rule,be sure to look for resistance areas. They are the areas where the price rise islikely to stall, forcing the measure rule to underperform. To use the measurerule, subtract the lowest low from the highest high in the formation, whichgives the formation height. In Figure 35.5, point A shows the lowest low at45s/8, whereas point B depicts the highest high at 497/8. Add the difference, 4'A(the formation height), to the highest high (point B) to get the target price. Inthis case, the target is 54'/s, met in early July.There are several ways to profit from rounding tops. The suggestedmethod is to wait for the breakout, prices to climb above the dome high. Sinceprices are already climbing, they continue moving up 94% of the time. That isa reassuring number but no guarantee of success. If you like to take more risk,
profitable opportunity for Sharon. She bought into the situation and sold after therising wedge breakout.
Table 35.4Trading Tactics for Rounding Tops
buy at a lower price (one-third of the formation height, above the right domelow). I use the 30% retrace amount since a rise of that magnitude usually
breaks a down-sloping trendline that sometimes forms as prices decline duringthe rounding turn. A breakthrough of a trendline or even a 30% retrace is usually strong enough to command attention from other investors (they jump onthe uptrend) and minimizes the chance of a downside breakout.If you purchase a stock after a rounding turn completes and see prices risefor a month or so, curl around, and fall below the right dome low, sell the
stock. Most likely it is going to continue down. Watch for a bounce at the rightdome low as that area sometimes acts as a support zone. As always, look forother areas of support to gauge how far the decline may go.
Trading Tactic
Explanation
Measure rule
Compute the formation height by subtracting the right domelow from the formation high. Add the difference to the high toget the target price.
Buy on breakout
Buy when prices close above the dome high.
Buy above 30% retrace
For a more risky but profitable trade, buy when prices riseabove the right dome low by at least 30% of the formationheight.
relaxing in a bar after work, surrounded by men. In other words, she is fun tobe with, the life of the party.
Right low support
The right dome low shows support. If prices throw back to thislevel and continue down, sell.
ing top pictured in Figure 35.5, she waited for just the right moment to buy. At
Sample TradeSharon is a high-energy player. She is the one you see careening out of controlwhen skiing down the expert slope. She is the one you see night after night
Her investment style mirrors her lifestyle. When she spotted the roundfirst, she thought it might be a head-and-shoulders top but the two shoulders
486
Rounding Tops
36
and head were at about the same price level and the volume pattern wasall wrong.In mid-June, when prices began heading up and pierced the downsloping trendline, she bought the stock and received a fill at 47. Then she heldon and watched the stock daily. As prices rose, she noticed that the oscillationsfrom minor high to minor low seemed to be narrowing. To her, these oscillations indicated that a rising wedge was forming, but the volume pattern wasabnormal. With a rising wedge, the volume pattern tends to recede over time.In early September, Sharon grew alarmed because the volume trend
Scallops, Ascendingand Descending
began to decline drastically. Her studies showed a tendency for a severe dropoff in volume just before a rising wedge breakout, so the day after prices
pierced the lower wedge trendline, she sold the stock at 62.Her analysis was perfect. After she sold the stock, prices pulled back to thelower wedge trendline and hung on for 2 more days before tumbling. At thestart of the new year, the stock reached a low of 341/s.
R E S U L T S SNAPSHOTAscendingAppearance
Prices peak, retrace, and curve around then form ahigher peak. The price pattern looks like the letter J.
Reversal or consolidation
Long-term (over 6 months) bullish consolidation
Failure rate
25%
Average rise
33%, with the most likely rise between 20% and 30%
Volume trend
Upward but looks like the letter U—highest at theends of the formation
Percentage meetingpredicted price target
71%
Surprising finding
Consecutive scallops in a trend get shorter andnarrower.
See also
Cup with Handle; Head-and-Shoulders Bottom,Complex; Rounding Bottoms
DescendingAppearance
Prices peak, curve downward and around, then form alower peak. The price pattern looks like die letter Jreversed.
