this periodthen quickly tapers off as prices round over at the top. Many times, the top
takes on the appearance of a head-and-shoulders formation or a double ortriple top. If you recognize any of these formations on your chart, ignore the
BARR top formation and obey die implications of the individual formations.The bump height, as measured from the highest high to the trendline,
should be at least twice the lead-in height. In this example, the bump height is8 (that is, 343/s - 263/s). This is more than twice the lead-in height of !3/s.The reason for the minimum two-to-one ratio is arbitrary. The idea is to
make sure that investor enthusiasm and, hence, momentum are getting carriedaway. An up-sloping trendline that turns into a bump with a higher slopingtrendline emphasizes the rising momentum. Sustaining such unboundedenthusiasm for too long is difficult and the stock price eventually declines. In
Figure 8.1, that is exactly what happens. Prices round over and start headingdown. Sometimes the decline is orderly and sometimes it is choppy. In nearlyall cases, prices return to the trendline. Once there, the stock may do severalthings. Fairly often prices bump up again, and that is called a BARR with a dual
bump or a dual BARR. Occasionally, a dual BARR consists of several bumpsThe first part of the formation, called the lead-in phase, leads to the bumpphase. The lead-in phase should be at least 1 month long and usually falls inthe 2- to 3-month range, but can be considerably longer. Prices oscillate upand down in this phase and have a range of at least $1 as measured from thehighest high to the trendline. This range, called the lead-in height, is calculated using prices from the first quarter of the formation.Figure 8.1, for example, shows that the highest high during the first quarter of the formation occurs on January 12, 1994, at 255/s. The trendline directlybelow this date has a value of about 24%, giving a lead-in height of !3/8. Theheight is important because the minimum bump height and target price, calculated later, use this value. A more accurate approach is to use the largest distance from the trendline to the high, which is not necessarily found betweenthe highest high and the trendline. Use whatever method makes you feelcomfortable.During the lead-in phase, subdued price action looks as if the stock isgathering strength for the bump phase. Prices do not move very far away fromthe trendline and usually appear rounded. If you visualize the formation as amountain range, the lead-in phase represents the foothills.
but the result is still the same. Prices eventually fall below the trendline.Sometimes prices slide up along the trendline for a month or so beforecontinuing down. At other times, prices drop straight through the trendline,turn around and climb again, before ultimately dropping. In a few rare cases,prices descend from the bump high and never make it back to the trendlinebefore moving higher. These cases commonly appear on weekly or monthlyprice charts.
Focus on FailuresIn Figure 8.2, a weekly chart, die first BARR on die left shows high volumeduring the initial stages of the bump, as you would expect. The bump heightto lead-in height ratio looks good (over 2:1) and clearly investor enthusiasm ishigh. However, prices continue climbing instead of rounding over and heading down.
Contrast die failed BARR with die one in the center. The middle BARRhas a nicely rounded appearance. The volume pattern is what you wouldexpect: high at die start, at the start of the bump, and when prices cross die
124
Bump-and-Run Reversal Tops
Statistics
Caterpillar (Machinery (const/mining), NYSE, CAT)
125
the two failure types cause the formation to fail 19% of the time. That is stillbelow the 20% maximum that I consider reliable formations to possess.
To reduce the failure rate to just 9%, wait for prices to close below thetrendline. Waiting boosts the success rate to 91% but reduces the profit thatyou would make if you sold near the top. In the Trading Tactics section of thischapter, I show you how to sell near the top before the decline really begins.
That way you can keep more of your profits or make even more by shorting.
StatisticsTable 8.2 shows general statistics for BARR tops. Most of the formations (531or 82%) qualify as reversals of the upward trend. A substantial number (81%)perform as expected, which is to say that prices decline below the trendline by
at least 5%. For those formations that succeed, the average decline is 24% asmeasured from the breakout point to the ultimate low.9
3
F
M
A
M
J
|
A
S
O
N
D
fails as prices climb away instead of moving below the trendline. The roundedappearing center bump-and-run reversal has good volume characteristics—high
Since averages can be misleading (because a few high numbers can pullthe average up), I graphed the frequency distribution of declines from the bumphigh to the ultimate low. Figure 8.3 shows the result. A frequency distributiongives a good indication of what the most likely decline will be for a stock in
volume at the formation start, bump start, and trendline crossing. However, prices
which you invest. The numbers are free of the distorting effects that large
decline below the trendline just 4%. That is called a 5% failure. The right bumpand-run reversal is a dual bump-and-run reversal formation because pricesapproach the trendline in March, form a second peak, then drop below the trendline.
