lips and extending the linedown beyond the handle. When price closes above the trendlinein the handle, buy the stock or add to your position. The inset inFigure 6.10 shows this scenario.• The standard buy location is when price closes above the rightcup lip—if it has a right lip. If not, buy when price closes abovethe price of the left cup lip.• If prices are predominantly flat leading to the rounding bottom—a flat base of several months duration—that often leads to a powerful rise after the breakout.• Throwbacks only occur 40% of the time and when they do occur,performance suffers (33% average rise versus 50% without athrowback). Avoid nearby overhead resistance to avoid a throwback. Figure 6.10 shows a throwback to the handle on the far right.• Patterns taller than the median 31.58% (height divided by thebreakout price) perform better than short ones, 52% versus 38%average rise.• Wide patterns—wider than the 196-day median—perform better, 48% average rise versus 38% for narrow patterns.• Patterns with breakouts near the yearly high perform best.• The median time from the right cup lip to the breakout is 33 days.
6. Descending Triangles (Tied with 5)
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Measuring Success
The measure rule for rounding bottoms uses the height of the cup fromthe bottom to the right cup lip if it has one (otherwise use the left cuplip). Add the height to the breakout price—usually the right cup lip ortrendline break if a handle is used (otherwise use the left cup lip)—to getthe target. Unfortunately, this works only 57% of the time.For a more conservative measure, use half the cup height and add itto the breakout price. Using this method boosts the success rate to 78%.For example, the height of the rounding bottom pictured in Figure6.10 is C (at 12.80) minus D (the lowest valley in the pattern at 5.51) or7.29. The target price is the height added to the breakout price, or 20.09(12.80 + 7.29). A more conservative target uses half the height, or 3.65,for a target of 16.45.
6. Descending Triangles (Tied with 5)• Average rise rank: 2• Breakeven failure rate rank: 7• Change after trend ends rank: 7Descending triangles are tied for fifth place with rounding bottoms. Thischapter assumes an upward breakout from a descending triangle,although a downward breakout occurs 64% of the time.The 47% average rise ranks second, and the number assumes perfectly traded patterns, so your results will vary. The breakeven failure rareis 7%, meaning that 7% of the patterns have prices that fail to rise atleast 5% after the breakout. Once price reaches the ultimate high, it tumbles 30%, placing the pattern in seventh place.Identification
Figure 6.11 shows an example of a descending triangle. Prices along thebottom of the pattern touch a horizontal or near horizontal trendline.Along the top, the trend slopes downward, ending when the two trendlines touch at the triangle apex. This one shows a throwback to the toptrendline that occurs just 37% of the time, so you should not depend onit happening to enter a position.
THE TOP 10 PERFORMING BOTTOMS
98
Nabors Industries, Ltd. (Oilfield Svcs/Equipment, AMEX, NBR)4847464544
Too MuchWhite Space
43424140
Throwback
39383736
DescendingTriangle
35343332
03
Jul
Aug
Sep
Oct
Nov
Dec
Jan 04
Feb
Mar
Apr
31
FIGURE 6.11 A descending triangle is flat along the bottom and the topslopes downward. Prices throwback to the top trendline in this example.The inset is not a descending triangle because prices do not cross the pattern enough times to fill the white space.
What should you look for when trying to find descending triangles?Fortunately, triangles are easy to spot, but here are a few guidelines tomake the job easier:• Look for two price trends, the valleys align horizontally or nearlyso, and the peaks slope downward. Both trends should followtrendlines connecting them.• Prices must touch each trendline at least twice.• Prices must cross the pattern from side to side, filling the patternwith price movement, not white space. Do not cut off a roundingturn and call it a descending triangle. The inset to Figure 6.11shows this situation. It’s not a descending triangle because of toomuch white space.• Prices usually break out downward, but we want to stay on thebullish side, so trade only upward breakouts. A breakout occurswhen price closes above the downsloping trendline.
