
16% in 39 days
Second leg price decline
27% in 60 days
Corrective phase percentage retrace
40% to 60%
Percentage of formations starting near12-month price low (L), center (C),or high (H)
L0%, C6%, H93%
Figure 26.5 This measured move down is really the corrective phase of a measured move up.
Measure rule
43% of second legs are longer than first legs
flag a potential problem. With such a large retrace, prices will probably declineto at most the prior low and stall (because the second leg is slightly smaller thanthe first one). It did not even go that far. Prices declined to the prior minorhigh at 13'/2 and held steady for a week before moving higher.Why did this formation fail? The choice of a measured move down forthis situation is poor because of the extent of the corrective phase. If we lookat the larger picture, we discover that the first down leg is nothing more thanthe corrective phase of a measured move up!
the formations. The failure rate is quite close to the 20% maximum that Ideem acceptable for reliable formations.The average decline amounts to 36%, as measured from the highest highreached in the first leg, through the corrective phase, to the lowest low in thesecond leg. Since you probably will not be able to identify a measured movedown until sometime in the second leg, your average decline is likely to be considerably less than 36% (probably about 20% since the corrective phase bringsprices up). The most likely decline is between 25% and 40%. Figure 26.6shows the results of a frequency distribution of declines for all successful formations. Notice the center of the graph has four columns of about equalheight. If you ignore the catch-all column on the right of the figure, the fourcenter columns have the highest frequency. As such, I consider them to be representative of what you can expect to earn from this formation. Again, let me
StatisticsTable 26.2 shows the only statistics for this formation. I uncovered 622 formations in 2,500 years of daily price data. Such a large number of formationsmeans they are common, offering plenty of investment opportunities.Of the formations I uncovered, the vast majority (88%) are reversals ofthe upward trend; the remainder are consolidations. Consolidations typicallyoccur as part of a long downtrend. Sometimes the formations are small whencompared with the total down move, whereas others are part of two or three
cascading formations in the same bear run.For measured moves, I define a failure to be when prices do not declinebelow the low established in the first leg. I did multiple passes to be sure that Ilocated as many of the failures as I possibly could. This amounted to 22% of
remind you that the decline measures from the highest high in the first leg to
the lowest low in the second. Once you identify a measured move down, a significant portion of the decline may already have occurred.The average formation length is 153 days (about 5 months). The first legaverages a price decline of 2 5 % in 54 days; the corrective phase posts an average gain of 16% in 39 days, and the second leg declines by 27% in 60 days. Youcan see in Table 26.2 that the two legs are nearly the same in percentagedecline and time.How much does the corrective phase recover? On average, about 40% to60% of the first leg decline. Figure 26.7 shows a frequency distribution of the
Trading Tactics
379
percentage price retrace shown by the corrective phase when compared withthe first leg decline. The highest column, the one on the right, is excludedbecause it is a catch-all column for large percentage retraces. Ignoring theright column, the 45% column is tallest but is closely joined by the columnsfrom 40% to 60%. Thus, I conclude that the corrective phase retrace is mostlikely to fall within the 40% to 60% range.Due to the nature of the measured move down, the chart pattern usually
forms near the yearly high. A frequency distribution of the formation start(the highest high in the first leg) when compared with the prior yearly price
range shows that 93% of the formations begin in the highest third of the yearlyprice range. Many of the other formations are ones that occur as prices slidedown a trendline and create several measured moves down in a row.I counted the number of formations meeting or exceeding the measure30
35
40
Percentage Decline
Figure 26.6 Frequency distribution of declines for the measured move down.Ignoring the right column, the most likely decline is between 25% and 40%.
rule and discovered that only 43 % of the formations have second legs that areequal to or longer than the first legs. I consider values above 80% to be reliable.This means you should not depend on the target being met. The 80% benchmark hits when the second leg down move is equal to two-thirds of the first leg.
Trading TacticsTable 26.3 outlines trading tactics and the measure rule. Use the measure ruleto help predict how far prices will decline. Refer to Figure 26.8 during the discussion of its computation. In the figure, four points outline the measuredmove: A through D. First, tabulate the height of the first leg (shown by pointsA and B) by subtracting the lowest low (42) from the highest high (527/g). Thisgives a difference of 107/8. Subtract the difference from the highest high in thecorrective phase (point C at 473/4). The result is a target price of 367/s. Pricesmeet the target on December 7.Once you suspect that a measured move down is forming, probably justafter the corrective phase completes and prices start down, short the stock. Use
45
50
55
Percentage Retrace
Figure 26.7 Frequency distribution of the percentage price retrace. The corrective phase typically retraces between 40% and 60% of the prior decline.
