the slope of the linear regression line calculated using volume data fromthe start of the formation until prices moved outside the trendline boundaries.Table 45.2 shows the average breakout volume. It is highest the day afterthe breakout, at 131% of the prior day, and tapers downward but remains highup to a week later. Like falling wedges, the volume pattern is irregular. Usually,the pattern trends downward with each day having a lower volume than thepreceding one but that is not the case here. Although volume begins to recede,it bounces up twice over the next 5 days.
Since large numbers can sway averages, I looked at each formation andcomputed the volume moving average up to the day before the breakout. Then
I compared the result with the volume on the day of the breakout. In only 38%of the cases does above average volume accompany the breakout day. This follows the belief that downside breakouts can fall on their own weight (withouthigh volume).Table 45.3 shows premature breakout statistics. A premature breakout iswhen prices close outside the trendline then return within the formationboundary. Figure 45.2, for example, shows an upside premature breakout. Pre-
mature breakouts, either up or down, occur 22% of the time in this study. Theresults divide into downside breakouts (9%) and upside breakouts (16%). Someformations have both upside and downside breakouts.Only 3 % of the formations have a premature downside breakout with agenuine breakout upside. This is reassuring since it is difficult or impossibleto distinguish a premature downside breakout from a real one. Should youTable 45.3Premature Breakout Statistics for Rising Wedges
Figure 45.5 Frequency distribution of losses for rising wedges. The most likelygain is 15% and nearly half the formations have gains less than 15%.
624
Description
Statistic
Number of premature breakouts (up or down)
40 or 22%
Number of premature downside breakouts
1 6 or 9%
Number of premature upside breakouts
29 or 16%
Premature breakout down, genuine breakout up
6 or 3%
Downside premature breakout distance to apex
60%
Percentage showing above average volume on prematuredownside breakouts
56%
626
Wedges, Rising
Trading Tactics
627
mistakenly sell short on a premature breakout, your chances of success arestill high.How far to the wedge apex do premature breakouts occur? On averagethey break out 60% of the way to the apex. This compares with genuine breakouts occurring 61% along the way. In other words, premature breakouts look
The days to the ultimate low, at 78, is quite brief. The low value coincideswith the small average loss (19%). Generally, the longer it takes to reach theultimate low, the larger the loss.
like the real thing.
to be a low number, it contrasts with 38% of regular breakouts showing above
performance over the yearly price range, we find that the best performing formations are those with breakouts in the lowest third of the yearly range. However, all three ranges are quite close in value. The results support the belief thatweaker stocks fall further.
average breakout volume. Volume for premature downside breakouts is 113%of the 25-day volume moving average.Table 45.4 shows breakout statistics. The formations in this study have
Trading Tactics
The average premature breakout volume seems to confirm this belief.Breakout volume is above average 56% of the time. Although this may appear
A frequency distribution of the breakout price reveals 68% of the formations have breakouts in the highest third of the yearly price range. Mapping
breakouts 61% of the way to the apex. The apex is where the two trendlines
meet in the future. A scatter plot of the distance to the apex versus the result-
short. Fullbacks occur quickly, on average just 10 days after the breakout. Anypullback occurring over 30 days is not a pullback at all; it is just normal price
Table 45.5 shows trading tactics for rising wedges. The measure rule for risingwedges is opposite that for falling wedges. The measure rule says that pricesshould decline to the start of the formation (the lowest low), at a minimum.Even though the predicted decline is usually small, only 63 % of the formationsmeet the benchmark. I view a score of 80% as being reliable, so this formationcomes up short.Figure 45.6 shows one application of the measure rule. The well-definedrising wedge passes all the identification guidelines outlined in Table 45.1. Aninvestor willing to short the stock would use the measure rule to gauge theprofitability of the trade. In this example, the target price is the lowest price inthe formation, or 29%. Prices drop through the target just over a week after thebreakout.To improve the chances of investment success, sell short after a downsidebreakout. Prices must close outside the formation trendline before you place a
behavior.
trade. Following this guideline for the stocks in this study lowers the failure
ing loss is inconclusive. Although falling wedges seem to have the most powerful breakouts about two-thirds of the way to the apex, the relationship widi
rising wedges appears to be more random.Most of the breakouts from rising wedges occur downward (82%). Eleven(6%) have downside breakouts but prices turn around and move higher. Since
this failure rate is so small, it should not be of major concern. Once pricesbreak out downward, they continue lower nearly all the time.Fullbacks occur 53% of the time. This is a bit too low to plan an investment strategy around. However, if you want to trade a wedge and miss thebreakout, you might have a second chance should prices pull back to the formation. Once prices begin heading lower, after the pullback, sell the stock
rate from 24% to 6%. The trade-off is that you might be giving up some profitas you will be making a trade after prices begin moving down. Still, I will takea small profit over a loss any day.
