time. Patterns with upsloping necklines perform better than do those with downsloping ones (23%postbreakout decline versus 21%, respectively).• HSTs with a higher left shoulder peak when compared to theright shoulder peak perform better, 25% postbreakout declineversus 20%, respectively.Measuring Success
The measure rule for HSTs is different from other chart patterns. Measurethe height from the highest peak in the head vertically to the neckline asFigure 7.12 shows in the inset. Subtract the result from the breakoutprice, the point where price closes below the neckline. The result is thetarget price.For example, say the head peaked at 12, the neckline was at 9, andthe breakout was at 10 in the inset. The height would be 3 (12 – 9), andthe price target would be 7 (10 – 3). Since 7 represents a 30% declinefrom 10, that’s an unlikely plunge so look for a closer target. In my tests,the measure rule worked just 55% of the time. That’s slightly better thana coin toss, so look for underlying support where price may rebound.If you own a stock showing an HST, compute the target price. Isthe decline large enough so that you should sell now? Most times, the answer will be yes, as you can’t be sure how far price will decline.Case Study
Like all bearish chart patterns, HSTs shout a sell signal that you can hearif you cock your head just so and listen. Here is one trade where I caughttheir message and escaped before a dramatic downturn, as my notebooksuggests:12/20/01. Filled 300 at 35.10, up from 35.05 asked when Ilogged in. This is an upward breakout from a symmetrical triangle with a book score of +1. A long-term holding yielding6%, the downside is limited because of massive support zonein the 32–34 range. Upside is the old high.I show where I bought the stock in Figure 7.12. The symmetricaltriangle is one of the tools with which every trader should be familiar.
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WPS Resources Corp. (Electric Utility (Central), NYSE, WPS)44
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FIGURE 7.12 An upward breakout from a symmetrical triangle signaled abuy and the head-and-shoulders said sell.
Prices cross the pattern from side to side before breaking out. The bookscore I refer to is a method for predicting how well a chart pattern will doafter the breakout. For more information, read my book Trading ClassicChart Patterns (John Wiley & Sons, 2002). Scores above zero mean thechart pattern is likely to beat the median rise. The stock missed the 44.55price target by $1.43 when you include the two dividend payments.The location where I bought in Figure 7.12 points to a small, tightflag. This knot of congestion just after the breakout confirms the upmove. Swing traders should look for the combination of breakout andnearby tight pennant or flag. It can lead to a sharp, vertical move.Because I wanted to collect the dividend for the long term, holdingon was not a problem. An ascending triangle came and went with thegood fortune of having an upward breakout. A downward breakoutwould have been a sell signal, regardless of the buy-and-hold mentality.Then the head-and-shoulders top appeared and I was concerned. Mynotebook again:6/5/02. I sold 300 shares, my holdings in the company, at market this afternoon. The stock dropped below round number
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support at 40, confirming an HST. I think interest rates areheaded up and the stock has been climbing for so long, it’sworth taking the 13% gain, 6% dividend rate, and runningwith the cash. The market has been struggling recently andutilities along with them. I can always buy back in at a lowerprice. Still, support is at 38–39 and that might be as far downas she goes. Filled at 39.52.You can see the drop that resulted after my sale. As an end-of-daytrader, I am usually a day or two late in my trades. Swing traders wouldhave sold sooner, when it was clear that price had pierced the neckline.Price pulled back to the breakout price (point A) before tumbling fromover 41 to just above 30, a decline of 26% in about a month.Prices paused at 38 to 39, as predicted, before pulling back to A. Asprice dropped from A, it also paused near the same region (37–38) before continuing the decline. On the trade, I made over $1,600 or 15%,including dividends.
Measured Moves and the SimpleABC CorrectionMeasured moves are unlike other chart patterns because they don’t havebreakouts, so performance is difficult to gauge. Nevertheless, they are asuseful as a frying pan is to bacon.Measured moves come in three flavors: measured move up (MMU),down (MMD), and the simple ABC correction. The simple ABC correction is a special case of an MMD. Measured moves point the direction andextent of future price moves, and that helps you determine when to sell.Identification
Figure 7.13 shows several examples of measured moves, two up, and twodown. Downward measured moves are represented by the zigzag patternEFGA and the larger one EADH. Measured moves up are ABCD andHIJK.Let’s take the first one, EFGA. The length of the first leg, EF issupposed to equal the length of the second leg, GA. The move FG iscalled the corrective phase. It retraces the prevailing downward trend.Similarly, AB is the first leg, CD is the second leg, and BC is the corrective phase.