378
the measure rule to predict the price target, but expect prices to come up short.Place a stop-loss order l/s above the corrective phase high (the corrective phaseis a source of support and resistance). For a more conservative target, followthe measure rule using two-thirds of the first leg height. Prices reach the newtarget 80% of the time. For example, two-thirds of the first leg height in Figure 26.8 is 7!/4. Subtracting this value from the corrective phase high gives acloser target of 40'/2. Cover your short if prices rebound off a support zone orapproach the measure rule target.After a measured move down completes, the corrective phase often spellsa resistance zone for future moves. Prices pause on the approach to the
380
Measured Move Down
Sample Trade3 Com Corp. (Computers & Peripherals, NASDAQ, COMS)
Table 26.3Trading Tactics for the Measured Move DownTrading Tactic
Explanation
Measure rule
The second leg is about 10% shorter than the first leg, so expectthe actual price to fall short of the target. Compute the length ofthe first leg from the highest high to the lowest low (at the startof the corrective phase). Subtract the result from the highesthigh reached in the corrective phase to get the target price(which is met 43% of the time). For a more conservative target,use two-thirds of the first leg height. This shortened heightmeans that prices hit the target 80% of the time.
Short during secondleg, stop loss
Short the stock as soon as it becomes clear that a measuredmove is in progress. If prices rise above the corrective phasehigh, then close out your position. Prices occasionally will rise upto the corrective phase high a second time before ultimatelydeclining, so put your stop about % (or more) above the high.
Close out
Cover your short when the price drops to a support area andmeets resistance to a further decline, especially if prices near the
Support/resistance
381
measure rule target.
Oct95
The corrective phase shows future support or resistance.
Figure 26.8 Measured move down followed by corrective phase. Eddy made $5per share trading this (points A-D) measured move down.
corrective phase low and at the high. Figure 26.8 has these zones labeled. Ifyou are nimble, you can anticipate this rise and trade long once the measuredmove down completes. Sell if prices run into trouble during the corrective
phase and begin heading lower. In a bull market you can generally expectprices to eventually push through the corrective phase resistance and move upto the old high.
Sample Trade
ber 1995. Every so often, he would draw trendlines along the bottoms of theminor lows and notice how the upward trend seemed to be accelerating (thetrendlines grew steeper over time).Since he knew this could not last, he was ready for a trend change, which
occurred on November 14 when prices pierced the trendline, moving down.Instead of shorting the stock immediately, he decided to wait for a pullback. Much to his surprise it never came. Prices moved steadily lower untilthey reached a support level at 42. From that point on, prices rose higherfor the next week and a half. Then, they dropped sharply, tumbling $3 inone session.
People are nasty; just ask Eddy. He is an airline reservation agent. Between thecompany monitoring his phone calls to be sure he peddles a car and hotel
when appropriate and the people screaming at him from the other end of thephone, it is a tough living. There is nothing he can do about equipment problems or the weather, but people do not seem to care. Even the full moon getsinto the act as that is when the crazies call.What he would really like to do is invest in the stock market. He does itnow but to a limited extent because of his cash-flow problem. Fortunately, with
a few clicks of his computer mouse he can flip to the Internet and monitor hislatest stock pick when he is not busy.
That is how he uncovered the situation shown in Figure 26.8. He watchedthe stock climb from a low of about 10 in June 1994 to a high of 535/g in Octo-
When prices fell, they pierced a small up trendline, drawn along the bottoms of the climb from points B to C. Eddy recognized what was happeningwhen he drew the trendline on his chart. The chart pattern was making a measured move down, so he shorted the stock that day and received a fill at 42.He used the measure rule to compute the predicted price move andplaced an order with his broker to cover the short at the predicted price (367/s).Just 3 days after he placed the trade, the stock was covered. He made about $5a share or 12%.If you look at Figure 26.8, you can see that prices rose to the level of thecorrective phase bottom (point B), then retreated 2 days after Eddy completedhis trade. Later on you can see that prices also stopped rising at the top of thecorrective phase. The corrective phase is a zone of support and resistance.
