also shows an interesting pattern that is key in identifying thestart of a new price trend: the partial rise. After touching the lower trendline,prices again move up but fail to touch the higher trendline. As prices descend,they pierce the lower trendline and continue moving down. The chart alsoshows a similar situation that occurs earlier in the price pattern, around thestart of the new year. There is a rising price trend that fails to touch the uppertrendline. In this case, prices return to the lower trendline, then rebound andzoom up again to touch the higher trendline. The partial rise fails to predict a
change in trend. We further explore partial rises later.
Why does a broadening wedge formthe head of an investment conglomerateto buy shares in another company. Whtrading department to begin its buyingforces the price to climb even though theover several days and through several brkeep its buying quiet, but the word getmomentum players jump on your coattaing into the situation. This sends the stotrading department stops buying for theValue investors, sensing an overboto sell their shares at the higher price. SBut before it can reach its old low, thethe decline. Your trading department, seand buys while the price is still reasondecide the stock is worthy of a flyer andpany itself gets into the act and buys shators as a share-buyback program annouis nearing the expiration date and the co
to complete their promise to shareholdeThe stock makes a new high. Wh
pressure overwhelms die buying deman
76
Broadening Wedges, Ascending
*
Table 5.1
Identification Characteristics of Ascending Broadening Wedges
price will not drop far—not with everyone trying to buy at a good price. Whatyou have then are much higher highs from the unbridled buying enthusiasm
and higher, but more sane, lows as your conglomerate and the company itselftry to buy near a fixed low price. You never quite succeed and pay higher andhigher prices as the minor lows move up.Soon, however, the stock is too pricey even for your tastes. You may evendecide it is time to sell some, or all, of your holdings. Meanwhile, the momentum players send the stock coasting higher, but this time the price does notcome close to the upper trendline.Everyone has his or her ear to the ground listening, trying to figure outwhat all the buying enthusiasm is about. In the distance, a rumble sounds. Thesame-store sales numbers are going to be lower this quarter, the shorts say.This time the rumor finds sympathetic ears. The rumble heard earlier is thestampede of die smart money running for the exits. The price drops quickly. Itmay hover for a bit around support zones while novice investors, who have notgotten the word, buy the stock. When they finish placing their trades, themeager buying demand abates and the stock crashes through the lower trendline and heads down further.
Characteristic
Discussion
Shape
Looks like a megaphone, tilted up, with price action thatoutlines two up-sloping, trendlines.
Trendlines
The top trendline has a steeper upward slope than the lowerone and neither is horizontal.
Touches
There should be at least three distinct touches (or neartouches) of the trendlines on each side. This helps assureproper identification and performance of the formation.
Volume
Irregular with a slight tendency to rise over the length of theformation.
Premature breakouts
Very rare. A close below the lower trendline is usually agenuine breakout.
Breakout
The breakout direction is downward the vast majority oftimes, but an upside breakout is not unheard of.
Partial rise
Prices touch the lower trendline, climb toward the toptrendline, but fail to touch it. Prices reverse direction andbreak out downward from the formation.
Fleetwood Enterprises (Manuf. Housing/Rec. Veh., NYSE, FLE)
Identification GuidelinesThere are a number of identification guidelines, outlined in Table 5.1, thatmake this formation unique. As I discuss the different guidelines, consider theascending broadening wedge depicted in Figure 5.3. This formation is different from Figures 5.1 and 5.2 in that it is born from a region of consolidation.From the beginning of the study in July 1991, prices move generally horizontally and do not fall much below the 153/g level (Figure 5.3 shows only a portion of the prior price action).The situation changes just before the new year. Prices start moving up onDecember 23. They reach a new high in mid-January but soon move down. Atthat point, two tentative trendlines connect the highs and lows. Although it istoo early to form a definitive conclusion, a broadening wedge appears to betaking shape. After prices move up and touch the upper trendline then pullback to the lower one again, the broadening wedge formation is clearly visible.At the start of March, prices move higher but quickly stall, turn around, andpierce the lower trendline. The partial rise and trendline penetration suggest achange in trend is at hand.It is a false breakout. Prices travel higher for 3 days in a tight, narrow pattern then zoom upward and touch the upper trendline. The bottom trendlinehas to be redrawn to accommodate the slight decline below the old trendline. Clearly, prices have more work to do before declining below the lower
Nov 91
Dec
|an 92
Feb
Mar
Apr
May
Jul
Figure 5.3 A broadening formation that fails to continue moving down, requiring a redraw of the formation boundaries. The internal partial rise is rare, occurring
in just 18% of the formations.
trendline.