Measured Moves and the Simple ABC CorrectionAirgas, Inc. (Chemical (Specialty), NYSE, ARG)
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FIGURE 7.13 Shown are a variety of measured moves, such as EFGA,ABCD, EADH, and HIJK.
What should you look for when searching for measured moves?Here’s a list:• Measured moves act as reversals of the prevailing price trend. ForMMUs, look for a downtrend before the chart pattern begins.For MMDs, look for an uptrend preceding the pattern.• The first leg should be a straight-line run with little curve to it.• The corrective phase should be proportional to the first leg. Pricesusually retrace 40% to 60% of the first leg move. Be suspect oflarger retraces. Pair large first legs with large retraces; small firstlegs with small retraces. Avoid patterns that look like horizontalsaw teeth—the retrace has gone too far.• The second leg should approximate the slope of the first leg, butallow variation.• Volume trends downward throughout the pattern.The Simple ABC Correction
Figure 7.14 shows a simple ABC correction. I think of it as a nestedmeasured move. The first measured move is an MMU spanning the run
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Yahoo! Inc. (Internet, NASDAQ, YHOO)
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FIGURE 7.14 This chart shows a nested measured move, a simple ABCcorrection.
EADF. It’s a large move, and that’s the excitement behind this pattern. Ifyou buy in after the measured move down, you can make a chunk ofchange.The smaller pattern is an MMD, located at ABCD. That’s the simple ABC correction. The pattern corrects (retraces) a portion of the largermove. Here is how to identify the simple ABC correction:• Point E must be below point D, meaning that the MMD mustnot correct too far. MMDs that correct to or below the start ofthe MMU (point E) tend to fail more often.• The corrective phase of the large MMU is an MMD, like theABCD pattern shown. Only one MMD should be present withtwo straight-line runs, AB and CD. Discard patterns with pronounced turning points within those two down legs.• Within the MMD, points B, C, and D are below A. Be especiallycareful that C not be above A. You don’t want the measured movedown to correct too far.• Point D starts a major price up swing.
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That’s all there is to it, but it sounds more complicated than it reallyis. If you can identify an MMD and an MMU, then look for the firstnested inside the second. A buy signals when price makes the turn at D.Simple ABC Correction Trading Tips
Here are tips to trading the simple ABC correction (refer to Figure 7.14):• Draw a trendline from A to C and extend it downward. Whenprice closes above the trendline, buy.• For more aggressive traders, draw a trendline down from C andbuy when price closes above it (see the dashed line in the figure).Also, a close above the intraday high at valley B works.• For more conservative investors, a close above C or even A is thebuy signal.• Buy only if the market and industry are both trending upward, sothe stock can make the most of upward momentum.• Be prepared for price to reverse at A—36% do, and prices drop,confirming a double top.MMD and MMU Trading Tips
Trading an MMD or MMU is difficult because they often flame outsooner than you hope or expect. I recommend buying in once the corrective phase completes. If a flag, pennant, or any price patterns that followsa trend appears from B to C (see Figure 7.15), then draw a trendline alongthe peaks. Once price pierces or closes above the trendline, then buy thestock. For MMDs, once price pierces the bottom trendline, then shortthe stock.In either case, watch for price to reverse. The run may be a sharpone like that pictured in Figure 7.15, or it may die as price climbs to Band then reverses. If price does not follow a trend from B to C, then waitfor price to rise (fall) above the corrective phase high (low) for MMUsand MMDs, respectively. Even waiting for such a breakout is no guarantee of success. Measured moves are not easy to trade. I use them mostlyto help predict the eventual price move. They behave themselves betterwhen my money is not in the trade.If the projected top of the MMU (point D in Figure 7.15) intersects a downsloping trendline set up by prior price action, then expect
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Freeport-McMoRan Copper and Gold B (Copper, NYSE, FCX)D
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FIGURE 7.15 I bought after a falling wedge and sold at the top of ameasured move up.
price to reverse there. For example, in Figure 7.13 a downsloping trendline drawn along peaks E and G comes close to the top of ABCD, whereprice reverses. Notice that the measured move down EADH stops atpoint H, meeting a downsloping trendline joining valleys F and A. Thenthe price trend reverses.Like most chart patterns, measured moves perform best when there isno overhead resistance (to stop an MMU) or underlying support (to stop anMMD). Always check for resistance and support before trading. Trendlinesdrawn on the weekly scale highlight where price is likely to reverse. This isthe single best indicator of how profitable your measured move will be.If I am in a stock that forms a measured move, I want to know whathappens to price after the measured move completes. I studied the patternand found that for MMUs, price remained above the corrective phase 19%of the time. Price stopped somewhere within the corrective phase 35% ofthe time, another 31% continued lower but stopped before the start of thepattern, and the remaining 15% dropped below the start of the MMU.What you should remember is that 81% of the time, price returns to the corrective phase and perhaps goes much lower.
