Chances are that price will continue moving up, invalidating the tripletop, or prices may reverse before coming close to the other two peaks.I’ve been burned trying to predict a triple top.What should you look for when hunting for triples? Here are theguidelines:• Find three peaks, each a distinct, well-separated peak. The peaksare often sharp, inverted V-shaped, or one-day price spikes.• The three peaks should top out near the same price. Often themiddle peak is slightly below the other two.• Volume trends downward 59% of the time but is usually high beneath each peak. The first peak usually has the highest volume.• The pattern confirms as a valid triple top when price closes belowthe lowest valley in the pattern.• More triple tops occur in a bear market than in a bull market.
COMMON PATTERNS FOR THE TOOLBOX
180
Anadarko Petroleum Corp. (Petroleum (Producing), NYSE, APC)
1 2
757371696765
3ConfirmationLine
63
45 6
6159575553
A
51494745434139Jan 01
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FIGURE 7.20 A triple top (peaks 1, 2, 3) appears just before prices tumble. The three-peak pattern becomes a true triple top when price closesbelow the confirmation line.
Are peaks 4, 5, and 6 a triple top in Figure 7.20? Yes. The threepeaks are unique tops, not ones that are part of the same consolidationpattern (although peak 5 does look suspicious). The peaks don’t top outat the same price but they are close, with the middle peak 1.7% belowthe other two. Volume trends downward and is highest on the first peak.Finally, the pattern confirms when price closes below the lowest valley inthe pattern (point A).Sometimes, the triple top is actually a right-angled and descendingbroadening pattern. Look at the valleys, especially to the left of the chartpattern. If you can draw a downsloping trendline connecting the valleys,then you may have a broadening pattern. Look for a partial rise or decline to trade the pattern.Trading and Trading Tips
If you can draw an upsloping trendline along the two valleys between thethree tops, use that as the sell signal (a close below the trendline). That will
Triple Tops
181
get you out much sooner than waiting for confirmation—a close belowpoint B in Figure 7.21.Another tip deals with peaks 2 and 3. When peak 3 is below themiddle peak (peak 2 in Figure 7.21), then expect a stronger decline. Alower top suggests weakness because price attempts to make a new highand fails.Triple tops have a high failure rate: 10% fail to decline at least 5%after the breakout. Look for underlying support to gauge how far pricewill drop. If price drops to the support zone and then rebounds, can youtolerate the loss? What happens if price pushes on through and tumblesto the next support zone?Measure the rise leading to the triple top and check for a Fibonacciretrace of 38% to 62%. Price will often sink that far before recoveringand moving to new highs. It may pay to hold on, especially if the marketand industry are moving up and you have a long-term position in thestock (or want to hold it long term for tax reasons). Otherwise, sell whenprice closes below the confirmation point, whether using an upslopingtrendline or below the lowest valley.Apache Corp. (Petroleum (Producing), NYSE, APA)1
2
323130
3
292827262524
4 5 6
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Shorted
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B
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C2019
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Covered
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FIGURE 7.21 Two triple tops appear like the prior figure: different stocksbut the same industry.
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Finally, a high velocity rise (above the median 10 cents per day)leading to the triple top gives a larger decline after the breakout thandoes a low velocity rise. I used the trend start to the highest high in thetriple top as the measure, so check the Glossary to find out how to findthe trend start. You can see this behavior most easily on the weekly scale.Triple tops with prices sliding into them almost horizontally tend tobreak out downward then reverse quickly.Here are additional tips:• Pullbacks occur 61% of the time.• Patterns with pullbacks have postbreakout performance that suffersan average decline of 18% versus 21% for those without pullbacks.Before trading, check for underlying support.• Patterns within a third of the yearly high decline most, 21% versus 19% for the middle third and 18% for the lowest third of theyearly trading range.• Volume trending upward between the three peaks means a largerdecline postbreakout, averaging 21% versus 18% for those withupsloping volume.• Patterns both tall and narrow perform better than the other combinations of height and width by declining an average of 23%.For height, use the difference from the highest peak to the lowestvalley divided by the price of the lowest valley. If the result isabove the 19.44% median in a bull market, thenyou have a tall pattern. Patterns narrower than theultimate lowmedian 75 days are, well, narrow. Avoid those thatI determine theare both short and wide. They have declines averagultimate low bying 17% postbreakout.looking after thebreakout for the• A quarter of the triple tops reach the ultimate lowlowest valleyin the first week after a breakout; a third bottom inbefore a minimum20% price rise,less than two weeks.measured fromthe lowest valleyto the close. Istopped looking ifprice closed abovethe formationhigh, assumingthat an investorwould have placeda stop-loss orderat that price.