27Measured Move Up
tive phase, where prices retrace their gainsured move is forming. Only after prices sthe second up leg, should an investment bBy the Results Snapshot statistics youa 37% gain. Since an investor probably wuntil after the second leg begins, the gain w
Tour
In the preceding paragraphs I mentioned alines a measured move up formation with tfirst leg is composed of a rise in price tha trendline drawn on either side of thea channel.The corrective phase retraces a sub35% to 65%, before prices resume rising.begins in late January and extends throug
55% of the first leg price move. Once theRESULTS SNAPSHOT
Appearance
Prices move up, retrace, then move up again.
Reversal or consolidation
Long-term (over 6 months) bullish reversal
Failure rate
23%
Average rise
68%, with most likely rise between 30% and 60%
First leg rise
43% in 87 days
Corrective phase decline
14% in 45 days
Second leg decline
37% in 65 days
Percentage meetingpredicted price target
57%
See also
Flags and Pennants
The measured moved up formation is die reverse of the measured move down.The measured move up sports a 23 % failure rate, slightly higher than the 20%maximum I consider reliable formations to possess. However, the average gainis an astounding 68%, which is misleading. The value represents the price difference between the lowest low in the first leg and the highest high in the second leg. Obviously, this is a best-case scenario and you can expect your resultsto be a little better than half that rate. Why? The reason stems from being ableto identify the formation promptly. When the chart pattern enters the correc-
382
even more rapidly during the second leg. Yinstead of touching the trendline in a sort
Allegheny Ludlum Corp. (Steel (
Nov 92
Dec
|an 93
Feb
Mar
Figure 27.1 A measured move up. The seposted by the first leg.
384
Identification Guidelines
Measured Move Up
385
Applied Power (Machinery (const./mining), NYSE, APW)
topping out in June. The rise constitutes what is commonly called the secondleg. It is the rise from the corrective phase to the end of the formation.Once the formation completes, prices sometimes drop back to the level ofthe corrective phase. In this example, you can see that prices dropped to justbelow the top of the corrective phase (in July) before recovering. Of course,sometimes prices do not stop there at all. A trend change occurs and pricessimply tumble and return to the base of the formation or, worse, continuemoving down.
Identification GuidelinesTable 27.1 lists the identification characteristics for this formation. The formation usually, but not always, begins when prices bottom out after a downtrend. The declining price trend can range all over the scale. In Figure 27.1, forexample, prices reach the November lows after shooting up in a bull run thatstarts in December 1991 and ends 2 months later. Then prices meander—essentially moving horizontally with a slight downward bend. Six months later,they decline from a high of about 18'/4 to a low of 143/4.
May 95
|un
|ul
Aug
Sep
Oct
Nov
Dec
Figure 27.2 A falling wedge marks the corrective phase in this measured moveup formation. Note the receding volume trend of the wedge.
Consider Figure 27.2 where the price decline is short—barely a monthlong. Over the longer term (not shown in the figure), prices are rising. They
begin climbing in November 1993 at a price of 14'/2 and reach a preformationhigh of 27 in May 1995—a near double. The figure shows that the first leg hasTable 27.1
Identification Characteristics of the Measured Move UpCharacteristic
Discussion
Downward trend
A downward price trend that lasts from a few weeks to over ayear usually precedes the start of the formation. The formationbegins a trend change that usually starts from near the yearlylow.
First leg
Most times prices follow a trend channel upward before enteringthe corrective phase.
Corrective phase
Prices decline, usually between 35% to 65% of the first leg move,before heading upward again. The retrace is usually proportionalto the first leg rise: Large retraces follow large rises. Sometimesthe corrective phase resembles a saw-tooth pattern (a few sharprises and declines in a row) before prices break away and zoomupward. This saw-tooth pattern usually associates with a longprice climb leading to the formation.
Second leg
Prices rise, loosely following the slope of the trendline set by thefirst leg. Prices commonly fit inside a channel as they rise, but thisis not a prerequisite.
