it mayonly be a short retrace in an uptrend. Only when a change in the primarytrend occurs should long-term stock holders take action. Supplement the sellsignal from the downside weekly reversal with other fundamental and technical information before pulling the trigger.
Sample TradeMaggy decided to trade the weekly reversal shown in Figure 46.5. On dieweekly chart she noticed the broadening top formation taking shape. Whena weekly reversal appeared, she decided to sell the stock short and received afill at 43.The downside weekly reversal pierced the bottom trendline of a smalldescending broadening wedge that formed in late December. The downsidewedge breakout coupled with a partial rise to the top of the broadening topsuggested to her that prices would not only cross to the other side of the broadening top, but pierce the lower boundary was well. That is how she decidedto play it.You can see that the stock moved horizontally for 2 weeks before sinking.By mid-February, the stock had crossed to the lower boundary and pierced itas expected. Due to the downside breakout of the broadening top, she believed
S O N
D 9 2 F M A M
]
J
A
S
O
N
D
9
3
F
M
A
M
J
I
A S O
Figure 46.5 Broadening top formation with weekly reversals. The partial rise onthe broadening top formation is a clue to the downside breakout and coupled withthe descending broadening wedge means the stock is a good candidate to short.
the stock would eventually continue moving down and that gave her the confidence to ride out the turbulence in March 1993.Additional weekly reversals added to her confidence and kept her in thetrade. When the stock bounced off the August low of 191A, she took notice.The stock climbed to 24'/2 then retraced to 207/s. To her, the decline to the second low looked like a Fibonacci retracement (61.8% of the rise from 19'/4 to241/:) so she decided to sell the following week at 2l'/2. She made nearly 50%on the trade.
Tour
643
47
the gains, which is where the most likely gain comes from, suggests meagergains are the norm.How can you gain 44% in 3 months? Normally, you cannot. A frequencydistribution of the days to the ultimate high shows that most formations (47%)reach the high in 3 months or less. The next highest category, at 38%, is for
Weekly Reversals, Upside
those formations with long-term gains (taking over 6 months to reach the ultimate high). The large number of quick but small gains are why the most likely
gain is so low. It is not a contradiction at all, just a warning that this formationeither performs poorly or very well. There is little middle ground.The percentage of upside weekly reversals meeting their price targets at
84% is above the 80% reliability threshold. The high value should not come asa complete surprise since most bullish formations score well. The results arehelped, in part, by each stock participating in a bull market over the 5 yearsunder study.
I compared the gains for successful upside weekly reversals when theirvolume is half the 25-week moving average to reversals having volume 50%
RESULTS SNAPSHOT
above the average. The performance associated with the low volume varietyshow gains of 38%; the higher volume reversals have gains of 44%. The difference between the two results is statistically significant. However, when raising the volume benchmark to two, three, and four times the moving average,performance steadily declines. Another study of all formations, both successfuland unsuccessful ones, supports the deteriorating performance results as vol-
Appearance —
On the weekly scale, a higher high, lower low, widiclosing price above the prior weekly high
Reversal or consolidation
Short-term (up to 3 months) bullish reversal
Failure rate
23%
Performance improves with a wider weekly price range. The results rangefrom an average gain of 15% for those formations with a narrow price range to
Average rise
44%, with most likely rise being 20%
57% for those with a wider range.
Percentage meetingpredicted price target
84%
Tour
Surprising findings
See also
Reversals with moderately high volume (50% abovethe moving average) perform best but performancedeteriorates as volume increases. A wide weekly pricerange improves performance.Weekly Reversals, Downside
ume increases.