487
488
Tour and Identification Guidelines
Scallops, Ascending and Descending
Reversal or consolidation
Short-term (up to 3 months) bearish consolidation
Failure rate
3%
Average decline
24%, with the most likely decline about 20%
Volume trend
No discernible volume trend
Percentage meetingpredicted price target
52%
See also
Table 36.1Identification Characteristics of Ascending and Descending ScallopsCharacteristic
Discussion
Price trend
Prices should be rising leading to ascending scallops and decliningtoward descending scallops.
j shape
Both ascending and descending formations have two price peakswith a rounded recession in between. The ascending variety has ahigher right peak, whereas the descending scallop has a higher leftpeak. Ascending scallops look like the letter J and descendingscallops look like a reversed J.
Volume
Ascending scallops often show a U-shaped volume trend that getsheavier over time, but there is no discernible volume trend fordescending scallops.
Head-and-Shoulders Bottoms, Complex; RoundingBottoms
The classic definition of scallops refers to the ascending variety only, whereyou find repeated saucer-shaped formations in a rising price trend. I reasonedthat if there is an ascending variety, there probably is a descending variety. I
decided to find out, but before I discuss the two types of formations in detail,I think it is worth reviewing the major findings.
For ascending scallops, the failure rate at 25% is above the 20% maximum that reliable formations possess. Descending scallops have a failure rateof just 3%. Why the big difference in failure rates? The difference is because Iuse the highest high on the right side of the formation to calculate the percentage change to the ultimate high or low. For ascending scallops, this penalizes performance since the right edge is much higher than the left. Fordescending scallops, it helps performance because the right side is well abovethe formation low and the ultimate low.
489
moving higher over the intermediate- to long-term trend, that is, over 3, 6,
or more months. The descending variety occurs when prices are movingsteadily down.Figures 36.1 and 36.2 show examples of ascending and descending scallopformations, respectively. Figure 36.1 shows three ascending scallops with thefirst one being an especially large one. It looks like a rounding bottom exceptthat the minor high, where the formation ends on the right (in mid-April), iswell above the minor high on the left (during early December). This is typicalfor ascending scallops—the right side should be above the left. However, it is
The percentage rise for ascending scallops is 33%, respectable butmediocre when compared to other bullish formations. For descending scallops,
Great Atlantic and Pacific (Grocery, NYSE, GAP)
-36
Scallop
the declines average 24%; that is quite good (we usually see a 20% decline forbearish patterns). The measure rule is weak in both species and especiallyso with the descending variety—only 52% of the chart patterns reach theirprice targets.
One surprising finding is that consecutively ascending scallops get narrower and shorter, on average, when compared with prior scallops in a series.For example, in a line of four ascending scallops, the first one will be wider and
taller than the last one. The relationship for descending scallops is unknownbecause of a dearth of consecutive formations.
Tour and Identification GuidelinesTable 36.1 outlines identification guidelines for both ascending and descending scallops. One difference between the two types is the price trend leading tothe formation. As the name implies, ascending scallops appear when prices are
-20
Oct 92
Nov
Dec
|an 93
Feb
Mar
Apr
May
Jun
Jul
Figure 36.1 Three ascending scallops. The formation resembles the letter).
490
Scallops, Ascending and Descending
^^
Mar
Apr
Figure 36.2
May
|un
491
Focus on Failures
CNF Transportation Inc. (Trucking/Tramp. Leasing, NYSE, CNF)
Feb 93
Focus on Failures
|ul
Four consecutive descending scallops.
all right if the two peaks are close to each other in price. This often signals anend to the series of scallops and the rising price trend.The J-shaped pattern appears on the smallest scallop in Figure 36.1. Ihighlight this formation with some consternation. When hunting for scallops,one should look at the price lows, not the highs. If you connect the minor lowsof the first two formations, you see that prices have a bowl shape. The bowlshape is not clear in the smallest formation unless you trace along the highs.The smallest formation in Figure 36.1 also has the best volume pattern—a U-shaped trend. This is common for ascending scallops but should not beviewed as a requirement. The first scallop does not have an easily recognizablebowl-shaped volume trend but it is there. The volume spikes are higher nearthe formation ends than in the center.Figure 36.2 shows four descending scallops. You can see that the overallprice trend is downward. It starts on the left at about 20 and saucers down toabout 15. The descending scallops appear like reverse J patterns. The minorhigh on the right is below the left minor high and between the two peaks is arounded recession. You can see that the last scallop has minor highs that arenearly equal. This often suggests the receding price trend is nearing an end. Inthis case, prices reach the ultimate low in less than 2 months at 13s/8, quite closeto the last bowl low of 143/4.The volume trend is irregular. I have noticed a tendency for a volumespike to appear near the center of the formation as prices switch from movingdownward to upward. In Figure 36.2 you can see the spikes in late March andmid-June.