Table 45.4
Breakout Statistics for Rising WedgesDescription
Statistic
Downside breakout distance to apex
61%
Upside breakout
32 or 18%
Downside breakout
147 or 82%
Downside breakout but failure
11 or 6%
Fullbacks
78 or 5 3%
Average time to pullback completionFor successful formations, days to ultimate low
10 days2.5 months (78 days)
Percentage of breakouts occurring near 12-month pricelow (L), center (C), or high (H)
LI 5%, C18%, H68%
Percentage gain for each 12-month lookback period
L21%, C17%, H19%
Table 45.5Trading Tactics for Rising WedgesTrading Tactic
Explanation
Measure rule
Prices should fall to the bottom of the formation, at a minimum.
Sell after breakout
Wait for the downside breakout (prices should close outside thebottom trendline) to improve the chances of a successful trade.
Sell after pullback
If you miss the breakout and still want to trade the stock, sellshort after a pullback, once prices turn down.
Take profit quickly
Since the decline is meager, be ready to pull the trigger andclose out the trade.
628
Wedges, RisingFruit of the Loom (Apparel, NYSE, FTL)
bother him. In his spare time, he likes to trasense to make short sales work for him.After returning from vacation, JoeFigure 45.7. He missed the initial downwathe stock.
Viewing the chart from a longer-termformation was an upward retrace in a long
figure). At a minimum, he believed the stocat about 30. He would consider closing obefore unless prices rose against him. So, h
die formation at 36%, about 1A point aboveIf the stock continued in his favor, dieward measured move. Joe estimated diat th
take die stock to 28 and perhaps lower.When the stock pulled back to die botnext day, Joe sold the stock short and receOct
Apr 93
Dec
Figure 45.6 Symmetrical triangle precedes rising wedge. A downside breakoutfrom the symmetrical triangle suggests prices will fall. The measure rule for risingwedges is simply the lowest price in the formation, shown here at 29%.
If you miss the breakout, perhaps you can jump in on the pullback. Abouthalf the formations (53 %) pull back to the bottom trendline, so there is an evenchance that you can place a trade. After prices pull back, wait for them to startfalling again. Sell short only after prices begin moving down to help protectyourself from a stock that pulls back and continues rising.
measure rule that said the stock would fall
a decline of about 6% from die purchase p
Joe watched the stock closely and wa
below the measure rule target of 3 3 3A. Thenclimbed at the start of December, Joe ree
what he was able to gather, the fundamenchanged so he decided to sit tight.
The last guideline in the table suggests taking profits quickly. The aver-
age decline is 19% with a likely decline of just 15%. So, in all likelihood, thestock will decline only briefly before recovering. If the stock looks like it ismaking a turn upside, then close out your short position.
Even for short-term (long side) traders, I do not suggest they sell theirholdings if they see a rising wedge in a stock they own. Of course, if the fundamentals suggest otherwise, then sell your holdings and look elsewhere for
another opportunity.If you are considering shorting the stock, check die fundamentals andmake sure there is a good reason for the stock to weaken. Just because you hope
it will go down is no reason for the stock to comply.
Sample TradeAug 93
Joe is a midlevel manager at a large corporation. One of the qualities in whichhe is gifted is patience. He handles stress easily and does not let small problems
Sep
Oct
Nov
Dec
|a
Figure 45.7 Measure rule for rising wedges.fall to 33% and they do, in just 2 days.
630
Wedges, Rising
46
Even as the stock climbed above 35, Joe believed he was right. The tenacious attitude served him well on this trade and the stock soon began headingdown again. In May, the stock reached his target price of 30 and Joe consideredclosing out his position, but did not.The stock moved sideways for about 4 months then dropped down again.It reached a low of 25.43 in mid-December and headed backup. Joe closed outhis short position at 27, just a week after it made a new low. On the trade, Joemade almost $9,000, or about 25%, on his 1,000 shares in about a year.