Avoid
Avoid formations where the retrace travels too far down the firstleg. Anything beyond an 80% retrace is probably too far and toorisky to invest in.
a slight bow to it in the early part of the rise. However, you can extend the up
trendline and draw a parallel one connecting the minor highs and see that thefirst leg fits inside a trend channel. The second leg does even better. The bottom trendline touches several places and a parallel top trendline (not shown forclarity) also intersects the minor highs nicely.In this case, a falling wedge composes the corrective phase. This formation makes trading the measured move easy since it predicts a price rise. Onceprices break out from the wedge, buy into the stock and ride the upward move.If you bought the stock following this procedure, you would make somewhere
between 15% and 20%, depending on when you traded the stock. That is nota bad return for a hold time of about 6 weeks. Also note the very distinctivedown-sloping volume trend for the falling wedge.
The slope of the two trendlines, along the bottoms of the legs, are nearlythe same. It is somewhat surprising how often this holds true. However, justbecause there is a wide variation in the trend slope is no reason to eliminate aformation from consideration.In this example, the corrective phase sees prices retrace their prior gainsby 40%, within the usual 35% to 65% range for measured move up formations. Sometimes when the rise leading to the start of the formation is extensive, the corrective phase becomes long and choppy, resembling a saw-toothformation marked by quick rises and sharp declines. In such a case, it might be
386
Measured Move Up
Statistics
prudent to wait for prices to rise above the high established during the first legbefore investing. That way you can avoid the most common measured move upfailure.
Focus on FailuresWhat exactly is a measured move up failure? I define a failure of a measuredmove up chart pattern to be when prices do not rise above the prior leg high.The definition is a subjective measure. With deep corrective phases, even a riseto the old high can be a substantial move. Still, I feel the benchmark is a goodone, so that is the one used in the statistics.
Figure 27.3 shows the most common type of measured move up failure.The stock forms a double top that kills the second leg rise. The failure is clearsince prices rise to 37s/s, just I/B below the prior high before heading lower. Certainly the second leg does not near the price move of the first leg as do mostwell-behaved measured moves. Why does this particular formation fail? Thefigure shows a choppy, horizontal saw-tooth pattern leading to the first legrise. The first leg soars above the two tops of the saw-tooth and moves upsmartly. Then prices round over and start correcting. The figure, at this point,reminds me of a mini bump-and-ran reversal. However, the bump phase just
does not meet the two-to-one height ratio of die lead-in phase. Still, it doesgive you pause about investing in this situation.
387
The second leg starts rising with no significant change in volume. This isa warning sign. There is a common Street axiom that says rising prices needhigh volume but falling prices can decline of their own weight. This formationappears to be an example of that axiom. Since there is little upward buyingpressure to push prices higher, they fade out just below the prior top then tumble. The resulting decline sees prices fall below the start of the first leg.Before we move on to statistics, I want to alert you to some identificationproblems. You want to avoid formations that have corrective phases thatdescend too near the first leg start. I do not have a set amount for this, but Iwould probably steer away from formations that retrace more than 80% or soof the prior upward move.In addition, if the first leg does not follow a straight course upward or ifit fails to stay within a well-defined trend channel (as does the first leg in Figure 27.3), you might want to look elsewhere for a more promising situation.Sometimes when a chart formation does not feel right or look right, then it isgiving you a warning to stay away. Since this is a common chart pattern, youcan easily find another opportunity.When prices rise steadily for a long time, say over a year or more, then
begin a measured move up, the corrective phase might be excessively choppy.I mentioned this behavior in the Identification Guidelines section and in Table27.1, but it is something to keep in mind.Also, do not be too quick to buy into the situation. Remember that thecorrective phase should be proportional to the first leg rise. By that I meanprices should fall anywhere from 35% to 65% of the first leg move beforebeginning the second leg. If prices only fall 15 % before turning up, then itmight be a false breakout.Sometimes prior peaks are a key to how far prices retrace. These minorhighs are often places of support. When prices decline to that level, they pauseand move horizontally for a time before continuing down or rebounding. Volume is often a key to the level of support you can expect from these types of situations. A prior peak with high turnover will give more support to a stock onits way down. That is not to say that the stock will not burn through the support, just that it might take more of a push to fall off the cliff.
Statistics
Jan 93
Feb
Mar
Apr
May
Jun
Jul
Figure 27.3 A measured move up that fails after turning into a double top.