Scallops suffer from what I call 5% failures. A 5% failure is when prices breakout in the intended direction but fail to continue moving in the same directionby more than 5%. They double back and head in the opposite direction, sometimes causing an investor to lose money. Figures 36.3 and 36.4 show examplesof failures. There is nothing wrong with the ascending scallop in Figure 36.3in the April-May period. Prices round up nicely and continue higher while thevolume pattern is bowl-shaped if you disregard the twin spikes in early May.However, the late June formation marks the high for the stock. Again, there isreally nothing wrong with the pattern. The J shape is pronounced and smooth.The volume pattern is somewhat rugged but higher on either end than in thecenter. The narrowness of the formation is a clue to its failure. It is about 2weeks wide, which is quite narrow for scallops (the average width is about 2months). From the high at 19, the stock heads down in a choppy manner untilthe end of the study (mid-July 1996) where it is at 13'/2.Descending scallop failures are similar to the one shown in Figure 36.4.The formation sometimes acts as a reversal of the downward trend since pricesmove up substantially after the formation ends. The price trend leading to theformation is downward. This is not entirely clear from the figure, but the stockreaches a high of 365/s in late September 1993, then prices move down until
Abitibi-Consolidated (Paper & Forest Products, NYSE, ABY)
High Point
Mar 95
Apr
May
Sep
Oct
Figure 36.3 An ascending scallop failure in late June. Most scallops act as consolidations of the trend but the narrow ascending scallop in late June marks thehigh for the stock.
492
Scallops, Ascending and Descending
Statistics
493
Table 36.2
American Express (Financial Services, NYSE, AXP)
General Statistics for Ascending and Descending ScallopsAscendingScallops
DescendingScallops
Number of formations in 500stocks from 1991 to 1996
613
414
Reversal or consolidation
492 consolidations,121 reversals
310 consolidations,104 reversals
Failure rate
Description
Apr 94
May
|un
Jul
Aug
Sep
Figure 36.4 A descending scallop failure. This descending scallop acts as a reversal.
they reach a low of 251A in early July. After the formation reverses, prices climband reach a high of 50% in early April 1996.If you measure from the right minor high to the ultimate low (as marked
on the figure), the decline is less than 5%—a 5% failure. The only thing thatstands out about this formation is that it occurs well into a downtrend imply-
151 or 25%
14 or 3%
Average rise/decline of successfulformations
33%
24%
Most likely rise/decline
20% to 30%
20%
Of those succeeding, numbermeeting or exceeding price target(measure rule)
327 or 71%
206 or 52%
Average formation length
2 months (57 days)
1.5 months (49 days)
Days to ultimate high/low
8 months (231 days)
3.5 months (101 days)
Percentage of scallops occurringnear 12-month price low (L),center (C), or high (H)Percentage gain for each 12month lookback period
L2%, C14%, H84%
L51%, C34%, HI 5%
Consecutive number of formations
L56%, C40%, H31%
L24%, C23%, H27%
2 = 67%, 3 = 38%,4 = 18%, 5 = 8%,
2 = 62%, 3 = 27%,4 = 9%, 5 = 3%,6 = 1 %, 7 = 0%
6 = 3%, 7 = 2%,8 = 1%
ing a trend reversal is likely.
We see in the Statistics section that most descending scallops form nearthe yearly low, suggesting the trend has been moving down for some time.This downward trend coupled with a poor measure rule showing, where abouthalf the formations fall short of their price targets, leads one to believe that theperformance may be worse than the statistics suggest. In short, be careful about
the formation low without first moving 5% above the right formation edge.Failures for descending scallops are similar in that prices need to rise above theright edge high without first dropping by more than 5 %. The failure rates—at25% and 3% for ascending and descending scallops, respectively—measurefrom the high reached in the right scallop edge to the ultimate high or low. As
investing in a descending scallop that forms well into a downtrend.
explained earlier, this measurement penalizes ascending scallops and assists
Statistics
descending ones. The measurement accounts for the different failure rates andexplains the subpar 33% gain and exceptional 24% average loss for the twochart patterns. Despite these variances, I consider the measurement method tobe acceptable since the right minor high, when completed, is easy to identifyand serves as a good reference point.