returns can have on averages. Figure 8.3 shows that the most likely decline isin the 30% to 40% range.Figure 8.4 shows a frequency distribution of declines as measured from
Figure 8.2 A bump-and-run reversal on a weekly chart. The formation on the left
the high price at the breakout to the ultimate low. I use the high price because it
trendline. However, prices drop below the trendline by just 4%. Any formationrecovering after moving less than 5% below the breakout point is called a
Table 8.2
General Statistics for Bump-and-Run Reversal Tops
5% failure.The BARR on the right is a dual BARR. Prices near the trendline in late
March 1994, then just as quickly climb again forming a second peak beforedropping through the trendline. Often the peak of the second bump is belowthe first.On weekly and monthly price charts, you often see prices moving upsteadily over time. However, without the sharp bump-up of prices, the rising
Description
Statistic
Number of formations in 500 stocks from
1991 to 1996
650
Reversal or consolidation
531 reversals, 119 consolidations
Failure rate
123 or 19%
Average decline of successful formations
24%
Most likely decline
15% to 20%
Of those succeeding, number meeting orexceeding price target (measure rule)
462 or 88%
trend should not be labeled a budding BARR. The slope of the price trendline should rise from about 30% at the start to 60% or higher during thebump phase.As you look at Figure 8.2, you might think that many BARR formations
Average formation length
7 months (213 days)
appear as the failure on the left. However, the statistics show that that is not the
Number of rounded-appearing bumps
case. Ten percent have upside breakouts like the one shown. The other 90%
Number of multiple bump formations
493 or 76%166 or 26%
make it to the trendline and begin moving down. Of those heading down, 10%will move down less than 5% before recovering and moving back up substan-
Higher second (or later) bump
55 or 8%
tially. They appear as the BARR in the center and are 5% failures. Together,
Note: More than 80% of the formations studied have downside breakouts with an averagedecline of 24% below the breakout point.
Statistics
127
is closest to the trendline on the day of the breakout. Figure 8.4 shows that themost frequent declines occur in the 15% to 20% range. Depending on whenyou take your profits, you can do exceedingly well with this formation. In theTrading Tactics section, I show you a technique to assist you in selling near thetop instead of waiting for prices to plunge to the trendline (the breakout point).
For this formation, I designed the measure rule so that more formationsmeet the price target. I use the height of the lead-in subtracted from the break-
out point to predict the minimum price move. The Trading Tactics section ofthis chapter explains this more thoroughly, but the approach means 88% of the
40
50
60
70
Percentage Decline
Figure 8.3 Frequency distribution of declines measured from bump high to ultimate low. Most of the stocks in the study suffer declines between 30% and 40%,as measured from the highest high during the bump phase to the ultimate low.
stocks meet or exceed their price targets, on average.BARRs take time to form, about 7 months on average. When they formand move into the bump stage, the bump appears rounded 76% of the time.Compare Figure 8.5 with Figure 8.6. The stock in Figure 8.5 has a bumpwith a rounded appearance, giving investors plenty of time to sell the stocknear the high. Figure 8.6, on the other hand, shows a chart pattern with a muchnarrower peak. Investors had only a few days to catch the top before pricesmoved down quickly. The chart in Figure 8.6 is also a dual BARR. There is asecond smaller bump just before prices head below the trendline. Dual or multiple bump BARRs occur 26% of the time with only 8% of second or addi-
tional bumps having peaks that rise above the first bump.
MagneTek, Inc. (Electrical Equipment, NYSE, MAC)
Percentage Decline
Figure 8.4 Frequency distribution of declines measured from breakout high toultimate low. Looking at the decline after a downside breakout shows additionaldeclines of 15% to 20% as measured from the high at the breakout (the point closest to the trendline) to the ultimate low.