Figure 47.1 shows two upside weekly reversals. The one on the left is less successful than the one on the right. The left one comes amidst a downtrend andcorrectly signals a reversal of the trend. However, the reversal does not lastlong. Prices hobble up then move sideways for 2 months before declining
again. The second reversal works much better. It forms when prices score theThe Results Snapshot shows a quick synopsis of the statistical results for upsideweekly reversals. The formation performs substantially better than its brother,the downside weekly reversal. The upside variety sports a failure rate of 23%,still above the 20% maximum that I consider reliable formations should meet.Its average rise at 44% is quite high until you consider the most likely gain is20%. The difference between the two values suggests there are a significantnumber of large gains pulling the average upward. A frequency distribution of
642
lowest low on the chart but close higher. Prices climb steadily for about amonth, retrace some of their gains then climb in a stair-step fashion. Priceseventually move from a low of 125/8 to a high of 37—a gain of almost 200%.The first reversal, by contrast, shows a gain of 31 % from low to high. If you use
the closing price during the weekly reversal, then the gains moderate to 160%and 13%, respectively. I use the closing prices as die starting point in all calculations involving performance. This gives a somewhat more realistic flavorto the performance.
644
Weekly Reversals, Upside
Identification Guidelines
Adobe Systems (Computer Software ft Svcs., NASDAQ, ADBE)
645
Table 47.1Identification Characteristics of Upside Weekly Reversals
-38
Characteristic
Discussion
Weekly chart
Use weekly charts.
Downward trend
Prices should be in a downtrend or near the end of adowntrend. Ignore upside weekly reversals when thepredominant trend is upward unless they occur during acorrection of the upward trend.
Higher high, lower low
Prices must be higher than the prior week's high and lowerthan the prior week's low. Ties not allowed.
Higher close
Prices must close above the prior week's high
(not just a higher closing price, but one that is above the prior high). Once youhave located all the ingredients, you have found an upside weekly reversal.
Figure 47.1 Two upside weekly reversals. Although the left upside weekly reversal correctly signals a trend change, the right one is more prescient.
Figure 47.2 shows what upside weekly reversals look like. The first one(on the left) does not occur at the bottom of the downtrend. It is almost 2months late, but you can see how successful it is. Prices zoom from the close of9'/2 to 327/s. Although the reversal occurs in a 2-month uptrend, I consider itclose enough to the low pricewise to be a valid buy signal.
Sometimes, such as the upside reversal shown on the left, the formationis premature. At other times, such as the one on the right, the reversal is quitetimely. When it is early, it is usually by only a few weeks to a month or so, not
5 months premature (to the bottom) such as that shown in Figure 47.1.The large weekly price range and closing price are two clues to a changein trend. A lower low, higher high, and a close above die high of the prior weeksuggest prices will rise. Usually, they do and sometimes quite far.Volume, as you can see in Figure 47.1, can be spotty. Neither reversal hashigh or low volume; the number of shares traded is about midrange. This is notunusual as many well-performing upside weekly reversals have low or averagevolume during the week of the reversal.
Identification GuidelinesTable 47.1 shows identification guidelines for upside weekly reversals. Thefirst order of business in correctly identifying an upside weekly reversal is touse the weekly chart to look for a reversal in a downtrend. The reversal appearsas a weekly high above the prior week's high, a low below the prior week's low,and a weekly close above the prior week's high. In essence, you are looking fora wider price range than the week before with a close above the prior high price
92
F M A M
Figure 47.2 Successful upside weekly reversals. Points A and B, however, showupside weekly reversals that do not reverse. The price trend should be downwardleading to an upside weekly reversal. The August 1992 reversal occurs after a longdowntrend where prices are still near the low.
646
Weekly Reversals, Upside
Statistics
Contrast the reversal with points A and B in Figure 47.2. Both points areweekly reversals but prices do not reverse—they continue climbing. That isbecause the upside weekly reversal occurs in an uptrend and signals a continuation of the upward trend. The signals do not indicate how long the up trendwill continue, however, so you should be cautious about taking a position.Sometimes, the reversal will occur near or at the end of the up trend.Other upside weekly reversals appear during a retrace or consolidation ofthe upward trend (Figure 47.5 shows an example of this). The reversal signals
647
Alien Telecom Inc. (Telecom. Equipment, NYSE, ALN)
the end of the correction and a resumption of the upward trend.