Table 27.2 shows comparatively few statistics for measured move up formations. I located 501 formations and of these formations, 69% act as reversals ofthe prevailing trend. This means prices are heading steadily down before thestart of the first up leg. The remaining 156 formations occur as part of theupward trend.The failure rate at 23% is higher than the 20% maximum I like to see.The implication is that about one out of four formations fail to rise above the
388
Measured Move Up
Statistics
389
Table 27.2General Statistics for the Measured Move UpDescription
Statistic
Number of formations in 500 stocksfrom 1991 to 1996
501
Reversal or consolidation
156 consolidations, 345 reversals
Failure rate
114 or 23%
Average rise of successful formations
68%
Most likely riseAverage formation length
6.5 months (197 days)
30% to 60%
First leg price rise
43% in 87 days
Corrective phase price decline
14% in 45 days
Second leg price rise
37% in 65 days
Corrective phase percentage retrace
35% to 65%
Percentage of formations occuringnear 12-month price low (L), center(C), or high (H)?
L79%, C21%,
Measure rule
57% of second legs are longer than first legs
60
70
100
>100
Percentage Gain
first leg high before trending down. As mentioned in the Focus on Failures section of this chapter, many failures occur while prices are advancing and forming a second top. They stall out and turn lower, leaving a double top formation.For those formations that work as expected, the average gain is 68%. Asexplained earlier, this may sound like an outsized gain and it is. Since youprobably will not be able to (or want to, for that matter!) buy into a measured
move before the end of the corrective phase, the second leg (37% gain) betterrepresents the performance of the formation.Figure 27.4 shows the results of a frequency distribution of gains for successful formations in this study. I define the most likely gain as being represented by the highest columns. Since the column on the right is a catch-allcolumn, it is excluded from the analysis. The remainder of the chart indicates
Figure 27.4 Frequency distribution of gains for the measured move up. Excluding the tallest column, the most likely rise is between 30% and 60%.
ing on when you take a position in the stock, will probably be near the second
leg gain.I took a close look at the corrective phase retrace by doing a frequency
distribution of the percentage retrace for all successful formations. I graphedthe results using a 1% interval ranging from 20 to 80.1 wanted to see if therewas any truth to the belief that the retrace would be one of the Fibonacci ratioson a percentage basis. The Fibonacci ratio is the ratio between any two successive numbers in a Fibonacci sequence. The Fibonacci sequence begins withdie values of zero and one and successive numbers are the sum of the prior two
(as in 0, 1, 2, 3, 5, 8, 13 and so on). Once the sequence develops, two impor-
low in the first leg to the highest high in the second leg. If you invest near thestart of the second leg, you should reduce your expectations accordingly.
tant ratios between pairs and the inverse of alternate pairs become clear: 0.618and 0.382. The theory says that, on a percentage basis, support at the 62% and38% retracement levels is common.If there is any truth to die average retrace being a member of these values,then a frequency distribution would illustrate it. I do not show the graphbecause there are too many columns to be clearly presented, but the results areeasily described. The overall graph resembles a bell curve with noticeablepeaks. The first peak is at 35% and it towers above the surrounding ones. The
For a better gauge of the expected gains, consider the performance of thevarious components. The first leg has a 43 % average gain in about 3 months.The corrective phase brings prices down by 14% in 45 days, whereas the lastleg sends prices higher by 37% in about 2 months. Your likely gain, depend-
next few peaks, which are the tallest on die graph, fall at 47%, 50%, and asomewhat smaller one at 52%. As we advance up the scale, we find anodiercluster in die 62% to 64% range, widi 62% being die highest. Other peakstoward die outer ends of die graph are at 28% and 79%. If we boil down die
that the most likely gain is between 30% and 60%, with a tendency to gravi-
tate toward the upper end of the range. Since over a quarter of the formationshave gains over 100%, you might find a situation in which your gains are well
above the most likely gain. Remember, I compute the gains from the lowest
390
Measured Move Up
Pacific Scientific (Precision Instru
results, we find that the most common retraces during the corrective phaseoccur at 35%, 50%, and 62%, close to the predicted values of 38% and 62%.A frequency distribution of the start of each successful formation in theyearly price range shows that most of the formations begin life within a thirdof their yearly low. Only 21 % of the formations begin in the center third of the
yearly price range. The significance of this should be obvious but I state it hereanyway: If you think you have a measured move up occurring within one-third
of the yearly high, then you are probably wrong. Avoid those measured movesthat do not occur near the yearly low.