Measuring Success
Use the measure rule to predict a target price. Therule is the height of the pattern subtracted from thebreakout price. The height is the lowest valley subtracted from the highest peak. The breakout price istraditionally the price of the lowest valley but you canuse a trendline pierce like that shown in Figure 7.21.
Triple Tops
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For example, the measure rule for the triple top 456 in Figure 7.21is the price at peak 6 minus C subtracted from C. That gives a target of18. In a bull market, price hits the target a paltry 40% of the time, so select a target closer than the predicted one. If you see underlying supportbetween the breakout and the target, then expect price to stall when itnears support. It may not, but that’s the way to play it.As a check, change the dollar decline into a percentage. In Figure7.21, the stock was expected to drop 2.79, or 13.5% below the breakoutprice. That seems possible, as the loss is comparatively small. An unlikelydecline would be something like 30% or 40%.Case Study
The chart in Figure 7.21 looks suspiciously like Figure 7.20. Both occurduring the same periods in the same industry, but in different stocks.“Instead of waiting for the usual confirmation,” Jake gestured at point B,the lowest valley in the pattern, “I was able to jump the gun by shortingat the trendline break.”Why did he short the stock? “I checked the S&P 500 Index and itstarted declining in September 2000. In fact, if you draw trendlines starting from the November highs and lows, you get a descending broadeningwedge.” Think of a megaphone tilted downward. “The pattern wasn’tperfect, but when price bumped up against the top trendline in May andheaded down, I knew the rise was at an end. That decline coincided withpeak 3 in the triple top.”Both the stock and the index declined in step, bottoming in lateSeptember. Jake measured the drop from peak 3 to A and projected halfthe decline downward from point 6, in a measured move down–type decline. That gave him a price target just below 19.Why didn’t he cover the short at point A, when price started moving up?“Straight-line runs like the drop from point 3 to A often retrace. Iallowed up to a 62% retrace of that down move, but prices only climbedhalfway before reversing at the triple top. Then I used the measure rulefor triples to project a new target price. It coincided with the MMD target,” the measured move down.When price started moving sideways in mid-September after hittinghis target, he covered his short. “I was worried the quick decline from 22to 18 would reverse and zip back up to 22, so I got out.”
8Chapter
Event PatternsWhat They Are andHow to Trade Them
found nearly a dozen events that happen often, some every few months.Many you can trade, but they are a risky bunch (the failure rates aremuch higher than chart patterns) and require nimble trading skills tomake a profit. I describe most of them in this chapter.
I
The Dead-Cat BounceJake stumbled into the office as if he were on drugs, with eyes glazed anda blank stare. “Is your arthritis acting up again?” I asked, not knowing ifhe was in pain.“Is that a joke?”I returned to working on my manuscript until he was ready to talk.“Merck just pulled their drug Vioxx (an arthritis painkiller) off theshelves. The stock plunged from yesterday’s close of 45.07 to 32 andchange. I own almost a thousand shares.”“A dead-cat bounce.”“Yeah. What should I do?” He looked at me, his body white, wringing his hands as if he was trying to squeeze the last drop of water out of adishtowel. Worry lines etched his face. Not a pretty sight, but I had ananswer.185
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“Wait for it to bounce and when it peaks, sell what you’ve got, andthen short it.”His face regained its color. The corners of his mouth turned up andhe bounded out of the chair, heading for the door.Figure 8.1 shows what happened to the stock. The event declinetook the stock lower 28% then prices bounced. That lasted just two daysbefore the stock resumed tumbling again. Eventually, the stock bottomedat 25.60, for a total decline of 43%.If you trade stocks long enough, a dead-cat bounce (DCB) willlikely snare one of your stocks. I’ve been caught three times and have losta total of $15,000.A typical dead-cat bounce pattern takes the shape of the inset inFigure 8.1. The smart money knows something is wrong and they startdumping the stock at point A. In the Merck example, the stock peakedin June and the event occurred in September. The smart money got outearly.
Merck and Co., Inc. (Drug, NYSE, MRK)48464442
EventDecline
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FIGURE 8.1 The stock dropped 28% in one day when the companypulled Vioxx from distribution. After a bounce of just a few days, thedowntrend resumed.