The reversal shown on the right in Figure 47.2 occurs at the valley floor.If you look closely, you can see the weekly high is above the prior week's high,the low is below the prior week's low, and the closing price is above the priorweek's high as well. Prices rise 73% following the reversal, reaching a high of
almost 32, then drop to find support at about 23. Prices do not make a newhigh until January 1995.95
Focus on FailuresNot all reversals work out as expected. The failure rate at 23% is above themaximum 20% I consider reliable formations to possess. Consider the upsideweekly reversal shown in Figure 47.3.Many times, a down draft follows a brief spurt upward. When all is saidand done, prices end near where they begin. An investor viewing the developing situation shown in Figure 47.3 might think the same thing. In June 1995,prices lift out of a 7-month consolidation region between 22 and 26 (partiallyshown) and reach a high of 393/8 several months later. That is a nice climb andone would expect a 40% to 60% retrace of the gain. If the trend reverses, thenall gains could be lost and prices would return to where they began (to the 22to 26 area). That is what happened. The bottom of the weekly reversal occurs
right in the center of the consolidation region at 24. To me, the reversal suggests the decline is over and prices should climb, perhaps making a double top.It is a good investment opportunity except for one thing: The reversal fails.
F
M
Figure 47.3
A
M
)
J
A
S
O
N
D
9
6
F
M
A
M
|
An upside weekly reversal 5% failure. The upside weekly reversal
marks the bottom of the diamond bottom pattern that acts as a consolidation ofthe downward trend. The weekly reversal is a 5% failure because prices fail to continue moving up by more than 5%. The diamond is part of the corrective phase ofa measured move down.
Many times it is difficult to pin down a generic reason why a particular
type of formation fails. I looked at the statistics and noticed that the vast majority of failures occur with average or above average volume levels. Only 13% ofthe formations fail after showing low volume (volume during the reversal weekthat is 50% below the moving average). If you are considering buying a stockthat shows high volume during the reversal week, you might look for otherfundamental or technical factors to bolster your confidence of a successfultrade.
Sure, prices hit a higher high the week after the reversal but close lower.The 7 weeks look like a diamond bottom, except that the diamond does notreverse—it consolidates. Prices drop out of the diamond and signal a resumption of the downward trend. The decline from the high near 40, the pause at26, and the drop to a low of 16 should remind you of another formation—a
measured move down. The diamond marks the corrective phase of the measured move down.The upside weekly reversal in this situation is what I call a 5% failure.Prices move up by less than 5% before collapsing and heading significantlylower. In the nearly 500 formations I looked at, 5% failures occur 112 times or23%. That statistic may sound low, but it is really quite high.
StatisticsTable 47.2 shows statistics for weekly reversals. I uncovered 484 formations in200 stocks spanning a 5-year period. Since these formations are common andsince there is such a large number of them, I did not feel any need to search theother 300 stocks for additional formations.Of the formations I uncovered, 137 act as consolidations of the trend, andthe remainder act as reversals. Many of the consolidations turn out to be 5%
failures. Almost a quarter (23%) of the formations are 5% failures.