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99
• Volume slopes downward 83% of the time and can become quitelow days before the breakout.Trading and Trading Tips
Because descending triangles break out downward64% of the time, always wait for the upward breakout. If you are lucky, prices will break out downward, spin around, and then soar out the top. Ishow that scenario in Figure 6.12.The busted triangle, where prices break outdownward and drop less than 10% before rebounding, often leads to large gains. Trading busted chartpatterns is an easy way to make money, so I devotean entire chapter to them later in this book. Fornow, if you see a situation like that shown in Figure6.12, buy it. Also, watch for the throwback to occur,as you don’t want to be stopped out prematurely.
busted patternperformancea chart patternthat reaches theultimate high orlow less than 10%away from thebreakout and thenreverses direction.The performancemeasures how farprices move in thenew direction (thedirection oppositethe breakout)before reaching anew ultimate highor low.
Biomet Inc. (Medical Supplies, NASDAQ, BMET)424140
PriceTarget
39383736
A
35
C
34
Throwback
33
B
323130
Breakout
2928272603
Jul
Aug
Sep
Oct
Nov
Dec
Jan 04
Feb
Mar
Apr
25
FIGURE 6.12 This descending triangle breaks out downward then shootsout the top. Busted patterns, such as this one, suggest a powerful upwardmove.
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Figure 6.12 shows what I used to call a premature breakout. That’swhen prices break out in one direction and return to the triangle within aday or two before staging the real breakout later. Preemies are rare, however. Just 6% break out upward and 20% break out downward. As Imentioned, the downward preemies are a blessing as they sometimes leadto a busted pattern.The average distance to the breakout is 64% of the way to the triangle apex. However, my research says that the most powerful breakoutshappen 80% to 85% of the way. The sample size (31) is small, so do notdepend too much on the numbers.Descending triangles that appear far up a rising price trend tend toflame out quicker, meaning that the rise after the breakout is less. Mystudy showed that those near the beginning of a trend rise an average of39%. Those closer to the trend’s end rise 34%. The median rise to thetriangle is 72 days, so rises shorter than that are, well, short.Here are some interesting tidbits I found on descending triangles.They may help you select better performing triangles to trade.• Nimble swing traders can buy near the horizontal trendline andsell when prices turn at the top trendline.• Extend the two trendlines into the future for support and resistance zones.• The triangle apex acts as a future region of support and resistance.• A buy signals when price closes outside the top trendline (an upward breakout).• Narrow patterns perform better than wide ones with rises averaging 38% versus 32%. The median width is 47 days. Patternsshorter than the median are the narrow ones.• Patterns both tall (above the 10.72% median height divided bythe breakout price) and narrow (narrower than the median 47days) perform better than the other combinations of height andwidth.• If prices rise into the triangle, expect an upward breakout (whichoccurs 73% of the time), but always wait for the breakout beforetrading.• Patterns with breakout day gaps do well, with prices rising anaverage of 44% after the breakout versus 34% for those without gaps.
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• Above average breakout day volume tends to push prices higher:36% versus 33% for those patterns with breakout volume belowthe 30-day average.• Postbreakout performance improves when volume slopes upwardin the formation—40% average rise versus 34% for those with areceding volume trend.• Triangles with U-shaped volume tend to outperform with pricesrising 44% after the breakout versus 29% for those with domeshaped volume.• Seventy-three percent acted as continuations of the prior pricetrend, 27% were reversals.Measuring Success
The measure rule for descending triangles is simply the height added tothe breakout price. The height is the difference between the price of thehorizontal trendline (the lowest valley) and highest peak in the pattern.Add this difference to the breakout price—the point where price crossesthe trendline. This method works 71% of the time. It’s fallible, but it doesprovide a price target you can work with. After you compute the target,look for nearby support and resistance zones. Price may stop there.As an example of how to apply the measure rule, Figure 6.12 showsthe highest peak in the pattern at point A and the lowest valley at B(ignore the downward breakout). The price difference is 35.34 – 33.17,or 2.17. The breakout price is 34.31—the value where price pierces thedownsloping trendline (since we are looking for an upward breakout target). Thus, the target is the breakout price plus the height, 34.31 + 2.17,or 36.48. I show the price target on the figure.I walked into my office and there was Jake, yawning. “A yawn is asilent shout,” I said.He lightly slapped his cheeks as if to wake up and then pointed atthe computer screen. “I’m reading your manuscript. It’s boring. It needssomething. Like jokes. Lots of jokes.”“It’s not supposed to be funny, Jake. It’s nonfiction finance, not anovel.”“But it’s boring!”“If I fill it with jokes, readers will post nasty notes on Amazon saying it’s trite.”
