in volume. The increase meant that the runwould be an extended one, as there seemed to be enough enthusiasm to sendprices higher.All bull runs must pause now and again and this situation was no different. Michelle saw the stock pause and consolidate for nearly a month duringJuly. She looked back at the chart and noticed that the stock had reached a zoneof resistance where there were several old highs that stalled prices near the 21level. Volume picked up and when prices shot upward, she immediately recognized the measured move formation. Did she sell? No. She hung on for theride. Michelle calculated that the stock would rise to 253/8, a new yearly high.She suspected that the stock might find resistance at the old highs of 24, andthat is exactly what happened. A symmetrical triangle formed in the stock. Theformation obeyed the rules for symmetrical triangles, lower highs and higher
lows with a receding volume pattern, andrecdy identified it.Since there was no way to tell whichof the triangle, she sat tight. Then pricesbreakaway gap or an exhaustion gap? Shejust after a region of consolidation, it was mwould continue rising, but how far? Shehalfway mark of an up move. She knew tsometimes act like half-mast formations, smeasure rule for Symmetrical Triangles).but one worth waiting for. Her calculatedprices jumped out of the triangle.About a week after prices left the triafell back. When prices closed the gap idecided to sell her holdings. Fortunately,and she was able to sell her shares at 24'/2watched, the stock tumbled back to the midie center of the support zone. Then, the stand posted a new high, she wondered if shafter reviewing the chart 6 months later anrange.
*
28One-Day Reversals
Tour
395
One-day reversals (ODRs): The only surprise in the Results Snapshots is thatthe formations perform so well. Sure, the 24% failure rate for tops is above the20% maximum I arbitrarily assign to reliable formations, but it could be worse.The average loss for tops at 19% is quite close to the average of 20% for allbearish formations. However, bottom reversals, with gains averaging 26%,are well short of the usual 40% for bullish patterns. The most likely rise is10% to 15 %, about what you would expect. I suspect that by the time you place
a trade after this formation, it will be too late and your return will be unremarkable.Fullbacks are prevalent (happening in 71% of the ODR tops) and suggestyou might wait for them before investing in an ODR top. Throwbacks are a bitweak, however, so do not depend on seeing them in ODR bottoms.
TourThe ODR top shown in Figure 28.1 marks the crest of an unbalanced headand-shoulders top. It appears after a long climb that begins in January. The
ODR has a closing price near the daily low and the spike itself is longer thanmany of the spikes over the preceding year.Figure 28.2 shows what the bottom version of the ODR looks like. Itappears after a downtrend that in this case is not very long. The downtrend
R E S U L T S SNAPSHOT
TopsAppearance
A large 1-day upward price spike with prices closingnear the low
Reversal or consolidation
Short-term (up to 3 months) bearish reversal
Failure rate
24%
Average decline
19%, with most likely decline being 10%
Volume trend
Heavy volume on reversal day but recedes quicldy
Fullbacks
71%
Synonyns
Climax Day, Selling Climax
BottomsAppearance
A large 1-day downward price spike with pricesclosing near the high
Reversal or consolidation
Short-term (up to 3 months) bullish reversal
Failure rate
17%
Average rise
26%, with most likely rise between 10% and 15%
Volume trend
Heavy volume on reversal day but recedes quickly
Throwbacks
61%
Synonyms
Climax Day, Selling Climax
394
Figure 28.1 A one-day reversal top appears as a large spike with a closing pricenear the daily low. It marks the head of an unbalanced head-and-shoulders top.
396
Identification Guidelines
One-Day Reversals
397
Identification Guidelines
Thomas Industries Inc. (Building Materials, NYSE, Til)
How do you identify ODR tops and bottoms? Table 28.1 highlights somecharacteristics to assist you in your selection process. First, start with a pricetrend. In many cases, the ODR occurs at the end of the trend, so the trend isusually a long drawn out affair (over several months). Some ODRs occur afterprices move for only a few weeks, so it varies from formation to formation.For ODR tops look for a rising price trend; for ODR bottoms, the trendshould be declining. Do not make the mistake of picking an ODR top in adeclining price trend or an ODR bottom in a rising price trend. Althoughthese spikes might act as consolidations, it is best to limit your selections to
Aug 93
Sep
Oct
Nov
Dec
Jan 94
Feb
Mar
Figure 28.2 A one-day reversal bottom appears after a downtrend. Note thelarge downward price spike with a closing price near the daily high.