Table 36.2 lists statistics for ascending and descending scallops. These formations are plentiful—I logged between 400 and 600 formations of each. Most ofthe formations act as consolidations of the prevailing trend. If the trend leading to the formation is upward (for ascending scallops), then prices resume
their uptrend shortly after the formation ends.I log a failure if prices move in an unexpected direction for too long. Forascending scallops, a failure occurs when prices move downward and slip below
I compute the most likely gain or loss by using a frequency distribution of
the gains and losses. Figure 36.5 shows a graph of the gains and Figure 36.6shows a graph of the losses.In Figure 36.5 the two highest columns represent the most likely gainbecause they have the highest frequency. Even though the average gain for allsuccessful formations is 33%, the most likely gain rests between 20% and 30%.
V.
Statistics
495
Figure 36.6 shows a distribution of the losses. The tallest column, at 20%,represents the most likely loss since it has the highest frequency. However, thetwo adjacent columns are quite close to the tallest one so the likely decline mayrange between 15% and 25%. I view these figures as representations of whatyou might expect to make if you trade these formations.I discuss the measure rule in the Trading Tactics section, but it involvescomputing the height of the formation and adding the result to the right edgehigh or subtracting it from the lowest low in the formation. The result is dieminimum price target. For ascending scallops, 71% of the formations meet orexceed their predicted price targets, whereas only 52% of descending scallops
Percentage Cain
Figure 36.5 Frequency distribution of gains for ascending scallops. The mostlikely gain is between 20% and 30%.
meet theirs. I view values above 80% to be reliable, so scallops fall short of thebenchmark. What does this mean? If you buy a stock and see a scallop developnear the beginning of the price trend, prices will likely meet the target. However, if the trend has been in existence for a long time (say, over 4 months),then there is a greater chance that prices will not meet the predicted target. Ofcourse this depends on the overall market. Declines during a raging bull market may be short-lived, so factor in the market accordingly.The average formation length is quite short, less than 2 months for bothtypes of scallops. Some, such as that shown in Figure 36.1, will be longer than
average and some will be shorter, but overall, there seems to be a tendency forthe formation to last between 1 and 3 months.The time it takes to reach the ultimate high or low is about double thatfor ascending scallops than for descending ones. Coupled with the average riseor decline, this suggests the declines are steeper, more violent, and the risesmore drawn out and sedate. It also suggests investors should be patient, at leastfor ascending scallops, and let the stock play out before selling.Where in the yearly price range do the formations occur? For ascendingscallops, most of them occur within a third of the yearly high as measured from
the high at the right end of the formation. For descending scallops, most occur6%
within a third of the yearly low. Overlaying the performance on the yearlyprice range, we discover that ascending scallops occurring within a third of
their yearly low perform best, with a 56% average gain. I hasten to add thatthere are only 8 formations in this category, well short of the 30 samples
25
30
35
50
>50
Percentage Decline
Figure 36.6 Frequency distribution of losses for descending scallops. The mostlikely loss is 20%.
494
needed to make definitive conclusions. However, die other two categories haveenough samples and suggest that the lower diey occur in the yearly price range,the better performance will be. Descending scallops, on the otiier hand, aremixed. Performance is essentially flat, ranging between 23% and 27%.I included a tabulation on the number of consecutive formations in astock. In essence, I wanted to know how likely it is diat a second, diird, orfourth (and so on) formation would occur in a trend. It turns out that it is quitecommon to have more than one scallop in a single uptrend or a single downtrend. In odier words, about two-thirds of the time a second scallop appears
496
Scallops, Ascending and Descending
Trading Tactics
497
after the first one (in the same trend). A third scallop will appear about a thirdto a quarter of the time. Table 36.2 shows the remainder of the percentages.Why is this significant? If you are considering shorting a stock that showsthree cascading scallops, there is a good chance that you will be making a mistake. Only 9% of the formations have four descending scallops in a row andthat suggests the end of the downtrend is near. The more scallops you find, thehigher the likelihood the end of the trend is approaching.