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He shrugged, but hair stood up on the back of my neck. He was upto something. I just couldn’t figure out what it was.
7. Ascending Broadening Wedges (Tied with 8)• Average rise rank: 9• Breakeven failure rate rank: 2• Change after trend ends rank: 6Ascending broadening wedges (ABWs) rank seventh for performance,tied with Eve & Eve double bottoms. ABWs show an average rise of 38%if you trade this one perfectly. The breakeven failure rate is 2%, meaningthat 2% of the patterns failed to rise at least 5% after the breakout. Thatperformance places the chart pattern in second place. Finally, once pricereaches the ultimate high, it tumbles 31%, ranking sixth.Before I get too far, I studied 255 ABWs, but only 58 broke out upward in a bull market, and those are the ones I discuss in this chapter.Identification
Figure 6.13 shows what an ABW looks like. Two trendlines follow theprice action. Both slope upward but the top one is steeper than the bottom one, so they diverge. The pattern reminds me of a cheerleader’smegaphone tilted upward. To make sure you identify an ABW correctly,look for three touches of each trendline. That helps select patterns thathave the broadening characteristic and improves performance.Here are the guidelines for selecting ABWs:• Three peaks and three valleys should near or touch upslopingtrendlines.• Neither trendline should be horizontal.• The top trendline should slope upward more steeply than thebottom one.• The pattern should look like a megaphone tilted upward.• Volume trends upward 64% of the time.If you draw a trendline across peaks A, B, and C in Figure 6.13, itwould make a larger ABW. The bottom at D marks a partial decline thataccurately predicts an upward breakout 35% of the time. That’s not verygood, so you shouldn’t put much faith in it.
7. Ascending Broadening Wedges (Tied with 8)
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Air Products and Chemicals, Inc. (Chemical (Diversified), NYSE, APD)
45
C
4443
B4241
D
A
40393837
AscendingBroadeningWedge
363534
97
Aug
Sep
Oct
Nov
Dec
Jan 98
Feb
Mar
Apr
May
33
FIGURE 6.13 An ascending broadening wedge appears as shown, but alarger one connects ABC on the top. D marks the bottom of a large partialdecline correctly predicting an upward breakout from the ABC pattern.
A partial decline occurs when price leaves the top trendline andheads down but swings upward before coming close to or touching thebottom trendline. An immediate upward breakout follows if the partialdecline works as expected.When searching for a partial decline, work with an established chartpattern, meaning the peaks and valleys touch the each trendline at leastthree times. Only then should you look for a partial decline, and it mustbegin before the breakout.For the larger ABW (points A, B, and C), a breakout occurs whenprice closes above point C in Figure 6.13. For the smaller ABW (betweenpoints A and B), the breakout occurs when price closes above B, thehighest peak in the pattern.Trading and Trading Tips
For experienced traders, 73% of ABWs breakout downward, and a partial rise can get you in before the breakout. In Figure 6.14, a partial rise isat point A, and it predicts a downward breakout. (That does not happenin this example, but pretend that it does.)
THE TOP 10 PERFORMING BOTTOMS
104
Standard Pacific (Homebuilding, NYSE, SPF)
33312927
Throwback
2523
ConfirmationLine
21201918
A
171615141312111000
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
Jan 01
Feb
9
FIGURE 6.14 The partial rise shown at point A usually predicts a downward breakout from the pattern. Here, the breakout is upward.
How do you identify a partial rise? Once the price pattern is established (meaning price touches each trendline at least three times), lookfor prices that rise off the bottom trendline but don’t come close to ortouch the top trendline. When prices return to the lower trendline, animmediate downward breakout occurs 74% of the time. Trading a partialrise is not easy because it can look like the pause that often occurs midway through a rise heading to the top trendline. Short the stock once it’sclear prices are heading back to the lower trendline. If prices bounce upward off the trendline, cover your short immediately. Price may stillbreakout downward, but the odds shift against that happening.If you don’t have a partial rise or decline to trade, here are additionaltrading tricks. Warning: Performance numbers are based on 58 perfecttrades, too few in many cases to be reliable.• For swing traders, buy when price touches the lower trendline andsell as it approaches the top trendline, and then reverse the trade.• Place an order to buy just above the third peak. If prices rise andmake a fourth trendline touch then begin heading down, sell immediately to avoid a return to the bottom trendline.