Oct 92
Nov
Dec
Aug
Sep
Oct
Figure 8.5 A bump-and-run reversal with a rounded bump occurs 76% of thetime, on average. Notice the premature downside breakouts in mid-April, a week
or two before the actual breakout. The ultimate low reached in October is at aprice of 121/4, a decline of over 50%.
126
Pi irvir^_ar>f4 Diii-» Doi/arcral Tr\r*cDUII lk/~Cll IU~'i\ui i " \v. v v^i j«i i \jfs*>
Statistic
129
Table 8.3Breakout Statistics for Bump-and-Run Reversal Tops
Figure 8.6 A bump-and-run reversal with a pointed-looking first bump, leavinginvestors precious little time to get out of the stock. Many semiconductor stocksshowed similar price patterns in late 1995, setting the stage for an industry-widedownturn. The ultimate low reached in mid-January 1996 comes after a decline ofnearly 70%.
Description
Statistic
Premature downside breakouts
58 or 9%
Downside breakout but failure
57 or 9%
Upside breakout
65 or 10%
Downside breakout
584 or 90%
Horizontal breakout
1 or 0%
Pullback
226 or 39%
Average time to pullback completion
12 days
Breakout day (and succeeding days)volume compared with day beforebreakout
1 36%, 164%, 126%, 118%, 116%, 115%
For successful formations, days toultimate low
3 months (94 days)
Percentage of breakouts occurringnear the 12-month low (L), center (C),or high (H)
LI 2%, C43%,
H46%
Percentage decline for each 12-monthlookback period
L46%,
H30%
"
C37%,
Note: The most significant declines occur near the yearly price low, but BARRs do notoften occur there.
Table 8.3 shows statistics related to breakouts. Only 9% of the formationshave premature breakouts. As you would expect, prices stay at or above the
At what point in the yearly price range do downside breakouts occur? Iremoved breakouts that occurred less than 1 year after the start of the study
trendline until the genuine downside breakout occurs. Only 9% of the formations studied break out downward and, without declining meaningfully, moveback up. These are 5% failures.
and compared the price on the breakout day with the range over the prior year.I divided the yearly price range into thirds and compared the breakout pricewith three categories: the lowest third, center, and highest third. The results
Most of the BARR formations have downside breakouts: 584 or 90%
show that only 12 % break out near the yearly low, 43 % are in die middle, andthe rest occur near the yearly high. These results make sense. The highestenthusiasm for a stock is when it reaches new highs. Such bullish enthusiasm
move lower with only one moving horizontally. Over a third (39%) of the formations show a pullback to the formation base. Fullbacks occurring over a
month after a breakout are removed. Such price movements are really changesin die trend and not pullbacks at all. Fullbacks complete their return to die formation base within 2 weeks (12 days), on average.What is the volume pattern like on the day of the downside breakout?
Comparing the volume the day of the breakout and for the next week with thevolume the day before the breakout, you can see that the highest volumeoccurs the day after die breakout (64% above the benchmark, or 164% of thetotal). Presumably, once investors notice the stock moving below the trendline,they sell the next day, sending the volume figure soaring.On average, it takes 3 months (94 days) for prices to reach the ultimate
low. The ultimate low is the lowest price before a significant trend changeoccurs.
feeds momentum and propels the stock even higher. Eventually, supply risesalong with the price and quenches demand. When that happens the stockrounds over and heads down. Even though the stock declines, there are stillmany investors who try buying on the dips or who believe the decline will beshort. They help slow the decline and may even turn it around.Mapping the performance over the three categories results in some surprises. For those formations breaking out near the yearly low, prices decline byan average of 46%. Breakouts in the highest third of the yearly price rangedecline by only 30%. I expected the reverse. I assumed that you would get thelargest declines near the yearly high, not the yearly low.Upon reflection, this makes sense. Since the BARR is a representation ofmomentum, upside momentum carries prices upward. Even after a reversal,
130
Trading Tactics
Bump-and-Run Reversal Tops
131
some investors continue to hope (by buying more shares as prices decline) thatthe stock is only retracing its gains and will soon rebound.When a BARR occurs near the yearly low, presumably the stock is already
lines parallel to the trendline assist in that determination. The first line, calledthe warning line, is lead-in height above the trendline. A second trendline, par-
in the doghouse. Although some investors are exuberant about the rising price,
The warning line serves as a signal that a BARR may be forming. Onceprices move solidly above the line, consider doing any fundamental or technical research on the stock to prepare yourself for a sale.
once it begins to descend, they quickly run for cover. Bad news follows badnews and sends the stock down even further.