Weekly Reversals,Downside
R E S U L T S SNAPSHOTAppearance
On the weekly scale, a higher high, lower low, andclosing price below the prior weekly low
Reversal or consolidation
Short-term (up to 3 months) bearish reversal
Failure rate
37%
Average decline
18%, with most likely decline being 10%
Percentage meetingpredicted price target
73%
Surprising findings
Failures become more likely as the time from theclosest peak lengthens. A wide weekly price rangeresults in better performing reversals.
See also
Weekly Reversals, Upside
Perhaps the most remarkable feature of the downside weekly reversal formation, if you can call it a formation, is its high failure rate at 37%. One out ofthree downside weekly reversals fail! I consider failure rates below 20% to beacceptable, so this chart pattern should serve as a warning: Perhaps you shouldskip this one.The average decline is 18% with a likely loss of 10%. The average declineis a little less than what you would expect (20%) from a well-performing bearish
631
632
Weekly Reversals, Downside
reversal. The reversal does have some interesting statistical findings. First,weekly reversals usually occur near a price peak and quite often near a major peak(signaling a change in the primary trend). The further from the peak the reversal occurs, the more likely it is to end in failure. This makes intuitive sense
because prices are already sliding down the trend before the reversal hits andtakes them closer to the ultimate low.
As I was researching weekly reversals, I came across an analyst who suggested that the best performing reversals are those with large weekly priceranges and high volume. I investigated and discovered that a large weekly pricerange does indeed improve performance. However, there are not enough formations to determine if a wide price range and high volume produce superiorresults. I discuss this in the Statistics section of this chapter.
Identification Guidelines
633
ment with some trepidation because I only consider weekly reversals to bevalid when they occur on or near an uptrend.For example, the reversal on the left is close enough to the end of theuptrend to be a part of it (imagine prices moving up the week after the revers a l . . . you would hardly notice the down draft). With the reversal on the right,it is a bit harder to write-off 3 or 4 weeks of declining prices. When consider-
ing the long-term trend, the decline is over a year long.Why do downside weekly reversals form and why do they work? As pricesclimb following an upward trend, momentum typically increases in the earlystages of a rise then diminishes before reversing. Prices follow. If the change inmomentum is sharp, occurring in the span of a week, or sometimes even just a
day, then a weekly reversal can occur. In the early part of the week, prices arechasing momentum higher. Prices make new highs, perhaps on a daily basis,
bubbling upward from buying pressure as investors bid up the stock.
TourWhat do downside weekly reversals look like and why do they form? As anoverview, Figure 46.1 shows two examples of a downside weekly reversal. Thefirst reversal on the left comes just two weeks after the stock peaks. It marks thestart of an extended downtrend that sees prices decline from their high of 373/8
to a low of 103/8, a plunge of 72%! The second weekly reversal occurs furtherfrom the twin peaks in early December 1992. Since prices are already declin-
ing, it serves as confirmation that prices will continue falling. I write that state-
Announcement of surprisingly bad earnings, poor same-store sales numbers, orsome other fundamental or technical change occurs, buying enthusiasm dwindles, and selling pressure escalates. The momentum shifts from upward todownward. If the fundamental or technical winds are strong enough, prices
dive and by the end of the week close below the prior week's low.The weekly high price, after being carried upward by the rising momentum earlier in the week, forms a new high, but by week's end the trend reverses.The smart money, sensing the changing trend, takes flight and dumps the stock,contributing to the sharpness of the momentum change. As prices head down,the selling intensifies, driving down the stock still further.
Identification GuidelinesTable 46.1 outlines the identification guidelines for downside weekly reversals.Use the weekly charts to make identification easy. Look for downside weeklyreversals in an uptrend; they warn that the upward trend is about to reverse.
About half the time, the weekly reversal occurs exactly on the peak: The trendis upward and it makes a new high then prices plunge. In such a situation, diereversal is easy to spot and easy to believe. But what about the other 50% of thetime when the reversal occurs after the peak?If the reversal occurs well into a downtrend, ignore it. The trend may
continue down or it may be near the bottom but it is best not to rely on the signal. For those reversals occurring near the end of the uptrend, you have todecide if they are reversals of the uptrend or consolidations of the downtrend.