reversals and depend on a trend change.Figures 28.1 and 28.2 show an ODR top and an ODR bottom. In Figure28.1 you can see part of the upward trend that begins at a price of $5.70 nearlya year before the reversal. Figure 28.2 shows a much shorter and sharperdecline. A zoom-out of the figure shows an upward trend that begins inNovember 1992 and peaks in August. Then, the stock moves horizontally andtumbles for 2 weeks down to the ODR.Both figures show large price spikes that seem to poke well beyond theirpeers. The daily range exceeds anything on the charts up to that date. Thespikes seem to stand alone with good visibility to the left.Another key identification guideline is where prices close. For tops the
begins just 2 months before the reversal. The ODR bottom has a closing pricenear the daily high and accompanies high volume, and the spike is longer than
closing price should be at or near the daily low. Bottom reversals show just dieopposite: The closing price should be near the daily high. The closing pricenear the end of the range suggests prices are likely to continue in the new
other spikes throughout the prior year.Why do ODRs form? When I see a large price spike, I think of one thing:stop running. Imagine a series of stop-loss orders placed consecutively belowthe current price. It does not take much of a downward move to trigger thefirst stop. If the number of shares being sold is large enough, coupled with theassistance of short sellers, traders, and market makers, the price may drop evenfurther. When that happens, the next stop triggers and so on. The price tumbles until enough buying demand comes on-line to stop the cascade. This stop
direction. For tops the direction is down and for bottoms it is up. Although dienext day's trading range may cover some of the ODR, prices commonly close,and the range moves, in the predicted direction.
Characteristic
Discussion
running (or gunning the stops) is intentional.
Price trend
Once it is over all the people wanting to sell their shares have already sold,so there is overwhelming buying demand. The price recovers to near where it
For ODR tops, look for a price uptrend over several weeks ormonths. For ODR bottoms, the price trend should be down.
Large spike
Both tops and bottoms sport tall price spikes. The spikes should betwice as large, or more, as the average spike over the prior year.
Close near end
For tops the closing price should be near the low of the day, and forbottoms it should be near the high. By near, I mean within onethird of the daily range.
Volume
Volume is usually higher on the reversal day than the prior day andcan be unusually strong.
Table 28.1
Identification Characteristics of One-Day Reversals
started the day. At the close, a long thin line appears on the bar chart. It is an
ODR, where prices start the day about where they end, but in the interim,prices plummet several points. The selling pressure abates leaving only buyingdemand to carry prices higher over the coming days.The same scenario applies to ODR tops. Prices quickly rise but finish theday near the lows. Afterward, overwhelming selling pressure takes prices lower.
398
Statistics
One-Day Reversals
399
American Brands, Inc. (Tobacco, NYSE, AMB)
The last guideline is volume. Usually, an ODR, either a top or bottom,shows high volume, certainly volume that is above the prior day. This is clearin Figure 28.2, where the high volume lasts for several days as prices climb, butis less outstanding in Figure 28.1. Volume seems to be higher on bottoms thanon tops, supporting the belief that rising prices need a push while decliningprices can fall of their own weight.
Focus on FailuresUnfortunately, failures occur too often with these formations. Failures such asthose shown in Figures 28.3 and 28.4 are typical. Figure 28.3 shows an ODRtop failure. The price trend is up, the ODR spike towers above the surrounding prices, the closing price is near the daily low, and there is high volume—all the ingredients needed for a successful ODR. It works. Two days later,prices drop from an ODR high of 39 to a low of 35!/2.If investors were to try to take advantage of this situation, they may notrecognize an ODR until the next day or even later. Therefore, I compute performance using the lowest price in the ODR to the ultimate low. In this case,the ODR low is 37'/8, rendering a price decline of 4%. I consider declines ofless than 5% as failures (the so-called 5% failure).
Jul 92
Aug
Figure 28.4
A one-day reversal bottom fails after prices rise by less than 5%.