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For MMDs, 16% remain below the corrective phase, 35% stop rising within the corrective phase, 31% rise above the corrective phase butbelow the MMD’s start, and 18% continue rising above the MMD’sstart. The numbers are similar to MMUs, with 84% rising to at least thecorrective phase and sometimes much higher.Here are additional tips that I dug up for measured moves:• The larger the corrective phase retrace, the better the chance ofmeeting the price target.• Patterns with U-shaped volume reach their price targets more often than do those with dome-shaped volume.• A longer corrective phase means a more powerful move. ForMMUs, corrective phases longer than the median 26 days meansecond leg rises averaging 36%. Corrective phases shorter than themedian show second leg rises of 29%. For MMDs, the mediancorrective phase length is 21 days and the second leg decline averages 28% versus 22% for long/short corrective phase lengths, respectively. Because the corrective phase should be proportional tothe first leg move, I think this means that wide patterns performbetter than narrow ones.MMU and MMD Performance Profiles
Here is the performance profile for 577 MMU patterns in a bull market:• The first leg rise averages 46% in 87 days.• The corrective phase retraces an average of 47% in 32 days.• The second leg rise averages 32% in 60 days.• Volume trends downward 61% of the time.• Volume is dome shaped 62% of the time.Here is the profile for 647 MMD patterns in a bull market:• The first leg decline averages 27% in 61 days.• The corrective phase retraces an average of 48% in 30 days.• The second leg decline averages 25% in 62 days.• Volume trends downward 74% of the time.• Volume is dome shaped 61% of the time.
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Measuring Success
The beauty of the measured move is its predictive power. The measurerule for MMUs and MMDs is that you take half the first leg move andadd it to the lowest valley in the corrective phase. For the MMU shownin Figure 7.15, that means taking the difference between points A (9.75)and B (14.19), for a height of 4.44. Divide the result in half (2.22) andadd it to the low at C (12.81) to get a target of 15.03. This works 85% ofthe time.For MMDs, the measure rule is similar. For measured move EFGAin Figure 7.13, measure the decline from E to F, take half of it, and subtract it from the peak at G. To put numbers to the letters, E is at 27.13,and F is at 21.13 for a height of 6. Half of the height is 3. Subtract 3from the high at G (24.50) to get a target of 21.50. Prices reach the target 83% of the time.In my test of over 1,200 measured moves, I found that 45% of thesecond legs were as long as the first ones in MMUs, and 35% of MMDshad second legs that were as long as the first legs. Thus, don’t depend onthe second leg being as long as the first. Use half the first leg move instead.The most frequent corrective phase retrace of the first leg move is40% to 60%, close to the Fibonacci numbers of 38% and 62%.Case Study
Figure 7.15 shows a near perfect trade as far as timing goes. I followedthe construction of the falling wedge and bought 500 shares, filled at10.50. A falling wedge has price action that follows two downslopingand converging trendlines. The measure rule says the top of the pattern isthe price target. Price hits the target 70% of the time. So, I had a 70%chance that price would rise to the round number 15.After I bought, you can see that price struggled to move higher. Itthrew back to the upper wedge trendline at A before beginning its climb.A few days later, a mining analyst said that the company would be theonly U.S. copper producer to be in the black for the quarter because ofits Indonesian mine. Price started moving up then shot skyward like amodel rocket, pausing in its flight at B.Two days after B, the company reported a 33% drop in earningsbut the company remained profitable. The stock seemed to ignore thenews as the corrective phase of the MMU continued building the tightflag BC.
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After refueling the second stage, the model rocket took off again,shooting higher for two days before waffling upward. The parachutepopped out at D, completing the MMD, and I bailed out a day later,selling the stock at 16 for a gain of $2,700 or a massive 51%.Notice how prices slipped back to E, the top of the corrective phase.Expect that type of decline, or worse, after a measured move completes.