77
78
Broadening Wedges, Ascending
A month later, prices return to the lower trendline and move higher for afew days. However, the rise stalls and prices pierce the lower trendline. Like areplay of the price action a month earlier, prices return to the trendline andstart moving higher. However, this rise falters on low volume and quicklyreturns to the lower trendline. When prices gap down on April 16, the genuinebreakout occurs. In rapid fashion, prices plummet to below 123/4, nearly a 50%decline from the high.Looking back at Figures 5.1, 5.2, and 5.3, there are several characteristicsthat ascending broadening wedges have in common. The overall shape appearsas a megaphone. This appearance is not uncommon for broadening formationsexcept that this megaphone tilts upward: both trendlines slope higher. Theupper trendline has a higher slope than the lower one, giving the formation abroadening appearance. The lower trendline also slopes upward separatingthe formation from the right-angle and symmetrical varieties of broadeningformations.In my studies of ascending broadening wedges, I select formations thathave at least three touches of each trendline (or at least come close). The threetouch minimum helps remove consideration given to normal price action andhelps identify reliable chart patterns.The volume pattern is irregular but generally rises as prices move up andrecedes as prices decline. Although it is not clear from the charts, volume tendsto rise over time. However, this tendency is slight when considering all ascending broadening wedges and is not a mandatory selection guideline.Figure 5.3 shows an exceptional premature breakout. Usually, prices follow the lower trendline and do not penetrate it until very near the breakout.When prices do break out, the price action can be messy, as shown in the figure. Sometimes the price runs straight through the lower trendline withoutpausing, and sometimes it weaves around the trendline before finally continuing down. In either case, the breakout is usually downward.The partial rise, already mentioned, occurs in nearly half of the ascendingbroadening wedges. Since it usually occurs just before a breakout, it is animportant trend change indicator. In a partial rise, prices start moving up, afterhaving touched the lower trendline, then stop before touching (or comingclose to) the upper one. Prices return to the lower trendline and usually headlower, staging a genuine breakout. Note that a partial rise must begin from thelower trendline, not as an upward retrace from the top trendline.
Focus on FailuresFigure 5.4 shows what a failure looks like. Although prices break out downward, they fail to continue moving down by more than 5%. The breakoutoccurs at a price of 50'/s and prices move to a low of 485/s about 2 weeks later,resulting in a 3% decline — too small to register as a success.
Eaton Corp. (A
Oct
Figure 5.4 An ascending broadenPrices decline less than 5% below the
Only 7 out of 126 or 6% of th
continue moving down by more t
However, it does not mean that faan ascending broadening wedge, twill break out downward. This is ayou wait for an actual breakout. Al24% that either move up or movesomething that you should take lighfor a confirmed breakout before in
Statistics
Table 5.2 shows general statisticsmations are more plentiful thanlocated 157 in 500 stocks over a 575% act as reversals of the prevailThe failure rate is comparatievery four formations has an upsioccur, the failure rate drops to a mtions fail to continue moving downout. These 5% failures are rare an
80
Broadening Wedges, AscendingTable 5.2General Statistics for Ascending Broadening Wedges
Description
Statistic
Number of formations in 500 stocksfrom 1991 to 1996
157
Reversal or consolidation
39 consolidations, 118reversals
Failure rate
38/157 or 24%
Failure rate if waited for downside breakout
7/126 or 6%
Average decline of successful formations
20%
Most likely decline
10%
Of those succeeding, number meeting or exceedingprice target (measure rule)
73 or 61 %
Average formation length
4 months (116 days)
For successful formations, days to ultimate low
3 months (95 days)
Partial rise followed by a downside breakout
63/75 or 84%
Partial rise as a percentage of all formations
48%
Partial rise not at formation end
29 or 18%
Percentage with rising volume trend
59%
Note: Most formations break out downward and a partial rise is often a clue to a downsidebreakout.