Do ascending scallops change their shape as they climb? I measured thewidth of each scallop and where it occurs in a series of consecutive scallops
(over a single uptrend). Figure 36.7 shows the results. Only four points areshown because the sample size diminishes beyond four scallops in a row. Thefirst scallop has an average width of 62 days but by the time the fourth scallopin a series appears, the width decreases to 47 days, on average. So, if you discover a narrow ascending scallop well into an uptrend, you might consideravoiding the stock. Otherwise, you might be investing near the top.
Do ascending scallops become flatter as they climb? Figure 36.8 showsthe result of the analysis. The first scallop has an average height, as measuredfrom the highest high to the lowest low, of about 18%. This drops to 14% bythe time the fourth scallop in a row appears. Again, I graphed only four points
Figure 36.8 Graph showing formation height of ascending scallops. Ascendingscallops become slightly flatter as they climb.
because of the rarity of trends containing more than four ascending scallops ina row. I tried to apply the analysis to descending scallops without success.Only three points are available (because of the sample size) and the results areinconclusive.
Trading TacticsTable 36.3 shows trading tactics for ascending and descending scallops. Thefirst trading tactic is to determine how far prices are likely to move once theformation completes. This is called the measure rule because it involves measuring the formation height and applying it to the breakout point.
Number in Series
Figure 36.7 Graph showing narrowing width of ascending scallops over time.The more consecutive ascending scallops that appear in an uptrend, the narrowerthey become. If you see a narrow ascending scallop forming after a long uptrend,you might avoid taking a position in the stock.
The measures for both ascending and descending scallops begin by computing the formation height in the same way. Subtract the lowest low reachedin the bowl from the high reached on the right side of the formation. Once youhave the height, add the value to the highest high on the right side of the formation for ascending scallops or subtract it from the lowest low for descending scallops. The result is the minimum expected price target. An examplemakes the calculation clear. Consider the ascending scallop that forms duringlate September as shown in Figure 36.9. Apply the measure rule to this formation by subtracting the formation base from the right side high. Point B showsthe base low at 12'/2 and the right side high, point A, is 16. The difference of3 /2 is the formation height. For ascending scallops, add the difference to theright-side high (point A) to get the target price of 19'/2. Prices meet the target
498
Scallops, Ascending and Descending
%J
Sample TradeCKE Restaurants, Inc. (Restaurant, NYSE, CKR)
Table 36.3Trading Tactics for Ascending and Descending ScallopsTrading Tactic
Explanation
Measure rule
Compute the height of the scallop by taking the differencebetween the right-edge high to the lowest low in the formation.For ascending scallops, add the difference to the highest right-edgehigh, and for descending ones subtract the difference from thelowest low. The result is the minimum expected price target.
Lip retrace
Once prices crest the right lip high, prices fall. If they drop belowthe bottom of the formation in an uptrend, then the formation is afailure and you should avoid the stock or close out your position.Likewise, if prices rise significantly above the top of the right edgein a downtrend, then the formation is also a failure.
Buy point
Take a position in the stock once prices drift below the right-edgehigh. For ascending scallops, wait for prices to bottom out. Fordescending scallops, sell short immediately once prices reach theright-edge high and head down.
Stops
Ascending scallops: '/B below the lowest low. Descending scallops:VB above the right lip high.
Avoid
Be careful of shorting a stock showing a descending scallop thatforms many months into a downtrend. The downtrend may benear the end.
in late April (not shown on the chart). If the scallop is descending, then subtract the difference from the formation low (point B) to get the target price. Insuch a case, the target would be 9 (12'/2 - 3'/2).In both cases, the formation height uses the right-side high, not the left. Forascending scallops, this makes the measure rule much harder to fulfill becausethe right side is much higher than the peak on the left. For descending scallops,the measure rule is easier to meet because the right side is lower than the leftside. Still, ascending scallops meet their targets more often than descendingones by 71% to 52%. This statistic implies that the descending variety formnear the end of the trend—something you should keep in mind if you intendto short a stock containing a descending scallop.Once a scallop completes, prices decline. They retrace all or a part oftheir gains (that is, from the right-edge high to the bowl low) before headinghigher (in the case of ascending scallops) or continuing down (for descendingscallops). In Figure 36.9, you can see that the retrace after the first scallopbrings prices down to the height of the left scallop lip at 14'/4. The retrace afterthe center scallop sees prices return to near the bowl low.For ascending scallops, once prices crest on the right side and begindeclining, wait for the decline to end. In some cases, another scallop will formand it will be relatively easy to buy during formation of the bowl. For descending scallops, you will want to sell short as soon as the right side peak becomesobvious and prices head down.