Figure 28.4 shows a similar situation with an ODR bottom. Here, diedownward spike is obvious. Volume attending the spike is high and prices close
near the high for the day. The situation suggests prices will move higher andthey do for nearly 2 months, then they begin moving lower again. From thedaily high at the ODR to point A, the ultimate high for this formation, pricesclimb by less than 4%. This performance qualifies as a 5% failure.
Circus Circus Enterprises, Inc. (Hotel/Gaming, NYSE, CIR)
The reason for failure in each case is similar. Can you guess what it is?They both stumble across support or resistance barriers that they cannot penetrate. Figure 28.3 has significant support at the 351/2 level, whereas Figure 28.4
has resistance in the 43 to 44 range. The movement stalls at the zones andreverses, setting up for the eventual failure. The lesson to be learned fromthese two failures is that you should always look to see how far you expect the
move to go. Consider the areas of support and resistance before making atrade.
Statistics
|ar>96
Feb
Mar
Apr
Figure 28.3 A 5% failure of a one-day reversal top. Prices drop to a support levelthen recover.
Table 28.2 shows statistics for ODR tops and bottoms. ODRs are not as plentiful as some other formations, but that is not to say they are scarce. On thecontrary, I uncovered 235 tops and 331 bottoms in the stocks I examined.Almost a quarter (24%) of the ODR tops and 17% of the ODR bottomsfail. Prices continue moving in the same direction after the formation as before(in other words, 5 % failures, where prices briefly move in the expected direction then reverse). When they do work, ODR tops have average declines of19%, whereas ODR bottoms rise by 26%.
400
One-Day Reversals
Statistics
401
Table 28.2General Statistics for One-Day ReversalsDescription
Tops
Bottoms
Number of formations in 500stocks from 1991 to 1996
235
331
Failure rate
56 or 24%
5 7 or 17%
Average decline/rise ofsuccessful formations
19%
26%
Most likely decline/rise
10%
1 0% to 1 5%
Percentage of pullbacks/throwbacks
71% or 165
61 % or 202
Average time to pullback/throwback completion
13 days
16 days
Days to ultimate low/high
2 months (66 days)
3 months (96 days)
Percentage of ODRs occurringnear 12-month price low (L),center (C), or high (H)
16%, C17%, H77%
L.35%, C34%, H31%
15
25
30
L20%,C22%, HI 7%
L30%, C23%, H28%
Volume for ODR day and next5 days versus day before ODR
182%, 110%, 77%,62%, 69%, 72%
214%, 107%, 86%,75%, 74%, 74%
Number of ODR days withvolume above prior day
170 or 72%
285 or 86%
9 3 or 40%
176 or 53%
35
40
45
50
>50
Percentage Cains or Losses• Tops
Percentage gain for each12-month lookback period
Number of days with twiceprior day's volume
20
Q Bottoms
Figure 28.5 Frequency distribution of returns for one-day reversals. The chartsuggests that the most likely return is less than 15%.
If we divide the prior year's price range into three parts, we discover thatODR tops predominantly form within a third of the yearly high. This is nosurprise, really, because the chart pattern forms after an extended up move.ODR bottoms form near the yearly low but not decisively so. You can see
that the range splits evenly around 30% and change. This surprised me. IFigure 28.5 illustrates the results of a frequency distribution of losses or
expected bottoms to appear near the yearly low, not spread evenly across the
gains for ODR tops and bottoms, respectively. By far, the tallest columns arethose situated near the 10% and 15% categories. These categories signify themost likely returns for ODRs. Almost half (49%) of the tops decline by 15% or
range. The results suggest that ODR bottoms happen after a short price
less, an alarming result if you short a stock expecting a long decline. Bottoms
perform marginally better, but that is scant comfort when the study periodencompasses a raging bull market.Pullbacks at 71% and throwbacks at 61 % are reassuringly high (especiallypullbacks). However, they take somewhat longer than usual to complete at 13and 16 days, respectively (normal completion time is about 10 to 12 days). Ifyou are considering shorting a stock showing an ODR top, you would probably be wise to wait for a throwback before investing. After the throwback, waitfor prices to head down again before selling short.The time it takes to reach the ultimate low or high is brief, at 66 and 96days for ODR tops and bottoms, respectively. This coincides with the smallaverage losses and gains for the two formation types. Small returns take a correspondingly shorter time to reach their price targets than do larger gains.
retrace, not an extended downtrend.If we substitute the performance into the yearly range, we discover that thebest performing tops occur in the center of the yearly price range (with declines
averaging 22%), whereas bottoms outperform near the low (a 30% rise). Theresults are close enough to each other that nothing meaningful results, but youcan use the information to select better ODR candidates. Choose ODR bottoms near the yearly low and ODR tops in the center third of the yearly pricerange for best average performance.