24
The Dead-Cat Bounce
187
When the event decline begins, it takes price down from B to C, amassive drop. Then the brokerage firms start touting the stock. “If youloved it at 50, it’s a steal at 25.” “It’s a fire sale! You can pick up a shareof stock for 30 cents on the dollar. Buy aggressively.” The hype pushesthe stock up and it bounces to D. That’s when the smart money beginsshorting the stock.If the company announces a stock buyback and insiders say that theprice represents value and that they are buying like crazy, the stock maycontinue recovering but that’s rare. Most likely, the stock eases over andcontinues down to E, below the event low at C. If the event is earningsrelated, chances are that another DCB will occur in three months time.DCB by the Numbers
I’ve studied the dead-cat bounce extensively—almost 700 events—so letme tell you what I found. The event begins in the middle third of theyearly price range 44% of the time. Just 25% of the time does the eventbegin within a third of the yearly high. Clearly, the smart money is selling the stock, forcing it lower.The event decline averages 31% but can range from 15% to over75%. By event decline, I mean the price decline as measured fromthe close the day before the event announcement (B) to the trendlow (C) posted before prices begin the bounce. The median decline laststwo days. Forty-six percent make a lower low the day after the massivedecline, 17% make another low the next day, then 9% and then 3%. Aprice gap occurs 74% of the time.Once price hits bottom after the event, it begins to bounce (C toD). This phase sees price rise an average of 28% and it takes 23 days.Twenty-two percent of the time, the bounce will be high enough to closethe gap made during the event.Then the fun resumes. Prices ease lower, declining an average of30% from the high at the bounce (D) to the new postbounce low (E).On average, it takes 49 days before price hits bottom. When everythingis completed, in 67% of the DCBs I looked at the stock will bottom18% below the event low (C).Another massive decline (at least 15%) follows the first one 26% ofthe time within three months and 38% suffer a decline of at least 15%within the next six months. For those stocks recovering, 38% close theevent day gap in three months, and 58% close it in six months.
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Trading and Trading Tips
If you are caught in a DCB, the best thing to do is wait for the bounceand sell a long holding then. An upsloping trendline works well to timethe exit. Draw it beneath the valleys as price rises. When price closes below the trendline, then sell. The odds suggest that the price will continueto go down, plus another DCB could happen in three or six months.For aggressive traders, short the stock once it crests during thebounce phase (point D in Figure 8.1). On the way to E, the stock maystall at the event low price (C), so watch for that.If you see a stock with a wonderful chart pattern in which youwould like to invest but a DCB happened within the last six months,avoid the stock. Higher failure rates from chart patterns come from stockswith DCBs.
Case Study
“Here’s how I traded a DCB,” Jake said and pushed me off the chairwhere I was working. He pulled up a chart of Airgas, shown in Figure8.2. “I bought 500 shares at 15.94 after the breakout from a head-andshoulders bottom.” The measure rule for the pattern said price wouldrise to 15.63, just a little above where he bought.“If the profit potential was so low, why did you take the trade?”At first he shrugged his shoulders then said, “I thought it wouldclimb to resistance at 18 easily, and it might even go up to meet the Junehigh at 21. With a little luck the old high at 27 would fall by the wayside, and then only the stars could stop it.”“Wishful thinking.”“No kidding, but I was right. The stock made it up to 18.”“What happened here?” I pointed to A on the monitor.“Earnings announcement. The stock tumbled 15% (A to B). Iwaited for the stock to bounce and when it did, I sold. It turns out, I soldtoo soon as the stock really bounced, almost closing the gap (C).”“Did you make any money?”“Yeah. $220. That may not sound like much but it could have beenworse.” The chart doesn’t show it, but the stock made a near straight-linerun down to 7.88, recovered to 14 then sank to 4.63 in June 2000.”
The Inverted DCB
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Airgas, Inc. (Chemical (Specialty), NYSE, ARG)
18
SoldAC
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Bought16
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FIGURE 8.2 Jake bought after the head-and-shoulders bottom brokeout upward and sold when it looked like the bounce phase of a dead-catbounce was over.
The Inverted DCBWhat happens to price when the company announces unexpectedlygood news? Sometimes, the stock shoots up by 5%, 10%, 20%, or morein one day. Then the price tumbles. Figure 8.3 shows two examples. Thefirst, at point A, happened when the company got news that banks extended a liquidity facility related to a receivables program. I have no ideawhat that means, but the market liked it. The stock shot up 26%, peaking at B. For a few days, the stock moved horizontally then began a swiftdecline to C. The drop measured 39%.At F, the company said that quarterly sales slightly exceeded its earlier outlook. Up the stock went to D, peaking 47% above the close theday before the news. Then another decline set in, this time taking thestock down 59%.I term this behavior—a rapid one- or two-day rise followed by adecline—an inverted dead-cat bounce, or iDCB.