Confused? Take another look at Figure 46.1. The reversal on the leftoccurs in a downtrend, but it is only 2 weeks from the end of the uptrend, so IFigure 46.1 Two downside weekly reversals. The one on the left is a timely downside weekly reversal. Both reversals occur just a few weeks after a high.
view it as significant. The other reversal, as explained previously, occurs on theupward retrace (the secondary trend) in a long downtrend (the primary trend)
634
Weekly Reversals, Downside
Airborne Freight (Air Transport, NYSE, ABF)
Table 46.1
Identification Characteristics of Downside Weekly ReversalsCharacteristic
Discussion
Weekly chart
Look for weekly reversals on weekly charts.
Upward trend
Prices should be in an uptrend. Ignore downside weeklyreversals when the predominant trend is downward. In aretrace after an uptrend, as long as the reversal occurs nearthe peak (less than 5 weeks away and near in price) then Iconsider it valid.
Higher high, lower low
Prices must be higher than the prior week's high and lowerthan the prior week's low. Ties not allowed.
Lower close
Prices must close below the prior week's low.
and is 3 or 4 weeks into the downtrend resumption, so it does not signal areversal. Ignore it.To help identify downside weekly reversals, I programmed my computer to
use linear regression on the daily high price over 40 trading sessions—about 2
93
A
S O N D 9 4 F M A M |
I A S O N D 9 5 F M A M J
| A S O N D 9 6 F M A
M|
Figure 46.2 Three downside weekly reversals. A higher high, lower low, and aclose below the prior week's low are key elements of a weekly reversal. The reversal should occur in or near the end of an uptrend.
months' worth of daily prices. It correctly selected weekly reversals near enough
to the uptrend to be significant and ignored those further down the trend.Lest you be deceived into thinking linear regression is all you need toprogram, Table 46.1 shows that other characteristics are important too. On theweekly chart, the current high must be above the prior week's high price; the
Advanced Micro Devices, Inc. (Semiconductor, NYSE, AMD)
weekly low must be below the prior week's low, and the closing price must alsobe below the prior week's low. In this regard, the week is wider than the priorweek with the closing price signaling the direction prices will move.Figure 46.2 shows three weekly reversals, two of which are significant.
The first reversal (on the left) occurs as prices are peaking on an uptrend. Thehigh forms a price peak that is above the other prices over the last 3 months.
The low and close are below the prior week's low and close. It is a valid downside weekly reversal and it warns of a new downtrend beginning. The centerreversal occurs in the midst of a downtrend. Since prices are obviously heading down, ignore the reversal signal. The last reversal, the one on the right,occurs 5 weeks after prices peak. However, the high price has not declinedmuch from the peak, so I consider it to be a valid downside weekly reversal. As
you can see in Figure 46.2, prices meander lower for the next 6 months.
Focus on FailuresThe failure rate of downside weekly reversals is an alarming 37%. The breakout direction is assumed to be down, since a lower low occurs, so false breakouts are not a problem. However, 5% failures, where prices fail to continue
9 3 N D 9 4 F
M A M )
J
A
S
O
N
D
9
5
F
M
A
M
I
J
A
S
O
N
D
Figure 46.3 A 5% failure of a downside weekly reversal. The upside breakoutfrom the symmetrical triangle top serves as a warning of strength and the weeklyreversal as a throwback attempt.
moving down by more than 5%, are the problem. Figure 46.3 shows what a 5%635
636
Statistics
Weekly Reversals, Downside
Table 46.2
failure looks like. You can see in the figure that prices break out upward fromthe large symmetrical triangle top, then make a downside weekly reversal.However, instead of trending down as prices should after a downside reversal,
they plateau for an additional 2 weeks then climb. Once a higher high andhigher low occurs, the downside weekly reversal is a failure.An investor seeing the weekly reversal forming in the stock and takingadvantage of it would probably be pleased. Eventually, just 5 weeks after thereversal signals, prices move significantly lower by descending from 31 to 22.Then prices form a double bottom that confirms in early January when pricesclimb above the confirmation price of 263/4. As you can see, prices continue
General Statistics for Downside Weekly ReversalsDescription
Statistic
Number of formations in 200 stocks from
1991 to 1996
412
Reversal or consolidationFailure rate
151 consolidations, 261 reversals153 or 37%
Average decline of successful formations
18%
Most likely decline
10%
moving up and peak at 39'/4 before tumbling and trading at 13 by the end of the
Of those succeeding, number meeting orexceeding price target (measure rule)
189 or 73%
study.