648
Weekly Reversals, Upside
Table 47.2General Statistics for Upside Weekly ReversalsDescription
Statistic
Number of formations in 200 stocks from
1991 to 1996
484
Reversal or consolidation
1 37 consolidations, 347 reversals112 or 23%
Failure rate
Most likely rise
44%20%
Of those succeeding, number meeting orexceeding price target (measure rule)
314 or 84%
For successful formations, daysto ultimate high
7 months (218 days)
Percentage of reversals occurring near12-month low (L), center (C), or high (H)
L30%,
C38%,
H32%
L48%,
C40%,
H45%
Average rise of successful formations
Percentage loss for each 12-month lookbackperiodAverage volume week before and after versusweek of reversalPercentage that high volume (50% aboveversus 50% below 25-week moving average)reversals perform better than low volume reversals
40
59%, 82%
50
Percentage G
Figure 47.4 Frequency distribution of gainsthe weekly reversals have gains of less than 2
44% versus 38% gain butpercentage deteriorates athigher volume
The average gain at 44% is comparatively high for bullish reversals. Thiscontrasts with the most likely gain of 20%. Figure 47.4 shows a frequency distribution of gains that helps explain the discrepancy. The highest column is theone with the highest frequency. Twenty-one percent of the formations havegains between 10% and 20%. On the other end of the scale, 17% of the formations have gains over 90%. The relatively large number of outsized gainsexplains why the overall average is 44% (the high numbers pull the averageup). More than a third of the formations (37%—the total of the first twocolumns) have gains less than 20%. It seems that you either do quite poorly orquite well with this formation. The way the bars in the chart orient (with thetallest ones clustered in the lower gains section) suggests your gains will be onthe modest side.By the way, the performance statistics in Table 47.2 use the closing priceduring the week of the reversal as the benchmark. The average rise, forinstance, measures from die closing price to the highest high before a significant reversal occurs (or until the end of the data).For those formations that work as expected, 84% meet their price targets.I created a measure rule for reversals that is similar to many other formations.Simply compute the height of the weekly reversal and add it to the closingprice. The result is the target to which prices will ascend, at a minimum. In
some cases, the weekly price range is comdicted target an easy shot.It takes, on average, 7 months to reactime for prices to climb an average of 44%.Where in the yearly price range dodivided the yearly price range into thirds foresults. The results were almost evenly splitmations—occurring in the center third of thmation can appear anywhere in the price rprice (which is at the top of the formation)end scores well with 30% of the formatioyearly low. Mapping the performance overagain show no significant trend. Those fothird of the range have gains averaging 48%have gains of 40%.Volume during the week of the reveThe week before the reversal occurs has anduring the week of the reversal. The wedrops to 82%.I define high volume as being 50% aand low volume to be 50% below the averamations (those that do not fail) into high a
650
Weekly Reversals, Upside
weekly reversals with high volumes score better than those with low volumes.The difference in the gains, 44% and 38%, respectively, is statistically significant. However, as I raised the high volume cutoff point to two, three, and fourtimes the moving average, the performance steadily deteriorated (from 44% at
2x, to 38% at 3x, to 29% at 4x).Some analysts suggest that high volume, when combined with a largeweekly price range, results in a better performing weekly reversal. Table 47.3shows the results of my study. I filtered the database of formations that have aweekly price range from 5% to 25% of the closing price and volume that iszero times (meaning that all formations qualify) to four times the volume of the25-week moving average. The table lists the average gain for the formationsfollowed by the number of formations meeting the criteria (the sample size)shown in parentheses. The percentage gains are suspect when the sample sizedrops below 30. The table shows values for all formations, including those that fail(which is different from the volume study just discussed) and the volume range,at up to four times the moving average, is larger than the earlier study.In the benchmark column, you can see that as the weekly price rangegrows, the formations perform better, with gains starting out at 15% and rising to 57%. In the column, all formations qualify regardless of their volumelevel. The other columns generally support the notion of improved performance after a wide weekly price range (scan down each column).
In Table 47.3, it is difficult to see how volume influences performance. As
Since this conflicts with the comshould improve performance, the low saancy. The real test is whether a stock doe
Trading Tactics
I do not list trading tactics in the usual taFirst, use the measure rule to estimate th
climb. Simply subtract the weekly low fr
of the reversal. The difference is the for
weekly closing price to get the target to w
Prices meet the target 84% of the time.As an example, look at the upside wThe high is at 21 l/s, the low is at 17\ anhigh minus the low or 33/4. Add the heightarget of 243/4. Prices hit the target about
The only other trading tactic is to be
downtrend—or reasonably close to the e47.5 occurs as part of a consolidation of
in August 1993 to a minor high in Janua
high of 26 to a reversal low of 173/s.
you scan across each row, sometimes the performance improves and sometimesit does not. However, when you sum the percentage gains of each column (the
last row in the table), it becomes clear that as volume increases, performancedeteriorates.