Pipe TopsPipe tops are a pattern that I found several years ago. At the time, I wondered what a double top would look like and how it would perform if thetops were just a week apart. I explored pipe performance on the daily andweekly charts and found that those on the weeklies performed betterthan did those on the dailies. If you know what a pipe bottom looks like,then flip that image upside down and you’ll have a pipe top.Identification
Figure 7.16 shows several pipe tops and a few pipe bottoms sprinkled infor variety. The pipe bottoms call the turning points quite well as do manyof the tops. Look at point A. This pipe acts as a continuation pattern because prices are already trending downward. Unfortunately, this pipe topappears near the end of the trend. The pipes shown in this figure workmuch better as reversals, such as the one at the peak in September 1999. Itcalls the turn exactly.Clustered together like neighbors with small lots are pipes B, C, andD, and they act as continuation patterns. Pipe C doesn’t confirm untilafter D completes. The inset shows confirmation, which occurs whenprice closes below the lower of the two pipe spikes; a lower close confirmsthe pipe as a valid chart pattern. Without confirmation, you don’t have apipe top.What should you look for when trying to find pipe tops?• Use the weekly scale. It gives better performance than thosefound on the daily scale.• Look for two adjacent, upward price spikes. The spikes should belonger than most over the prior year and should tower above thesurrounding landscape.• The two spikes should have a large price overlap.
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Apache Corp. (Petroleum (Producing), NYSE, APA)34
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FIGURE 7.16 Pipe tops and bottoms appear on the weekly chart, alongwith a diamond bottom and ascending triangle. The pipe top confirms whenprice closes below the lowest low in the pattern.
• The price variation between the tops of the spike is usually small,but can vary up to $1 or more for high-priced stocks. The median difference is 13 cents, average: 21 cents.• The right spike has lower volume than the left one 62% of thetime.• The pattern confirms when price closes below the lower of thetwo spikes.That’s all there is to it. The most important feature of pipes is thatthey look unique—twin birch trees towering above a forest of dwarfpines. Pipes should look unusually long and obvious.Trading and Trading Tips
Shorting a stock is fine for an experienced trader, but most investorsshould not attempt it. Thus, pipes serve as warnings of a coming pricedecline. Here are some numbers to help you decide whether to sell a longholding after a pipe top confirms:
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• Pullbacks occur 41% of the time.• Patterns with pullbacks have postbreakout performance that suffers an average decline of 16% versus 22% for those without pullbacks. If you see underlying support, the stock may reverse there.If price declines to the support zone, can you tolerate such a loss?What if price drops lower?• Patterns taller than the 10.23% median height divided by thebreakout price perform better than short ones (23% average decline versus 17%). I measure height from the tallest spike to thelowest one in the two-week pattern.• Pipes within a third of the yearly low decline most, 22% versus19% for the middle and high thirds of the yearly trading range.• Pipes with long spikes perform better (prices decline more postbreakout) than do those with short ones. This is the reason for selecting pipes with unusually long spikes.• Pipes with a lower left spike tend to perform better than do thosewith a lower right spike (declines averaging 21% versus 18%, and20% for pipes with even spikes).Measuring Success
The measure rule for pipe tops is the chart pattern high minus the low subtracted from the low. By high and low, I mean the higher and lower of thetwo spikes. That difference finds the height. Subtract the height from thelowest spike to get the target price. This method works 70% of the time ina bull market.For example, the pipe top shown in the inset at the top of Figure7.17 has a high price of 10 and a low of 9. The difference, 1, is the height.Subtract it from 9 to get the target of 8.Case Study
Jake smokes cigars. In February 2000, he was so engrossed in a pipe topon his monitor that he forgot about the cigar wedged between his teeth.The ash dropped off and burned a hole in his office chair. Figure 7.17shows what he saw (on the screen, not on his chair).The pipe top was a church steeple, but Jake knew it did not pointthe way to heaven. When price made a lower low a week later, he soldshort, getting an average price of 14.61. He leaned back in his chair and
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FIGURE 7.17 A pipe top leads to a profitable trade.
puffed on his cigar, chugging away like a locomotive climbing a steepgrade.He estimated that the stock could decline to the support area shownby the horizontal consolidation region (represented by the line at A), butmore likely would retrace the entire decline back to B. Why? “Priceclimbed too fast and was unsustainable. Look at the rise from the diamond bottom back in April 1999. Price climbed from 10 to 14 in fiveweeks and then gave back most of it. I expect price to do the same.”That was his wish, but things rarely work out that well. When pricepaused at A, he was not worried. He rechecked the company fundamentals and the current news, and was satisfied with what he found. Nevertheless, he tightened his stop—meaning he moved it closer to where thestock was then trading.Prices worked their way lower and when they neared the price at B,he started covering his short, closing out half of his position at an averageprice of 10.75.With the remainder, he decided to hold on. The following week,the stock made a lower low, but he became distracted. By the time he returned to the trade, the stock had risen a point, or almost 10%. Heclosed out the remainder of his position at an average price of 12.40.