Table 28.2 shows volume numbers for the two formation types. Bothshow heavy volume on the reversal day that quickly diminishes. Since this is an
average, I counted die number of ODR days with volume above the prior day.For ODR tops 72% are higher, whereas 86% of ODR bottoms have highervolume. If you set the benchmark to twice the prior day's volume, the scoresdrop to 40% for tops and 53% for bottoms, meaning that high volume usuallyaccompanies ODRs—well, higher than the day before the ODR at any rate.
402
One-Day Reversals
Trading TacticsI do not recommend trading ODRs. Although their average return is acceptable, the most likely return is just too small at less than 15%. I consider thesevalues just too skimpy to risk a trade. Coupled with a high failure rate, forODR tops anyway, one should look for a more promising formation. However,that is not to say that these formations are not useful. They are. If you are considering buying a stock and see a large upward spike on high volume, beware.Prices will likely head lower. The same applies to downward spikes, which signal a bullish reversal. Again, that is worth knowing if you see one of thesespikes in a stock you own. A large downward spike may cause you concern, but
it is really a bullish event. Prices generally move higher, especially if the closeis near the daily high.
Sample TradeConsider how Jim used an ODR top in a stock he owned (see Figure 28.6). Jimlikes to ski. When he left for his ski trip in mid-February, the stock was making new highs. He was having so much fun that he forgot to check in with hisbroker and was unaware of the 22% decline (from 25 to 195/s). When hereturned from his trip and got back into his daily routine, the news awaitinghim was shocking.Kaufman and Broad (Homebuilding, NYSE, KBH)
Jan 92
Figure 28.6 One-day reversal top formation following a pipe and a broadeningformation. Jim used the one-day reversal top as the final sell signal. Highlighted isa pipe top (pretend it is on the weekly scale) and a broadening bottom.
On a weekly scale, the stock made atumble and they did. As Jim followed themaking a sort of broadening formation. Hiout from a broadening bottom (a bottom sthe formation) could occur in either directihis charts. The day after he saw the ODdecided that the price was the best he couldtion, and ODR were all clues pointing to thgoing down. He sold that day at 223/s, wellIn Jim's case, he was not trading the foinformation to protect profits in a stock he areached a low of 113/8, about half the price
Tour and Identification Guidelines
29Outside Days
405
The formation comes in two varieties: those with upside breakouts and thosewith downside ones.Upside breakouts, as the Results Snapshot outlines, sport a failure rate of25%, just above the maximum 20% rate that I consider acceptable. The average rise is a subpar 32% with a likely rise of less than 10%. Downside breakouts perform substantially worse in some respects. Their failure rate isexceedingly high at 42% with an average decline of 17%. The average declineis not bad for a bearish formation but the most likely loss is less than 10%.With likely gains or losses of less than 10%, you have to consider whether thisformation is worth trading. Meager gains coupled with a high failure rate suggest dial this is probably one formation to avoid.
Tour and Identification GuidelinesTable 29.1 lists identification characteristics for outside days. This formationis easy to identify and it is also common. Figure 29.1 shows what I mean. I haveidentified over a dozen outside days in the chart (each dot highlights an outsideday). An outside day is just as it sounds: The daily price range is outside theprior day. By that I mean the high is higher than the prior high and the low is
RESULTS SNAPSHOT
below the prior low. In essence, an outside day looks like a 2-day broadeningformation; the price range broadens out.
Upside BreakoutsAppearance
A daily price range wider than the prior day;breakout is upward
Reversal or consolidation
Short-term (up to 3 months) bullish consolidation
Failure rate
25%
Average rise
32%, with most likely rise less than 10%
Surprising findings
Many. See Table 29.3.