Figure 5.5 Frequency distributionThe most likely decline is 10%, fol
long term. There are 81 formatioremainder of the formations splitterm, suggesting that the investm
term. If you short a stock showingout your position in less than 3 m
How far will a stock decline after a downside breakout? On average, thedecline is 20%. However, a frequency distribution of the declines tell a slightlydifferent tale (see Figure 5.5). The vast number of hits occur in the 10% category, suggesting that the most likely decline is about 10%. The 15% to 25%categories have a rather steady but declining trend, leading me to believe thelikely decline is probably understated at 10%. The likely decline is probably
One set of exciting statisticsprice rises. A partial rise, such as
the time (48%) but when it does o
84% of the time. In only 18% of tmation occur, such as that showadvantage of the partial rise, yochange. Sometimes that in itself
higher, perhaps in the 15% to 20% range.For a bearish formation, the measure rule usually is the height of the formation subtracted from the breakout point. However, for wedges, the price
regression, indicates 59% of the f
target is the lowest low in the formation, which is what I use for this formationtoo. I compare the ultimate low price with the formation start. Only 61% ofthe time is the ultimate low price below the formation low. This is not a veryreassuring figure; I consider values above 80% to be reliable.I compute the average formation length by subtracting the date of theformation end from the beginning. On average, the formation is about 4months long (116 days), and it takes almost as long (95 days) to reach the ultimate low.A frequency distribution of the days to the ultimate low helps determinein which investment category the formation belongs: short, intermediate, or
This result is weak and suggests vcator of the validity of this formatvolume series is irregular in appeaTable 5.3 lists statistics pertouts, only 1 formation breaks ouDownside breakouts (126) are mseven failures of downside breakostock fails to continue moving dowout before recovering substantiallhave horizontal breakouts.
to buy a stock.
The volume trend, as measu
82
Broadening Wedges, Ascending
"
Table 5.3Breakout Statistics for Ascending Broadening WedgesDescription
Statistic
Upside breakout but failure
1 or 3%
Downside breakout but failure
7 or 6%
Upside breakout
29 or 18%
Horizontal breakout
2 or 1 %
Downside breakout
126 or 80%
Throwbacks
2 or 7%
Average time to throwback completion
7 days
Fullbacks
26 or 21%
Average time to pullback completion
9 days
Percentage of breakouts occurringnear the 12-month price low (L),center (C), or high (H)
19%, C27%, H64%
Percentage loss for each 12-monthlookback period
L25%, C21%, H19%
Volume for breakout day and next 5 dayscompared with day before breakout
165%, 1 34%, 116%, 96%,114%, 109%
Trading Tactics
83
declines occur in the lower third of the price range with an average declinemeasuring 25%. This is larger man normal, but the largest decline occurringnear the yearly low is not surprising. Other bearish formations show this tendency. This behavior reinforces the belief that you should short a stock mak-
ing new lows, not new highs.Table 5.3 shows the volume for the week after a breakout as comparedwith the day before the breakout. There is high volume on the breakout day,as expected, and it measures 65% above the prior day (or 165% of the priorday's total). Throughout the following week, volume remains relatively high,although inconsistent.
Trading TacticsTable 5.4 lists trading tactics. The measure rule for this formation is differentfrom most other formations in that it is based on the lowest daily low, not onthe height of the formation.