7. Ascending Broadening Wedges (Tied with 8)
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• For aggressive traders, place a buy order when price touches thebottom trendline for a third time and begins moving up. Watchfor a partial rise to occur, and if one does, sell your position whenprice closes below the bottom trendline, as prices are likely tocontinue falling like a rock down a steep hill. If price bounces offthe top trendline instead of pushing through it, sell when priceretraces 62% of the prior up move.• For experienced traders, if the ABW is the corrective phase of alarge measured move down, then expect a downward breakout. Idiscuss measured move chart patterns in Chapter 7.• Tall patterns do better than short ones, with prices climbing 50%versus 30% after the breakout, respectively. Tall or short meansthe pattern height divided by the breakout price compared to the18.60% median.• Wide patterns, those wider than the median 66 days, performbetter than narrow ones, with prices rising an average of 39% versus 35%, postbreakout.• Seventy-six percent acted as continuations of the prior pricetrend. Reversals made up the remainder.The traditional breakout price is a close above the confirmationline, the highest peak in the pattern, as shown in Figure 6.14. Unfortunately, it can be difficult to tell when the stock has quit following the toptrendline and is breaking out. Many times, a close above the third peakwill correctly signal an upward breakout, so use that.For example, Figure 6.15 shows another ABW with price touchingeach trendline three times. The multiple trendline touches at 2 are closeenough together to be considered one touch. The same goes for point A.The traditional buy point is a close above C, which I show as the horizontal line, Buy 1. If you place a buy order at or above the third toptrendline touch, you will be on the correct side of the trade the majorityof the time. Price may retrace once it encounters the top of the pattern(as it does by dropping to B), so factor that into your stop price.If you spot the ABW soon enough, you can trade it as prices swingfrom side to side. Again, place a buy order when price begins rising afterthe third trendline touch (Buy 2). You can ride the stock upward to theprice level of C, or the stock may curl back into a partial rise and breakout downward. Be sure to sell if it closes below the lower trendline because the downward breakout means prices will tumble.
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United Parcel Service (Air Transport, NYSE, UPS)8483828180797877
3 C
Buy 1
76757473
2B
7271
1
Buy 2
7069
DA
E04
Feb
Mar
Apr
May
68Jun
Jul
Aug
Sep
Oct
Nov
67
FIGURE 6.15 Place a buy order at C for the traditional breakout, or at D,the third bottom touch, once price begins heading back up.
If price rises to the top trendline and bounces downward, swingtraders should take their profits. For others, sell if price drops below a62% retrace of the prior up move. By that, I mean measure the pricedifference between where the stock stops moving upward and the priorvalley. Take 62% of that and subtract it from where the stock stoppedmoving up. In this example, the decline to B is less than 62% of the D toBuy 1 move, so a sale is not needed. Hold onto the stock and hope pricerecovers as in this example.Measuring Success
The measure rule for ABWs helps predict a target price. Compute theABW height and add it to the breakout price to get the target. For example, the pattern in Figure 6.15 has a height of C – E, or 7.35. Add theheight to C (the breakout price) to get a target of 82.64. If support or resistance is nearby, then expect price to stall there and adjust your targetaccordingly.The measure rule for upward breakouts works 69% of the time.That is well short of the 80% I like to see, so you might want to use half
8. Eve & Eve Double Bottoms (Tied with 7)
107
the height in the computation. For the example shown in Figure 6.15,the height becomes 3.68. When added to the price of C, the new targetbecomes 78.97. Prices hit the nearer target 93% of the time.