Slightly over half (57%) of the formations fulfill the measure rule. Themeasure rule conveniently leads us into the Trading Tactics section.
Trading TacticsTable 27.3 shows trading tactics for measured move up formations. The measure rule predicts the level to which prices will rise. To estimate the targetprice, compute the height of the first leg. I use the measured move up formation shown in Figure 27.5 as an example. Locate the highest high in the firstleg. Usually this is somewhere near the beginning of the corrective phase, andpoint A indicates this in the figure. From this value (21H), subtract the lowestlow (H'/s) in the first leg, shown as point B. The difference (7) is the height ofthe first leg. Add it to point C (183/s)—or the lowest low in the correctivephase—to arrive at the target price. In this case, the target price is 253/8. Prices
reach the target just 10 trading days after the corrective phase ends.On a. price basis, the second leg is about 10% longer than the first leg, onaverage, even though it represents a 37% price change versus 43 % for the firstleg. (This anomaly is due to rising prices. If the percentages are the same, the
price move will not be.) However, just 57% of the formations have second legsTable 27.3Trading Tactics for the Measured Move Up
Jun 95
]ul
Figure 27.5
Aug
Sep
Oct
Nov
Measured move up formation w
rode this measured move up in a stock she owgap closed. A symmetrical triangle shows a typ
that are equal to or longer than the first legsthe successful formations fulfill the measure
to be reliable, so the measured move up form
Once you calculate the target price usinthe gain is large enough to justify a trade. Ifchart again. Are there areas of resistance onthe stock might get hung up? If so, you mighare lucky and significant resistance is abovprice upward to just below the resistance zonshoot into the resistance zone, so you will hayour position.
Trading Tactic
Explanation
Measure rule
Calculate the height of the first leg from highest high to lowestlow. Add the difference to the lowest low in the correct phase.The result is the expected target price. Decide if the predictedmove is worth the risk of a trade.
near the yearly low. In my analysis of thesewithin the upper third of the yearly price ra
Yearly low
Choose formations that start (have their lowest low during thefirst leg) in the lowest third of the yearly price range. Avoidthose forming near the yearly high.
highs in the corrective phase. Once prices d
When selecting a formation to trade, it
near the yearly low. After prices leave the corTo gauge the breakout point, draw a down-s
the stock. As the stock approaches the target
Buy
Take a position in the stock sometime after the corrective phasecompletes and prices rise during the second leg.
If prices are on a roll, go with the flow and
Support/resistance
The corrective phase shows future support or resistance.
to sell.
Obviously, if prices pause near but below the
392
Measured Move Up
Once prices begin moving down, they sometimes return all the way downto the corrective phase before meeting any meaningful support. They maypause at the top of the corrective phase or rebound at the bottom of it. Sometimes, prices just sail right on through. Whatever the case, be aware that if youdo not sell near the target price and decide to hold on, you might lose all yourgains.
Sample TradeMichelle is an engineer. Over the years, she has developed a thick skin to takethe ribbing from her college colleagues in a male-dominated profession. Evenwhen she ventured into the professional environment after college, the ribbingcontinued. Make no mistake: She is pretty and they just wanted her attention.I saw this firsthand when I stopped by her office with a question. She was notthere at the time, but her desk blotter had the scribblings of love notes fromdozens of men. Of course, I added my own. But I digress.If you were to give a Rubic's cube to Michelle, she would not necessarilysolve it. First, she would want to take it apart to see how it is constructed. Thisinquisitiveness coupled with her ability to solve tough problems in a uniqueway makes her special even among engineers. She is also an investor with thesame qualities.Michelle had a unique way to take advantage of the situation shown inFigure 27.5. She already owned the stock but believed it was running out ofsteam. During the prior November to February period (not shown), she sawthe stock form a double top. Prices declined from a high of 24'/s to the low of14'/s at the start of the measured move.Unfortunately, as a novice investor, she was unable to pull the trigger andsell it after prices confirmed the double top. She rode the decline down to thelow and saw 41 % of her gains evaporate. When the stock began moving up, shebreathed easier. Still, she vowed to do better the next time. As the stock startedits climb, she saw the increase