On the basis of the results in Table 8.3, you could argue that you shouldshort stocks that appear on the new low list in the newspaper and not on thenew high list. In any case, the largest declines from BARR formations occurwith breakouts in the lowest third of the yearly price range._____
Trading TacticsTable 8.4 lists tools to help judge when to sell a stock that contains a BARR aswell as the minimum price decline to expect from such a formation. As you
allel to the first two and lead-in height above the warning line, is the sell line.
By the time prices touch the sell line, you should have a firm grasp of thecompany, industry, and market outlook. The sell line is not an automatic sell
trigger, but it does confirm that a BARR is present. The sell line touch indicates that the momentum players have the upper hand. The game could continue for several weeks or months before the downhill run phase sets in, so donot be in too much of a rush to sell. Since most bumps appear rounded, thereis ample time to sell the stock. By waiting, you are giving the momentum play-
ers additional time to push the stock even higher.However, there are situations when you will want to pull the trigger
view your stock charts periodically, some stocks will follow trendlines upward.
quickly. If the company, industry, or market look dicey, then perhaps it is timeto take profits. You might not be selling at the exact top, but you never go
These are the ones to monitor closely. Occasionally, one will begin a rapid
broke taking a profit. Also, if the bump does not appear rounded, then consider
climb on high volume and enter the bump phase.
selling. A quick decline often follows a quick rise.
By definition, a BARR is only valid when the bump height, as measuredfrom the highest high to the trendline, is at least twice the lead-in height. Two
sell lines, each line lead-in height from the other. The chart is on a weekly scale
Figure 8.7 shows the BARR trendline and the two parallel warning and
Comsat Corp. (Telecom. Services, NYSE, CQ)
Table 8.4Trading Tactics for Bump-and-Run Reversal TopsTrading Tactic
Explanation
Measure rule
Compute the lead-in height (see Table 8.1 for the definition) andsubtract the result from the value of the trendline where pricescross the trendline moving down (end of the bump). The result isthe minimum price move to expect. Almost 9 out of 10 stocksmeet their price targets.
Warning line
Drawn parallel to the trendline and lead-in height above it. Theline warns that the stock is making a move and is entering the sellzone, an area between the warning and sell lines.
Sell line
A second trendline parallel to the warning line and lead-in heightabove it. Consider selling when prices touch the sell line,especially if the bump is narrow. Delay selling if prices continuemoving up. Draw additional lines parallel to the original trendlineand lead-in height above the prior line. When the stock roundsover and touches the lower trendline, sell the stock.
Sell zone
The zone alerts the investor to begin doing research to determineif taking profits is wise. Since valid bumps always touch the sellline (by definition, the minimum bump height is twice the lead-inheight, and that is where the sell line appears), an investor shouldbe ready to make a sell decision.
Note: Consider selling when prices rise above the sell line.
9 2 F M A M ) )
A S O N D 9 3 F M A M | )
A S O N D 9 4 F M A M | J A S O N D 9 5 F M
Figure 8.7 Bump-and-run reversal trendline and two parallel warning and selllines. There is plenty of time to take profits in this bump-and-run reversal. The stockreached a low of 17Yt in December, a 40% decline from the sell point in July. Alsoshown in the July to September period is a double top.
132
Sample Trade
Bump-and-Run Reversal Tops
133
Wlnn Dixie Stores Inc. (Grocery, NYSE, WIN)
and emphasizes the relaxed nature of some BARRs. If you owned the stockdepicted in Figure 8.7 and sold it when prices pierced the sell line movingdown, you would not have sold at the top. However, you would have avoided
the 40% decline that followed. The decline also points out that it can be easyto make money, on paper, in the stock market but difficult to keep it.Figure 8.7 also shows the measure rule in action. The measure rule is amethod used to predict the minimum price decline of the stock. For BARRs in
this study, almost 9 out of 10 stocks decline below the predicted price.To compute the predicted minimum decline, calculate the lead-in heightby splitting the formation along the trendline into four equal parts. In the first
quarter of the formation, compute the height from the highest high to thetrendline, measured vertically (or use the widest distance between the two).Subtract the result from where the trendline is pierced, heading down. In Fig-
ure 8.7, the lead-in height is 3'/2 (that is, 2\l/i - 18). The target price is thus215/8 (2S'/8 - 3!/2), reached during the week of the breakout.