Amgen Inc. (Drug, NAS
Table 47.3
Average Percentage Cain from Formations Meeting Criteria of Volume andWeekly Price RangeVolumePrice Range
Benchmark
0-1 x
1-2x
2-3x
3-4x
0-55-1010-1515-2020-25
15(48)35 (1 96)
16(35)32(101)44 (34)74(13)108(6)2.74
11 (9)
25(2)39 (23)
63(1)
23(16)25(4)48(4)1.60
5(3)15(4)10(1)1.28
Sum:
32(112)50 (47)57 (22)1.89
38 (69)32 (59)52 (24)45(11)1.78
35(1)
Note: The numbers in the table represent the average gain for those formations meetingthe price and volume ranges with the sample size in parentheses. Formations with a wideprice range perform better than ones with a narrow price range. High volume impedesperformance—if you trust the low sample numbers.
93
|
J
A
S
O
N
D
9
4
F
M
A
M
J
J
A
Figure 47.5 Trading an upside weekly reweek after the upside weekly reversal and
652
Weekly Reversals, Upside
In mid-July 1994, there is also another weekly reversal that is not highlighted in Figure 47.5. The reversal happens after a quick price retrace and it
marks the trend resumption. Earlier in the year, points A and B highlight twoweekly reversals, both of which are failures. They occur in a minor downtrend
and prices stabilize for about 2 months then move briefly lower. When pricesdecline below the low of the reversal, the reversal is a failure. Even thoughprices do climb into January 1994, die two reversals are disappointmentsbecause of the brief dip.The two failures emphasize one final point. Do you really want to tradethis formation? It sports an unacceptable failure rate of 23%, meaning it is
risky. Also, the gains might be outsized (44%), but the statistics suggest themost likely gain will be about 20%. You can do better with less risk tradingother formations. Or, better yet, use this as just one more tool in your toolbox
of indicators you check before trading a security.
Sample TradeEdward has a short fuse, a violent temper. Not only does he kill the messenger,he takes out the messenger's relatives as well. The people around him tiptoegently as they pass his cube, but management likes him because he has a master's degree in engineering and seems to know his stuff.
I had the misfortune to be called in on a problem with my print redirector software he was using. After spending a few minutes looking at the data andperforming a few tests, I concluded it was not a problem with my software. The
fireworks display came early that year as Edward lit up. He ripped me up oneside and down the other. I calmly walked away.
When the tables turned and he needed my help on one of his investments,he was very apologetic, almost submissive. He is new to trading and the upside
weekly reversal seemed intriguing to him. He paper traded it with modest success and decided to try it for real. He invested in the stock shown in Figure47.5. When the upside weekly reversal appeared, it fit his buy criteria, so hebought into the stock the following week at 201/2. It pleased him to see thestock climb right after buying. As the weeks went by, the stock seemed toclimb in stair-step fashion, moving up two steps and falling back one.
He drew a line along the volume tops and noticed it was following anupward-sloping trendline. Edward did not really know whether this was sig-
nificant, but the high volume seemed to be on up days, whereas the lower volume clustered around days when prices declined. To him this suggestedmomentum was moving up, helping propel the stock higher.
When he checked on the stock in early February 1995, he noticed thehigh volume and large weekly price range (highlighted in the figure by pointC). This concerned him. When he flipped to the daily price chart, the spike
Sample Trade
653
looked like a mountain: Prices quickly rose up to the peak and then declined.
The volume picture generally echoed the price pattern.The price and volume spikes looked to him like a one-day reversal (and aone-week reversal on the weekly scale). To Edward this suggested it was timeto bail out. He pulled his ripcord and received a fill at 34'/4.The trade netted him a gain of 67%, an amount he bragged about forweeks. Just over a year later when he looked at the weekly chart, he saw thestock had topped out at 66'/2. He could have tripled his money.Boy, was he pissed.
Statistics Summary
Statistics Summary
Average rise or decline
I typically measure the average rise or decline from theprice on the breakout day (using the daily high or low) thatis closest to the formation. The ultimate high or low is thehighest or lowest point before a significant change in trend(typically a 20% price change, measured high to low).
Likely rise or decline
Computed by measuring the individual percentage rise ordecline for each formation and tabulating a frequencydistribution of the results. The most likely rise or decline isthe range with the highest frequency and usually excludesthe rightmost column.