Figure 5.6 shows two ascending broadening wedges and application of themeasure rule. Both formations are well formed, but the first one has a tendencyto rise slightly above the top trendline before beginning its downhill run. The
chart marks the lowest low in each formation. The low serves as the expectedminimum price move. The formation on the left shows prices reaching the tar-
Throwbacks and pullbacks are rare for ascending broadening wedges.Since there are so few upside breakouts, it is no surprise that there are only twothrowbacks to the top of the formation. The time between a breakout andcompletion of a throwback is just a week. Other formations usually havethrowback durations of about 10 to 12 days. Again, the short throwback timeis probably due to the low number of throwbacks.Pullbacks, at 26 or 21%, are more plentiful but still rare when comparedwith other types of formations. The pullback completion time is just 2 dayslonger (9 days total) than its throwback brethren. For this formation, the numbers imply that throwbacks and pullbacks are not reliable and should not bedepended on to initiate a trade. If your stock does pull back, consider adding toyour position once prices begin falling again.
For downside breakouts, I examined where the breakout occurs over theprior 12-month period. The formation appears most often (64%) within onethird of the yearly price high. This may sound surprising since the breakout ison the bottom of the formation. However, since the wedge rises over time, thebreakout point lifts into the higher ranges. In essence, you will find ascendingbroadening wedges breaking out near the yearly high, probably near the end ofan uptrend.I divided the yearly price range into thirds and distributed the percentagedeclines over the range, depending on where the breakout occurs. The largest
get price in mid-November just as prices turn around and rebound. The formation shown on the right has prices hitting the target when they plummet.The reason for choosing the lowest low in the formation is simply forperformance. Using the formation low as the target price allows 61% of theformations to achieve the target. This means that almost two out of every threeformations decline below the formation low. I like to see performance numbers
Table 5.4
Trading Tactics for Ascending Broadening WedgesTrading Tactic
Explanation
Measure rule
Use the lowest price in the formation as the minimumprice move to expect. Do not use the formation heightsubtracted from the breakout point as the resultoverstates the anticipated decline.
Wait for confirmation
Although this formation breaks out downward 80% ofthe time, it is best to wait for a downside breakout beforeshorting the stock.
Partial rise
If a stock shows a partial rise and begins to head backtoward the lower trendline, consider selling short. Adownside breakout follows a partial rise.
Note: Wait for the breakout then trade with the trend.
84
Broadening Wedges, Ascending
Sample Trade
Centex Corp. (Homebuilding, NYSE, CTX)
Double Top
85
level and turn around. As prices decline after the second formation, the supportlevel at 36 changes into resistance. During March, prices try to rebound butturn away near the 36 level.An exception to the wait-for-breakout-confirmation rule is if a partialrise occurs. Looking again at Figure 5.6, you might conclude that there is apartial rise in the right formation. You would be wrong. I define a partial riseas when prices touch the lower trendline, move up, then return to the lowertrendline. The figure shows prices starting from the top trendline, not thelower one. Figure 5.2 shows a properly identified partial rise.If you detect a partial rise, consider shorting the stock. In 84% of thecases, a downside breakout follows a partial rise. Since you are getting a quicker
jump on the stock, your profits should be larger. When the stock declines tothe lower trendline, move your stop-loss order to break-even. If the stock
should turn around at the trendline and head up, consider closing out yourposition.
Sample TradeFigure 5.6 The measure rule as it applies to two ascending broadening wedges.Astute investors will recognize the twin peaks as a double top.
above 80%, so the 61% value is poor. As you look at the formation on theright, you can see how close the price target really is to the breakout price.If you were to compute the formation height and subtract it from thebreakout point, there would be even fewer formations meeting the price target.