For successful formations, days to ultimate low
3 months (80 days)
Percentage of reversals occurring near12-month low (L), center (C), or high (H)
LI 5%, C18%, H67%
Percentage loss for each 12-month lookbackperiod
L21%, C16%, HI 7%
Average volume week before and after versusweek of reversal
51%, 80%
Had an investor recognized the symmetrical triangle early enough, he or
she may have regarded the downside weekly reversal with skepticism. Theshort decline looks like a throwback attempt to the top triangle trendline. Insuch a case, the top trendline is an area of support that often repels prices.It is difficult to state a general reason why downside weekly reversals fail.When evaluating the veracity of the reversal signal, look for prior zones of support. If there is no support zone near the weekly low price, then the weeklyreversal will probably work out fine.Sometimes, a downside weekly reversal fails because it runs across a support zone that it cannot penetrate. At other times, it is an up-sloping trendline,connecting the low prices, that the reversal cannot pierce. Be sure to look forboth situations and trade accordingly.Market and industry forces play a part in the success of a downside weekly
reversal. If stocks are in a raging bull market, the reversal signal is more likelyto be wrong. Similarly, if the industry is doing well, that would suggest a shortlived decline.Since a wide weekly price range often accompanies a downside weekly
reversal, there is usually a fundamental reason why die stock has tanked. Finding the reason for the move can give you enough confidence to short die stockor sell a long-term holding.
StatisticsShown in Table 46.2 is a collection of statistics for downside weekly reversals.I limited my search to 200 stocks from the usual 500 because of die large number of formations uncovered. Most act as reversals of the short-term trend,whereas many of die consolidations are 5% failures. Just over a third (37%) ofthe formations fail to continue moving down by more than 5% before trending higher.The average decline of successful formations is 18%, whereas the mostlikely decline is 10%. I determine the most likely decline by using a frequency
637
distribution of losses and Figure 46.4 shows a graph of the results. I refer to thetallest column in the chart as the most likely decline simply because it has thehighest frequency. It is worth noting that combining the first two columns
shows that over half the formations have losses less than 15%, so, even thoughyour weekly reversal may not end in a 5% failure, the likelihood of having alarge loss is not very high. About one in five (21%) reversals have losses over25%. That is a comparatively poor showing for a bearish reversal.At first, I did not tabulate a measure rule for the formation but changedmy mind. I use the difference between the weekly high and low and subtract
the value from the weekly close. Almost three out of four (73%) formationsmeet their target prices. This is shy of the 80% value I consider reliable.It takes about 3 months to reach the ultimate low, which is the lowest lowbefore a significant trend change occurs. This statistic (as well as other performance statistics) uses the closing price during the week of the weekly reversalto the ultimate low. I used the closing price as a proxy for die price an investorwould likely pay.
Most downside weekly reversals occur in the highest third of the yearlyprice range. Again, I use the closing price as the benchmark. Mapping performance on top of the yearly price range, we find that the lowest third of the
range performs best with losses averaging 21%. The other two ranges areabout evenly split at 16% and 17%. The values suggest that a poorly performing stock (one that is near its yearly low) suffers comparatively larger declinesafter a downside weekly reversal.
638
Statistics
Weekly Reversals, Downside
639
Table 46.3Average Percentage Loss from Formations Meeting Criteria of Volumeand Weekly Price RangeVolumePrice Range
Benchmark
0-1 x
l-2x
2-3x
3-4x0(0)
0-5
6(58)
5(36)
8(20)
11 (2)
5-10
10(183)
1 1 (92)
10(75)
6(8)
3(2)
10-15
16(73)
12(35)
19(28)
19(5)
15(4)
15-20
20 (40)
22(14)
15(13)
24(9)
4(1)
20-25
24 (1 3)
31 (4)
21 (4)
17(2)
19(1)
Note: Shown is the average percentage loss from formations meeting the criteria of volume(columns) as a multiple of the 25-week moving average and the weekly price range (rows)expressed as a percentage of the closing price. Performance improves with a wider pricerange but the jury is still out on whether high volume is beneficial. Shown in parenthesesare the number of formations meeting the criteria (the sample size).