EVENT PATTERNS
190
Milacron Inc. (Machinery, NYSE, MZ)
5
D
B
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CFBustedDescendingTriangle
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BreakoutE
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FIGURE 8.3 The announcement of good news sent the stock higherat A and F, but only for a short time.
Trading and Trading Tips
For swing traders, the choice to trade or not is easy. Consider selling aftera large price jump (5% or more) when it occurs in one day. That meansselling the day after the announcement sends price higher. According tomy statistical review of nearly 31,000 samples where this occurred, selling was the smart move because price peaked the day after the announcement then retraced some or all of the gains.For position traders and investors, the choice is not so clear. Why?Because price continues upward sometimes. Perhaps the general marketor industry influences which way price will go, so be sure to checkthose when deciding to hold on or sell immediately. If the rise is verticalbut takes longer than a day or two, then consider holding onto thestock. Chances are the stock will form a flag or pennant, signalingadditional gains.If a flag or pennant develops, trade in the direction of the breakout.If the breakout is upward, hold onto the stock. A downward breakout isthe sell signal. One last thought: You never go broke taking a profit.
The Inverted DCB
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Case Study
Figure 8.4 shows how I made use of the iDCB information—a trade I’vewritten about in another book, Trading Classic Chart Patterns—but I’mso proud of it that I just had to share it again! I bought an upward breakout from a head-and-shoulders chart pattern then sold two days later fora 25% gain. Here are the details.With the stock trading near the yearly high, I expected the stock torise back to 16 or 17, forming a double top. With luck, the stock wouldcontinue higher. When I saw the head-and-shoulders bottom forming,I decided to trade it. A buy signaled when price closed above thedownsloping neckline, and I received a fill of 1,000 shares at an averageprice of 14.68. I placed a stop at 12.94, just below the 13 round numberand slightly below the right shoulder low (RS).In Trading Classic Chart Patterns, I describe how I scored the headand-shoulders pattern for a +3 score. I usually won’t trade a chart patternhaving a minus score. A positive score meant that the stock had a goodchance of rising to the 18.59 target predicted by the scoring system. Thatvalue comes from the median rise of 29.03% applied to the breakout price.Abgenix (Drug, NASDAQ, ABGX)
Neckline
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InvertedDead-CatBounce
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Sold
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FIGURE 8.4 I bought the stock the day before good news and solda day later.
7
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EVENT PATTERNS
The day after I bought the stock, it zipped up 20%, but I still don’tknow why. With such a tasty gain in just two days, I didn’t want to take achance and give it all back. So, I reviewed the situation and decided tosell. I sold my shares and received a fill at 18.308, for a three-day gain of25% or $3,600. That day the company announced earnings.What happened next amazes me even to this day. Look at Figure 8.4.The price tumbled, reaching a low of 7.76, or 60% below the peak theday before I sold. Wow!Case Study
“What are you doing?” I asked Jake. He was sitting on a swing, notswinging, but just sitting there, holding a stack of papers.“I’m reading your manuscript.” He lifted the pages and they flappedin the late summer breeze. “The chapter on inverted DCBs. I just tradedone.”Figure 8.5 shows his trade. The bottom of the large symmetrical triangle has a downward breakout in August. The rest of the triangle is offthe screen and the lower trendline skirts the bottom of other valleys soeven though the trendline looks drawn wrong, it is correct.“The symmetrical triangle had a score of +1 and a price target of18.46 (using my scoring system). Earnings were due in two weeks, so itwas a gamble, but one I felt worth taking. I thought the stock would dowell since others in the industry were going up gangbusters and the market was moving higher, too. I bought 1,000 shares at an average price of14.60.”He placed a stop at 13.60, point A in Figure 8.5. If the trade werestopped out, he would lose about 7%. He thought the 18.46 target wasaggressive and believed that the stock would stop at the January 2004high at 16.70 (not shown).“This looked like a busted symmetrical triangle.” Since the trianglebroke out downward but turned around and shot out the top, it suggested additional gains.“When the company announced earnings, the stock took off,” reaching an intraday high of 16.54, or up 15% from the prior close. “That wasclose to the January high, so I felt the stock had topped out. Five minutesbefore the close, I sold.” The trade filled at 16.18. In two weeks