Only 27% would meet the new, lower, price target, which is very differentfrom 80%. What about computing a target price that is nearer the breakout,say, using half the formation height subtracted from the breakout? This computation only results in a 64% success rate. The number is certainly better than27% but is not much of an improvement over the 61% number using the low-
est formation low.This formation has a good track record of downside breakouts. However,20% of the time prices either move horizontally or break out upward. If youwait for a breakout before investing, you substantially increase your chances ofa profitable trade. Once prices decline below the lower trendline, sell the stock
short. Be prepared to cover the short as prices near the target, especially if theprice approaches an area of support.The most likely decline from an ascending broadening wedge is just 10%,but it could be substantially higher. In computing the most likely decline, you
can use the measure rule. However, consider that support areas are probablybetter places to close out the trade. In Figure 5.6, the lowest formation low onthe left is also a support point. Prices decline to the low in early August thenhead up and create the formation. Several months later, prices decline to that
Curtis works the night shift at a large bakery near his home. Working at nightfrees up the daylight hours for other activities, such as sleep. Occasionally, hespots a situation such as that shown in Figure 5.6, one that makes the morningsun seem even brighter.Each day before he hit the sack, he plotted the stock and watched with
amusement the first broadening wedge form. When die second one appeared,he wiped the sleep from his eyes and took notice. It was not so much the broadening wedge that excited him; it was the wedge coupled with the double top.Together, they spelled an especially bearish situation, one that he was willingto shell out his hard earned money to trade.The day after the stock closed below the lower trendline, Curtis sold thestock short and received a fill at 39/2. He used the double top measure rule toestimate his target price. With a top at 453/t and a valley low of 36'/4, the targetturned out to be 26% (that's 453/4- 36'/4). He decided to place an order to coverthe short at 27'/8, just above the whole number and just above where everyoneelse was likely to place theirs. Then he went to bed.
Each day, before he closed the curtains to get some sleep, he would checkon his stock. To him, it was pleasing to see the stock begin moving downimmediately and sailing below the nearest broadening wedge target price(387/8). He lost some sleep worrying about the upward retrace in March, andwondered if the party were over.Curtis hung in there and the stock eventually pierced the resistance zoneand kept moving down. He hoped that the March resistance zone was just thecorrective phase of a measured move down, which would place the target priceat 22 1 /2, well below his target at 27'/s. He decided not to be greedy and lower
86
Broadening Wedges, Ascending
"
his target. Instead, he moved his stop-loss price down to just '/s above the resistance zone high at 363/8.On April 18 he was rudely awakened from his REM state by a phone callfrom his broker. The short was covered at his target price. He got up andstarted his computer and checked out the situation. All told, he made about $12a share. That put a smile on his face and he went back to his dream of tellinghis boss what he could do with the night shift
6Broadening Wedges,Descending
R E S U L T S SNAPSHOTAppearance
Price action follows two down-sloping trendlines thatbroaden out.
Reversal orconsolidation
Long-term (over 6 months) bullish consolidation
Failure rate
37%
Average rise
46%, with most likely rise being 20%
Volume trend
Usually increases over time
Throwbacks
40%
Percentage meetingpredicted price target
81%
Surprising finding
An upside breakout follows a partial decline 76% ofthe time.
What a surprise! When I discovered this formation, I thought it would act likea falling wedge, but it did not. Falling wedges are reversal formations, whereasdescending broadening wedges act as a consolidation of the prevailing trend.The volume pattern is also different from falling wedges. In the descendingbroadening wedge formation, the volume tends to increase over time but withfalling wedges, it decreases.87
88
Cognex (Precision I
Broadening Wedges, Descending
During my search through the various stocks in the database, I noticedthat this formation appears most often after an uptrend. Prices move down in abroadening wedge for several months then return to their original direction: up.The pattern is representative of a trend consolidation, reaffirming the statistics.How do you measure the failure rate of this formation? Once I knew thatthe formation acts as a consolidation of the trend, then trend reversals becomefailures. Also, formations that are consolidations but fail to move more than5% in the breakout direction (after a breakout) are also failures. Altogether,37% of the formations fail. That is well above the maximum 20% that I consider reliable formations to possess.Being a consolidation in a bull market, the average rise is a very high46%. The most likely rise is 20% and an astounding 40% of the formationshave gains above 50%! With bullish numbers like these, it makes the failurerate seem tolerable.The measure rule stacks up well, but that is no surprise considering theperformance is so good. Unlike ascending broadening wedges, this formationuses the formation height added to the breakout price to predict the target.Over 80% of the formations with upside breakouts meet or exceed their pricetargets.One surprise is really not a surprise at all for broadening formations: thepartial decline. When prices move down from the top trendline then rebound,an upside breakout occurs 76% of the time.