Figure 46.4 Frequency distribution of losses for downside weekly reversals. Overhalf the downside weekly reversals score losses less than 15%.
I compared the volume of a weekly reversal with the week before and die
week after. The weekly reversal has volume that is about double the prior weekbut it tapers off quickly. The following week has only 80%, on average, of theshares traded during the weekly reversal. When comparing the volume during
the weekly reversal with a 25-week moving average of the volume, I found 52%of the formations have above average volume.Many technical analysts attribute a significance to volume. A high volumebreakout, they reason, pushes prices further than a low volume one. I havefound that sometimes this is true and sometimes it is not. As it applies to downside weekly reversals, the belief is that a large weekly price range coupled with
high volume suggests a significant trend change. I investigated this claim andTable 46.3 shows the results.The table needs some explaining. It represents how downside weeklyreversals perform for the criteria of volume and price range. The column head-
ings are multiples of the volume level when compared with the 25-week moving average. The row headings show the size of the weekly price range,expressed as a percentage of the closing price during the downside weeklyreversal. Shown in parentheses are the number of formations meeting the cri-
teria (the sample size). When the number of samples drops below 30, the percentages become suspect.For example, in the second row, third column under "0-1 x" is the value
11%. Those formations having volume between 0% and 100% of the 2 5-weekmoving average and a weekly price range between 5% and 10% (during the
week of the reversal) score losses averaging 11%. Another example is the 24%listed in the intersection of the 2-3x column with the 15-20% row. The valuesays downside weekly reversals have average losses of 24% if their volume isbetween two and three times as large as the moving average and the weeklyprice range is between 15% and 20% of die closing price. Only nine formations make the cut, so the sample size is very small despite having over 400 formations to qualify.
I used the benchmark column to evaluate the other columns. The benchmark column is essentially all the formations (regardless of volume) sorted into
the weekly price ranges. I removed a few formations because they have excessively wide weekly price ranges and some start too close to the beginning of thestudy (there was not enough data to calculate a 25-week moving average).Duplicate entries are not allowed.Do formations with high volume and a large weekly price range perform
best? Yes. It is clear from the table that the weekly price range is important toperformance. As you scan down most columns, the general trend is one of increasing performance. As you scan across the rows, it is not entirely clearwhether volume improves performance. The diagonal, which shows a higherweekly price range and increasing volume, seems to indicate performanceimproves but the sample size is often too small to be too definitive.Not shown in either of the two statistics tables is the finding that failuresbecome more likely as the time from the nearest peak lengthens. I examined allfailures and counted the weeks from the nearest price peak (zero if the weeklyreversal happened to be the highest minor peak). Then I did a frequency distribution of the results. On a percentage basis, a graph of the result shows a line
640
Sample Trade
Weekly Reversals, Downside
641
ALZA (Drug, NYSE, AZA)
with an up-sloping trend. The sample size diminishes below acceptable levelsin the last 3 weeks out of the 5-week series, so I avoid any formal conclusions.However, if the trend is valid, it suggests that you should avoid taking a position in a stock with a downside weekly reversal too far along a downtrend (say,more than 3 to 5 weeks from the prior peak).
Trading TacticsI offer no specific trading tactics for downside weekly reversals. The measurerule, if you can call it that, is the formation height subtracted from the closingprice. The formation height is simply the weekly low subtracted from theweekly high on the week of the reversal. I use the closing price of the sameweek. My statistics show that prices meet the target 73 % of the time using thismeasure, short of the 80% I consider reliable.With a 37% failure rate, it is probably not worth shorting a stock showing a downside reversal—it is just too risky. Instead, I would use the formationas supplementary evidence of a trend change. If prices slip below a movingaverage, the relative strength index moves out of overbought territory, or someother technical indicator signals a trend change, then the weekly reversaladds value.Use the weekly reversal as a warning of a possible trend change, especiallyif you own the stock. The probability suggests the stock will decline but