Rank by score
I separated each table entry into bullish (1 to 35) andbearish (1 to 32) formations then ranked them by theirscore. The score is the average rise or decline times themost likely rise or decline divided by the failure rate. Thebest rank is 1 .
Notes and DefinitionsThis summary is an alphabetical list showing performance statistics for thechart patterns covered in this book. Various rankings of the top ten chart patterns follow.
Summary of Statistics for All Chart PatternsFailureRate(%)
ReversalorConsolidation
ThrowbackFullback(%)
AverageRise orDecline(%)
LikelyRise orDecine(%)
RankbyScore
Broadening Bottom,down breakout
6
C
NS
(27)
(15-20)
5
Broadening Bottom,up breakout
2
R
NS
25
10
13
Broadening Formation,Right-angled andAscending, downbreakout
9
R
P72
(18)
(10)
17
Broadening Formation,Right-angled andAscending, up breakout
6
C
T44
32
20
14
Broadening Formation,Right-angled andDescending, downbreakout
3
R
P33
(19)
(10-15)
4
Broadening Formation,Right-angled andDescending, up breakout
19
C
T23
27
20-30
24
Broadening Top, downbreakout
4
R
NS
(23)
(10-20)
3
Broadening Top, upbreakout
4
C
NS
34
10-15
15
Broadening Wedge,Ascending
6
R
T 7, P 21
(20)
(10)
13
Key to the tables:NM = Not material as there were too few to be significantNS = Not studied or does not apply to this formation( ) = Numbers in parenthesis are declines* = Unusual values due to low sample countP = Fullback
_—
._.__._.
T = ThrowbackExplanations of the column headings:
Failure rate
Reversal orconsolidation
Throwback, pullback
Percentage of formations that do not work as expected,including 5% failures. The numbers apply to formationsonce they stage a breakout (confirming the formation).
The letter R appears if the majority of formations act asreversals of the price trend and the letter C appears forconsolidations. If both R and C appear in an entry, then thechart pattern has no overriding majority of either type.A throwback is an upside breakout that returns prices tothe top of the formation or trendline boundary. A pullbackis a downside breakout that returns prices to the bottom ofthe formation or trendline boundary. Both occur after abreakout and return within 30 days. The percentages forthrowbacks apply to formations with upside breakouts only;pullback percentages apply to downside breakouts only.
655
Formation
(continued)
654
656
Statistics Summary
Statistics Summary
Summary of Statistics for All Chart Patterns (continued)
Summary of Statistics for All Chart Patterns (continued)
FormationBroadening Wedge,Descending, downbreakout
FailureRate(%)
41
ReversalorConsolidation
R
ThrowbackPullback(%)
P36
AverageRise orDecline(%)
(24)
657
LikelyRise orDecine(%)
(20)
FailureRate(%)
ReversalorConsolidation
ThrowbackPullback(%)
AverageRise orDecline(%)
LikelyRise orDecine(%)
Measured Move Down
22
R
NS
(36)
(25-40)
9
Measured Move Up
23
R
NS
68
30-60
12
One-Day Reversal,bottom
17
R
T61
26
10-15
29
One-Day Reversal, top
24
R
P71
(19)
(10)
26
NS
07)
(10)
30
Rankby
Score
25
Formation
RankbyScore
Broadening Wedge,Descending, upbreakout
37
C
T40
46
20
27
Bump-and-RunReversal Bottom
9
R
38
37
20
18
Outside Day, downbreakout
42
C
15
Outside Day, upbreakout
25
C
NS
32
10
30
34
C
P17
(17)
(25)*
24
C
T16
21
15-20
28
Bump-and-RunReversal Top
19
R
P 39
(24)
(15-20)
Cup with Handle
10
C
T74
38
10-20
20
Pennant, downtrend
Dead-Cat Bounce
10
R
NS
(5-25)
14
Pennant, uptrend
19
Diamond Bottom
13
R
T43
05)35
15
21
Pipe Bottom
12
R
NS
47
20
19
Diamond Top
25
R
P59
(21)
(20)
19
Pipe Top
18
C
NS
(21)