8. Eve & Eve Double Bottoms (Tied with 7)• Average rise rank: 7• Breakeven failure rate rank: 4• Change after trend ends rank: 6The Eve & Eve double bottom (EEDB) is what most chartists call theclassic double bottom. It has an overall performance rank that ties withascending broadening wedges. The average rise from perfectly tradedstocks is 40%, placing it seventh. The breakeven failure rate is 4%, for afourth place finish. Finally, the 31% decline after the trend changesplaces it sixth among bullish chart patterns.Identification
The Adam and Eve combinations of double bottoms are a somewhatrecent addition to the chart pattern landscape. The names describe theappearance of each bottom in the twin valley formation. Adam bottomsare narrow, usually one-day downward price spikes while Eve is morerounded looking and considerably wider than Adam.Figure 6.16 shows what an EEDB looks like. The two valleys arewide, rounded appearing turns, spaced several weeks apart. The rise between the bottoms is rather extensive. The double bottom confirms as avalid EEDB when price closes above the peak between the two valleys(shown as the confirmation line).What should you look for when trying to spot EEDBs?• Prices should trend downward before the left valley, but shouldnot drop below the valley. In other words, you don’t want to see alower valley adjacent to the first valley.• Each valley should appear similar: wide, rounding turns.• The rise between the two valleys should be at least 10%.• The two bottoms should appear near the same price—less than6% apart.
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108
JLG Industries (Machinery, NYSE, JLG)2019181716
ConfirmationLine
15
14
Handle13
Eve
Eve
12
AdamAdam
04 Feb
Mar
11
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
10
FIGURE 6.16 An Eve & Eve double bottom has two wide rounding valleys,not narrow price spikes as does its Adam counterpart.
• Several weeks (two to seven for the best performance) should separate the two valleys.• Volume is usually higher on the left bottom (volume trendsdownward 65% of the time).• Price must close above the confirmation line (the highest peak inthe pattern) before the twin bottom becomes a true EEDB.• If a double bottom forms a third bottom before the double bottom confirms, treat it as a triple bottom.For example, the EEDB shown in Figure 6.16 has a downwardprice trend that leads to the first valley without dropping below it onthe way down. Both valleys are wide, rounding turns (compare with theAdam & Adam double bottom in March). The rise between the twovalleys measures 20% from the lowest valley (the left one) to the peak.The two valleys are less than 2% apart in price (22 cents) and are 11weeks apart, as measured from the lowest valley in each bottom. That’s alittle wide, yet close enough for government work, as they say. Volume ishigher surrounding the left valley, as expected. Price closes above the
8. Eve & Eve Double Bottoms (Tied with 7)
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confirmation line in early September, confirming the pattern as a validEEDB.Figure 6.17 shows what the various combinations of Adam and Evebottoms look like. Eve is wide and rounded appearing. Adam is often a single spike or just a few days wide, long, and needle sharp. Eve sometimes hasspikes but they are shorter and more clustered, like shallow roots of a tree.Trading and Trading Tips
I have noticed that EEDBs, and all double bottoms for that matter, areriskier than many other chart patterns. Why? Because you find them atthe bottom of a price trend. The problem occurs after price confirms thepattern. That’s when traders come along and swat price back down. Thestock drops below the lowest valley, emptying your wallet.How can you prevent investing in busted patterns? Before taking aposition in any stock showing a chart pattern, look at the general market.I use the Standard & Poor’s 500 index as the proxy.I look for any chart patterns in the S&P and find it surprisingly easyto determine whether prices will trend up or down in the coming weeks.Transocean Inc. (Oilfield Svcs/Equipment, NYSE, RIG)31302928
Adam
AA
27
Eve26
DE
25242322
B
21
Shelf
20
Adam
Eve
19
Eve
EveC03
Jul
Aug
Sep
Oct
Nov
Dec
Jan 04
Feb
Mar
Apr
18
FIGURE 6.17 Shown are the different combinations of Adam and Eve bottoms. Pattern AA is an Adam & Adam double bottom.