Downside BreakoutsAppearance
A daily price range wider than the prior day;breakout is downward
Reversal or consolidation
Short-term (up to 3 months) bearish consolidation
Failure rate
42%
Average decline
17%, with most likely decline less than 10%
Surprise findings
Many. See Table 29.3
Outside days are mirror images of inside days. Outside days are characterizedby a wider price range, one that is both higher and lower than the prior day.404
The combination of the wide outside day with the comparatively narrowday before implies one thing: a price move. Traders, once they spot an outside
day, wait for prices to move above the high or below the low. That becomesthe direction they trade. For example, the first outside day shown in Figure29.1 begins with a 3A point difference between the high and low of the daybefore (46 to 463/4). The outside day widens the range to 467/s and 457/s. Thefollowing day, the day after the outside day, prices make a new high but thestock closes unchanged. A trader would be wise to wait for a definitive breakout—a close either above or below the outside day's high or low.Two days later a breakout results when prices move decidedly lower andclose at 45'/2, comfortably below the low of the outside day. A downward
Table 29.1Identification Characteristics of Outside DaysCharacteristic
Discussion
Higher high
The daily high must be above the prior daily high. No ties allowed.
Lower low
The daily low must be below the prior daily low. No ties allowed.
Daily range
The day before the outside day must have a daily range. In otherwords, the daily high cannot be the same as the daily low.
406
Outside Days
Focus on FailuresAllied Signal (Diversified Co., NYSE, ALD)
407
Scan the various figures in this chapter and decide for yourself whetherthis formation is trustworthy. Perhaps there are lessons to learn if we focus onthe failures.
Focus on Failures
)ul 95
Aug
Dec
Jan 96
Feb
Mar
Figure 29.1 Numerous outside days highlighted by black dots. Point A suggestsprices will move higher and they do, but only briefly. Point B is a more timely buysignal.
breakout appears, telling astute traders that prices should continue movingdown. And that is just what happens. The stock reaches a low of 41'/s in lateOctober.Before you get too excited about diis formation, look at point A on thechart in Figure 29.1. It highlights an outside day too. A day later prices closeabove the high posted by the outside day and it appears the stock is moving up.The breakout signal is correct, too, as prices close even higher the next day.But that is all. From that point on, prices tumble.Let us say you buy after the breakout (2 days after the outside day; thefirst day after die outside day suggests an upward price move so you buy thenext day) and happen to receive a fill at 46. During September you have ahandful of days to sell the stock at a small profit or break-even. Your first realchance to make a tidy sum is during the holidays in late November. On May 1the stock climbs to over 60. That is not a bad move from 46, but duringthe interim you would need the fortitude to wait out a decline to 41 (a 10%paper loss).By now you might be asking yourself if this formation really works. Takea look at point B. This outside day calls the turning point exactly. Imagine getting in at the low, 41'/s, and riding it up to 60. That is almost a 50% move. Ofcourse, it also requires perfect timing, a quality that eludes most of us.
Since this formation has no definitive breakout direction, one cannot assign afailure to a particular chart pattern simply because it breaks out in the wrongdirection. Instead, I wait for what I call a 5% failure. If a chart pattern breaksout upward, for example, moves up by less than 5% before turning around andtumbling, then the formation is a 5% failure. This also applies to downsidebreakouts. If a stock breaks out downward but travels down less than 5%before heading up substantially, it is a 5% failure.Figure 29.2 shows an example of a 5% failure. After a sharp run up beginning in late April, the stock takes a breather in mid-May and essentially moveshorizontally for just over a week before continuing up. It is during this pausethat the stock forms an outside day. The stock trades within a very narrowrange, 26'/s to 26. The following day, the outside day, the stock has a pricerange of 263/8 to 257/g. The wider range, both above and below the previousday's range, classifies the new day as an outside day.
Figure 29.2 The outside day suggests a downside breakout but prices movedown by less than 5% before recovering. The result is a 5% failure. Later, a deadcat bounce drops prices drastically before they bounce.