After the breakout, the stock rises back up to meet the trendline beforeresuming its decline. Since a trendline denotes a resistance area when approached from below, it is no surprise prices turn away. Prices form a doubletop in the July to September period and plunge downward.
|un 92
Jul
Aug
Sep
Oct
Nov
Dec
|an 93
Feb
Mar
Apr
Figure 8.8 Detailed bump-and-run reversal with sell lines, jenny raised her sellpoint as the stock climbed. Eventually, she sold the stock the day after it pierced alower sell line.
Sample TradeInterestingly, that was also the predicted decline point for the stock. If theJenny is a librarian. Before she goes home at the end of each day, she logs ontothe Internet and checks her stock portfolio. She did not notice it at first, but bymid-September, Jenny spotted a BARR forming in a stock she owned (Figure
8.8). She spent an hour searching the Internet for anything she could findabout the company. She checked the fundamentals, analysts' recommendations, insider buying and selling patterns, and anything else she could think of.She reviewed the reasons she bought the stock. Using the Peter Lynch
style of investing—that of buying a stock one is familiar with—held a specialappeal to her. She liked shopping at the grocery store chain and the productsthey sold were something she could really sink her teeth into. She felt comfortable owning the stock.
Jenny printed out the price chart and examined the BARR in detail. Shedrew the trendline along the bottom, divided the length of it into four equalparts, and computed the lead-in height. Then she drew the warning and selllines parallel to the trendline, each separated by the lead-in height. She computed the minimum target price to which the stock was likely to decline. From
the current price of 3 0, the target price was 2 3, a decline of almost 25%. Eventhough she still liked the stock, such a large decline made her nervous.She looked back through the chart price history and searched for supportzones so she could better gauge the area where any decline might stop. Thefirst support area was in the 23 to 24 zone, where a prior advance had paused.
stock fell below the support point, she noticed a second, more robust support
area between 20 and 22.What of the possible reward? How high could she expect the stock torise? Long-term price charts were no help as the stock was making new highsalmost daily. Jenny shrugged her shoulders as there was no way to determinewhere the rise would stop. Her only guess was that it might pause at 3 5, 40, or45, price points where investors might decide to sell. Any one of those pointscould turn the stock downward, she decided. Even the current 30 level mightbe the highest price the stock sees.After her analysis was complete, she was still confident that the stock heldpromise of additional gains. As with any stock caught by upward momentum,there was no telling how high the stock would climb before it stopped. Shedecided to hang on to the stock. If the stock declined to the warning line, shewould sell it. She placed a stop-loss order at 27'/2, the current value of thewarning line.During late September and into the start of October, the stock followedthe sell line upward. On October 12, the stock jumped upward again. After aweek or so, Jenny was able to draw another sell line parallel to the originalBARR trendline that intersected stock prices. She decided that should the stockfall to the lower sell line, she would dump the stock. She raised her stop-losspoint to 31. But the stock did not return to the lower sell line.
134
Bump-and-Run Reversal Tops
9
The stock reached a minor high of 343/8 on October 19, then retracedsome of its prior gains. It curled around and reached a low of 327/8 before turning around. Jenny printed out another price chart and drew a new trendline.This line had a slope of about 60 degrees. She smiled as the BARR was performing exactly as predicted.During the first part of December, prices pierced the 60 degree trendlinewhen the stock began moving sideways. Jenny suspected that the rise wasnearly over, but one could never tell for sure until it was too late. She decidedthat should the stock decline below the latest sell line, she would close out
Cup with Handle
her position.