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I also look at the NASDAQ composite, Dow Jones Industrials, Utility,and Transportation averages to round out the picture, depending on thetype of stock that I’m considering.Then I check the industry in which the stock belongs. Because I follow five or more stocks in the same industry, it’s easy to pull up eachstock and look at the chart. Is price trending upward? Are there any chartpatterns that signal a trend reversal (bearish patterns)? Are they tradingnear the yearly high?Often, either the general market (which I consider very important)or the industry will be weak enough to keep me on the sidelines. However, when the clay pigeons line up, I grab my rifle and start shooting.Here are additional tips for trading EEDBs:• Look for a shelf on the right bottom, a flat top that can act as asupport zone. I show it on the November Eve bottom in Figure6.17. For swing traders, buy when price closes above this threshold and sell at confirmation if price stalls there. Be aware that thedouble bottom may become a triple bottom.• For position traders and investors, buy when price closes abovethe confirmation price—the highest peak between the two bottoms. Trading before confirmation means a loss 64% of the time.That rate is how often price never makes it up to confirmation.• Sometimes, price will confirm the EEDB and then waffle up anddown, forming a handle. When prices break out of this congestion region, they often (but not always) move up in a strongtrend. Figure 6.16 shows the EEDB with handle scenario.• When the double bottom forms after a long, flat price trend (aflat base), the double bottom usually sports a large gain after thebreakout. Switch to the weekly scale and look for a flat base.Think of the double bottom as a pothole in a flat road before ahill. If price bounces out of the hole, it can drive uphill for an extended move.• If a pipe bottom (or any other bullish chart pattern) forms as part ofthe right Eve bottom, then buy the stock when the pipe confirms.• EEDBs both short and narrow tend to outperform (49% averagerise) the other combinations of height and width. Short meansless than the 16.4% median height divided by the breakout price.Narrow means less than the median 50 days wide.
8. Eve & Eve Double Bottoms (Tied with 7)
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• Patterns with breakouts within a third of the yearly low outperform the other two ranges (middle and high thirds).• EEDBs without throwbacks perform significantly better than dothose with throwbacks. Prices rise 48% versus 33% after thebreakout, respectively. Look for trades without nearby overheadresistance.• Double bottoms with volume heavier on the right bottom thanthe left do better after the breakout with price gains averaging43% versus 39%.• Look for a big W pattern—an EEDB with unusually tall sides.The decline leading to the EEDB is a straight-line run of severalpoints. Expect the breakout to return prices to where they startedthe decline. Figure 6.17 shows a big W between points D and E.Measuring Success
The measure rule for double bottoms is the height added to the breakoutprice. The height is the difference between the highest peak and the lowest valley in the pattern. Add the difference to the breakout price—thehighest peak in the pattern—to get a target price. Prices meet the target67% of the time after an EEDB breakout. That percentage is a little low,so be conservative with your targets—as in archery, the closer the target,the better the accuracy.The measure rule applied to the EEDB shown in Figure 6.17 is thedifference between B and C added to B. B is at 21.39, and C is at 18.49.The difference between the two, 2.90, is the height. Add the height tothe breakout (B) to get a target of 24.29. In this example price reachesthe target in mid-December.Case Study
“There you are.” Jake said. He found me in the barn, cleaning out thehorse stalls. “I had a great vacation! Let me tell you about . . .”“You were stopped out of Guess.”The corners of his mouth turned down. Fists clenched, his fingerscombing his hair backward, showing a receding hairline, he stompedback to the house to survey the damage. Figure 6.18 shows his trade.He bought 1,000 shares at 16.13 the day after the pattern confirmed (when price closed above the peak at point A, 16). Immediately
THE TOP 10 PERFORMING BOTTOMS
112
Guess Inc. (Apparel, NYSE, GES)
212019
Bought
18
Triple BottomConfirmation Line
17
A
1615
B14
CEve
Eve
13
Sold
12
11
04
Mar
Apr
May
Jun
Jul
Aug
Sep
Oct
Nov
Dec
10
FIGURE 6.18 An Eve & Eve double bottom confirmed but price backtrackedand changed into a triple bottom. Price didn’t rise very far before tumbling.
he placed a stop at 14.57, three cents below the valley at B, for a potential loss of about 10%.“I expected price to stall near the April high at 18.50,” Jake said andpointed to his notes on the computer screen. He read, “I don’t expect thisto work out well. I think the market is about to tumble. Guess I wasright on Guess.”“Why did you buy it?”He searched