408
Outside Days
Statistics
The next day the stock closes lower, suggesting a downside breakout.However, the stock, although posting a lower low the following day, closes
Table 29.2General Statistics for Outside Days
higher. If investors sell their holdings on the belief that a downward trend
change is at hand, they are disappointed in the short term. The stock moves up,in the process creating three outside days in a row, peaking in early June at293/8. The outside day is a 5% failure because the stock only drops about Vgbefore recovering.
-409
Description
UpsideBreakout
DownsideBreakout
510 formations in 51 stocks from1991 to 1996, limited to 10formations per stock
268
Look what happens 3 months later. The stock falls off a cliff and splashes$9 lower, a massive, 1-day decline of 38%. The stock executes a dead-catbounce and ends up closing even lower 4 months later (typical for a dead-cat
242
Reversal or consolidation
148 consolidations,120 reversals
133 consolidations,109 reversals
Failure rate
67 or 25%
101 or 42%
bounce).During the rounding over of the stock, there are a total of five outside
Average rise/decline of successfulformations
32%
17%
days, three of them predicting a decline. The last outside day with a downsidebreakout (suggesting lower prices) is just over a week before the tumble.We discuss statistics in a moment, but let me reference the failure rate.
Most likely rise/decline
10%
10%
For successful formations, daysto ultimate high/low
4 months (120 days)
1.5 months (49 days)
Percentage of outside daysoccurring near 12-month low(L), center (C), or high (H)
L21%, C25%, 1-154%
L33%, C29%,
Percentage gain/loss for each12-month lookback period
L49%,
LI4%, C20%, HI 7%
Volume day before to day afterversus 25-day moving average
86%, 112%, 115%
86%, 112%, 115%
Percentage gain/loss for volume1.5x 25-day moving average
37%
18%
Percentage gain/loss for volumeO.Sx 25-day moving average
29%
20%
For upside breakouts, the formation is above the 20% maximum permissible
rate with 25% being failures. For downside breakouts, the formation performseven worse: 42% are failures. Of the two, the upside breakout is more reliablethan the downside one, but still below par.I searched through the formations in the 51 stocks that I catalogued, andI could find no consistent guide to determining whether a formation is going
to fail or not. With a bull market from 1991 to 1996, the 5-year period underreview, it is no wonder that upside breakouts fail less frequently than downside ones.
At first I thought these formations occurred at short-term turning pointsbut that was rejected when I highlighted all formations in a stock (not just 10
C32%,
H32%
H38%
per stock as I have in the study). Outside days seem to appear all over theplace. I am inclined to think that these chart patterns are just random events
with no real value. With that in mind, let us look at the statistics.
StatisticsTable 29.2 shows general statistics for outside days. I programmed my computer to identify every outside day and it soon became apparent diat therewere too many to log. Not only did they clog my screen but they would haveoverloaded my spreadsheet as well, so, just like inside days, I limited the number of outside days I would review.The computer counts the number of formations in a stock and skips as
many as necessary so that I end up with 10 widely space formations per stock.For example, if a stock has 150 formations (which is not unusual, let me assureyou) over a 5-year span, the computer selects the first 1, skips the next 14, thenselects another and so on until it has 10 identified. Selecting the formations inthis manner spreads them out over time and using only 10 per stock diversifies
them over a number of different stocks and industries as well. I believe thatthe 510 formations I ended up using are a representative sample of the entiredatabase.Since chart patterns with upside breakouts might perform differently thandownside ones, I analyzed them separately. The pattern splits almost evenlybetween upside breakouts, with 268 formations identified, and downsidebreakouts, at 242 formations. In both cases, they act as consolidations of theshort-term price trend.The failure rate, at 25% for upside breakouts and 42% for downside ones,is above the maximum 20% that reliable formations possess. Failure is measured by first observing the direction of the breakout. When prices start a newtrend, the breakout direction is easy to ascertain. When the breakout directionis less clear, the closing price is the key along with a higher high or lower low.Eventually, the stock will close above or below the outside day and thatbecomes the breakout direction. Then the ultimate high or low is found bydetermining when the trend changes, typically with a significant price move in
410
Statistics
Outside Days
an adverse direction. If prices fail to move higher than 5% before reversingdirection and dropping through the outside day's low (for upside breakouts) orhigh (for downside ones), then the formation is a failure. In short, prices mustmove more than