The stock moved up again. A few days after Christmas, the stock reacheda new high of 393/4 and Jenny was able to draw another sell line. During thenext 2 weeks, the stock declined to the lower sell line, then rebounded to challenge its recent high. On January 15, it peaked at 397/s, a smidgen below the 40resistance number she estimated earlier.To Jenny, the day looked like a one-day reversal, but she could not be sure.Taken together, die two highest points looked like a double top but the recession between them was not deep enough to qualify and the two peaks were a bittoo close together. Still, it was a warning sign and it made her nervous.Less than a week later, the stock declined below the lower sell line.Should she sell or hold on for additional gains? She looked back at the profitshe had made so far and decided not to be greedy. She sold the stock at 363/4 onJanuary 22. The next trading day, the stock closed up l'/4 at 38, and she wascrestfallen.She continued to monitor the stock and watched it hesitantly movehigher over the next 2 weeks. She tried to take solace in the large profit sheachieved, but it was little comfort in the face of missed gains. Did she sell toosoon? Should she have held on? On February 23, her questions were answeredwhen the stock dropped below her sell point, heading down.
Jenny watched the stock drop to 35 and find support at that level. Then,it continued moving down. In early April, the stock declined below the original trendline and she calculated the minimum target price of 31. This wasreached within the week and the stock continued falling.
She turned her attention to other interesting situations and forgot hertrade until July 1994. By chance, she pulled up a chart of the company and washorrified to see that the stock had declined to a low of about 21, almost a 50%decline from the high.
R E S U L T S SNAPSHOTAppearance
Looks like a cup profile with the handle on die right
Reversal or consolidation
Short-term (up to 3 months) bullish consolidation
Failure rate
26%
Failure rate ifwaited for breakout
10%
Average rise
38%, with most likely rise between 10% and 20%
Throwbacks
74%
Percentage meetingpredicted price target
49% using full formation height, 73% using halfformation height
Surprising finding
Cups with a higher right lip perform better, 40%versus 3 5 % average gain.
See also
Bump-and-Run Reversal Bottom; Rounded Bottom
Shown above are the important statistics for the cup-with-handle formation.The failure rate is 26%, above the 20% that I consider acceptable. However, ifyou wait for an upside breakout, the failure rate drops to 10%. The average gainis 3 8%, which is good, but below the 40% garnered for most bullish formations.The most likely rise ranges between 10% and 20% and it is evenly distributed.A closer examination of the results shows that 39% of the formations have gains
135
136
Identification Guidelines
Cup with Handle
137
less than 20%, whereas the outliers, those with gains over 50%, represent 27%of the formations.Throwbacks after an upside breakout occur in nearly three out of fourchart patterns. This suggests an interesting way to play the cup-with-handlepattern: Wait for the throwback before buying the stock. This technique alsoboosts the average gain by a small amount. I discuss this further in the Trading Tactics section of this chapter.The percentage of formations meeting the predicted price target is apathetic 49%. Most measure rules, which predict the target price, involve computing the formation height and adding the result to the breakout price. Withthis pattern, the cup height can be considerable so it should come as no surprise that only half the formations meet their price targets. I explore changesto the measure rule in the Trading Tactics section that improve the priceprediction.A surprising finding that is discussed in the Statistics section is a tendency for cups with a higher right lip to outperform those with a higher left lip.The difference, an average gain of 40% versus 35%, is statistically significant.
TourThe cup-with-handle formation was popularized by William J. O'Neil in hisbook, How to Make Money in Stocks (McGraw-Hill, 1988). He gives a couple ofexamples such as that shown in Figure 9.1. The stock climbed 345% in lessthan 2 months (computed from the right cup lip to the ultimate high). This wasthe best performing stock in this study. Unfortunately, it does not meetO'Neil's criteria for a cup-with-handle formation. I discuss my interpretationof his criteria in a moment, but let us first take a closer look at the chart pattern. The stock began rising in early August at a price of about 5'/2 and climbedsteadily until it bumped up in early December. Volume, incidentally, was veryhigh for the stock at this stage. The stock climbed robustly then rounded overand plunged back through an earlier trendline. It completed a bump-and-runreversal (BARR). During its climb, the stock reached a high of 267/s during lateDecember and a low of 123/s after the BARR top—a loss of 54%. The rise anddecline formed the left side of the cup. Over the next 2 months, prices meandered upward and pierced the old high during late March. The rise to the oldhigh completed the right side of the cup.Profit-taking stunted the climb and prices moved horizontally for almost2 weeks before resuming