499
Ascend ng Scallop
Ascending Scallop
Figure 36.9 Three consecutive ascending scallop formations. Kristy bought thestock at point C once prices rose above the top of the ascending scallop. The lastscallop has a V-shaped bowl and a right rim that almost makes it to the high of theleft side. She sold at point D.
Stop-loss points should be '/s beyond the support or resistance level. InFigure 36.9 place a stop-loss order at 123/8, or '/s below the formation low(point B) for the first scallop. If the loss from the purchase point is too large,consider moving the stop to just below the left peak. As you can see in Figure36.9, the left peak is an area of support, but it varies from formation to formation.For descending scallops, place the stop for short trades l/% above the rightpeak. In Figure 36.2, the scallop on the left would have a stop placed at 19'/2.
Sample TradeHow do you trade these formations? Sometimes it helps to have inside information. That is what Rristy's boyfriend is doing time for in a low-securityprison. She has become the primary trading arm of the relationship, a hobbyshe had long before her beau came along.Kristy was intrigued by the scallop formation shown on the left in Figure36.9. The V-shaped look to the bowl concerned her as did the poorly shapedvolume pattern. But she liked the prospects for the restaurant company and herfundamental analysis was thorough and tasty.Before she bought the stock at point C, she computed the estimated gainand compared it to the risk of a loss. The targeted rise was to 183/4 (she calculated
500
Scallops, Ascending and Descending
37
using the right-side peak 3 days earlier). The risk point was 14, the high of theleft side and a massive support area reached in early 1994. At her purchase pointof 1 5 '/4, the risk was 1 1A ( 1 5 '/4 - 1 4) and the potential reward was 3 '/2 ( 1 834 - 1 5 !/4).The nearly three to one ratio was high enough to risk a trade.She felt gratified when prices closed at the high for the day, suggestingprices the following day would move higher still. When she looked at the stock
Shark-32
the next day, prices did reach a new high but closed lower. As she posted herdaily quotes for the stock, the declining price trend over the next week or twoconcerned her, but not unduly so. Rristy recognized the rounding turn ofanother scallop forming and saw that her stop held.
Day by day she followed the stock and did not like the third scallop in theseries (the rightmost one). The bowl shape was irregular and the volume pattern was unconvincing. When prices stopped at the old high before collapsing,she knew the rise was at an end. She pulled the plug on the operation at 16%,shown as point D in the figure.In the short term, Kristy was right in that prices headed lower. Theymoved down until reaching the low of the bowl but then rebounded. By midJune, they had nearly doubled, reaching a high of 28 A, 10 points above the target price of 18%. Still, on her 1,000 shares, she cleared almost $1,500 on the
trade.
RESULTS SNAPSHOTUpside BreakoutsAppearance
A 3-day symmetrical triangle with consecutivelylower highs and higher lows. Breakout is upward.
Reversal or consolidation
Short-term (up to 3 months) bullish consolidation
Failure rate
41%
Average rise
32%, with most likely rise between 10% and 15%
Volume trend
Downward
Throwbacks
64%
Surprising finding
Horizontal symmetry improves results.
See also
Triangles, Symmetrical Bottoms; Triangles,Symmetrical Tops
Downside BreakoutsAppearance
A 3-day symmetrical triangle with consecutivelylower highs and higher lows. Breakout is downward.
Reversal or consolidation
Short-term (up to 3 months) bearish reversal (55% offormations) or consolidation
Failure rate
44%
Average decline
21%, with most likely decline less man 10%
501
502
Shark-32
^-
Volume trend
Downward
Fullbacks
58%
Surprising finding
Horizontal symmetry improves results.
See also
Triangles, Symmetrical B