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Ascending and Symmetrical TrianglesI checked my spreadsheet of trades and found that I win most often trading symmetrical triangles, followed by descending triangles. I get my buttkicked trading ascending triangles. Your luck may be different, and I amsure the results will change over time. I have two ascending triangletrades on now, and both became profitable the day after I bought, so Iam hopeful. (Both led to big, quick gains).Identification
Figure 7.18 shows two symmetrical triangles and one ascending triangle.The symmetrical triangles have two converging trendlines that boundprice action. The breakout direction is unknown until it happens. Theascending triangle has a flat top and upsloping price trend on the bottom. An upward breakout is assumed, but it can be downward as the figure shows. Since the breakout direction is unknown, it is critical that youwait for the breakout.
Albermarle Corp. (Chemical (Diversified), NYSE, ALB)
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FIGURE 7.18 Two symmetrical triangles lead the way to a large ascendingtriangle.
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The key to identifying chart patterns is to look for straight linesalong peaks or valleys. Those are the lines your brain wants to constructon the price chart. Then look for curves. Between straight lines andcurves, you’ve got the gamut covered. Triangles are like cumulus cloudsnear the great lakes: They appear often, but here’s what to look for.Ascending Triangles• Look for peaks that top out near the same price (a horizontaltop).• Find prices that make higher valleys. Prices should touch an upsloping trendline drawn beneath the valleys.• Prices must touch each trendline at least twice.• Prices must cross the chart pattern from side to side, leaving littlewhite space within the body of the pattern.• The two trendlines converge at the triangle apex.• Volume trends downward 77% of the time from pattern start tothe day before the breakout.• A breakout occurs when price closes outside the trendline boundary. An upward breakout occurs 70% of the time.Symmetrical Triangles• Look for a converging price trend: higher valleys and lower peaks.• Trendlines drawn along the peaks and valleys form two converging trendlines that join at the triangle apex.• Prices (the peaks or valleys) must touch each trendline at leasttwice (four trend reversals).• Prices must cross the pattern from side to side, leaving little whitespace.• Volume trends downward 86% of the time from the pattern’sstart to the day before the breakout.• A breakout occurs when price closes outside the trendline boundary. An upward breakout occurs 54% of the time.Trading and Trading Tips
I learned the first tip from two independent sources and examined thecharts to be sure it held promise. That is, when a symmetrical triangle
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forms at the start of an uptrend, expect a large move. You can see this onthe weekly scale. Symmetricals well along in the trend tend to fail moreoften than those at the start. By trend, I don’t mean the trend start or ultimate high because those terms have specific definitions. I mean thelong-term price trend on the weekly scale.Additional tips for ascending triangles include:• Throwbacks occur 57% of the time. Pullbacks occur 49% of thetime.• Always check for support or resistance before trading becausethey can cause pullbacks or throwbacks. Patterns with pullbackshave postbreakout performance that suffers an average decline of17% versus 20% for those without pullbacks. Throwbacks haveresults even farther apart: 31% for those with throwbacks and41% postbreakout rise for those without throwbacks. If you seeunderlying support or overhead resistance, the stock may reversethere and you may end with a loss.• Tall patterns perform better than short ones. Tall means tallerthan the 10.13% median height divided by the breakout price(upward breakouts) or 12.02% median for downward breakouts.Tall patterns, for example, have price that rises 44% postbreakoutversus 30% for short patterns.• Those with a long-term rise leading to the chart pattern climb anaverage of 37% after the upward breakout. Those with a shortterm decline leading to the pattern show a 41% rise after an upward breakout.Tips for symmetrical triangles follow:• Throwbacks occur 54% of the time. Pullbacks occur 59% of thetime.• Patterns with pullbacks have postbreakout performance that suffersan average decline of 15% versus 21% for those without pullbacks.For upward breakouts, the rise is 25% for those with throwbacksand 38% postbreakout rise for those without throwbacks.• Tall patterns perform better than short ones. Tall means tallerthan the 14.48% median height divided by the breakout price(upward breakouts) or 14.50% median for downward breakouts.Tall patterns, for example, have price that rises 38% postbreakoutversus 26% for short patterns.
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• Patterns with heavy (above the 30-day average) breakout volumedo better. For example, symmetricals with heavy volume showpostbreakout rises averaging 35%. Those with weak breakoutvolume rise 24%.• Patterns both tall and narrow outperform. T