May 95
Jun
Figure 6.1 The descending broadeupward trend. Two down-sloping treout. Volume usually increases over tim
Canandaigua Brands Inc. A (B
TourWhat does the formation look like? Figure 6.1 shows a well-formed descending broadening wedge. The stock begins rising in June 1994 and rounds overat the top a year later, in August. In September, the stock starts down in tightoscillations that broaden over time. A month later, two trendlines drawn acrossthe highs and lows make the wedge shape clear.Volume at the start of the formation is well below normal. As the formation develops, volume is erratic, but trends higher. Computing the slope of thevolume line using linear regression confirms the result; the slope is positive,which indicates volume is getting heavier.In mid-October, prices gap up and shoot above the upper trendline. Abreakout occurs. Volume spikes upward also and continues to be heavy for several days as prices climb.As you look at die chart, you may make an interesting observation. Theprice trend has three stages: The first stage is the long bull-run from June 1994to August 1995, leading to a consolidation or retrace for 2 months (secondstage), then prices move higher (third stage). In Figure 6.1, the broadening formation is a consolidation of the upward trend. Taken as a whole, it looks likethe corrective phase of a measured move up chart pattern.
May 92
Jun
Jul
Aug
Se
Figure 6.2 The descending broadeniintermediate-term downward trend.
90
Identification Guidelines
Broadening Wedges, Descending
Contrast Figure 6.1 with Figure 6.2, where a descending broadeningwedge acts as a reversal of the intermediate-term price trend. Prices peak inMay 1992 and head lower. During August, prices begin to broaden out as theycontinue their downward spiral. By mid-September, a descending broadeningwedge forms.Volume is low at the start of the formation but does have a few spikes.Into September, volume moves up and becomes even more irregular. Atthe start of October, as prices begin moving up, volume recedes. Prices piercethe top trendline on negligible volume and head higher. A trend reversalis at hand.Up to October, prices have been trending down rather steadily, thenprices reverse course and start climbing. By January prices reach the old high.During late January and early February, prices pierce the old high and recorda new one. A year later, prices soar to a high of 32, almost triple the lowachieved during the formation (103/4).
Identification Guidelines
91
tern is narrow at the start but gets wider over time. Neither trendline is horizontal, which is a key consideration since it differentiates this formation fromother types of broadening formations.
There are a number of touches of the minor highs against the top trendline and the minor lows against the bottom one. There should be at least twodistinct touches—two minor highs and two minor lows—of each trendline tocorrectly define a broadening formation.The slope of the volume trend is usually upward, unlike formations fromthe narrowing wedge family: They have volume trends that recede over time.
The increasing volume pattern seems to catapult prices higher, sending themout the top of the formation. Volume at the breakout is usually high but neednot be. As long as demand exceeds supply, prices will rise.Since the formation represents a consolidation of the prevailing trend,
prices continue in the same direction they were traveling before the formationbegan. As shown in Figure 6.3, if prices are heading up, they will continuemoving up after the formation completes.Sometimes, however, the formation acts as a reversal of the trend. Figure6.2 is an example of a reversal. There is no easy way to differentiate a budding
consolidation from a reversal. Both often occur at the end of a rising price
Table 6.1 outlines the identification guidelines for the formation, and Figure6.3 shows another example of a descending broadening wedge. Figure 6.3shows two down-sloping trendlines that encompass a series of oscillatingprices. The two trendlines look like a megaphone, tilted down. The chart pat-
trend. In a consolidation, the breakout is usually upward and prices resume
climbing. In a reversal, the breakout is downward and prices head lower. Onlythe breakout direction decides whether the formation represents a consolidation or a reversal of the prior price trend.Alaska Air Group Inc. (Air Transport, NYSE, ALK)
Table 6.1Identification Characteristics of Descending Broadening WedgesCharacteristic
Discussion
Shape
The formation looks like a megaphone tilted down. Twodown-sloping trendlines outline the price action.
Down-slopingtrendlines
Both trendlines slope downward, with the lowertrendline having a steeper slope. Thus, the two linesbroaden out over time. Neither trendline is horizontal.
Trendline touches
The formation requires at least two distinct touches of eachtrendline.
Volume
Usually rises over the length of the formation. However, thevolume pattern is not a prerequisite.
Breakout
Since the formation acts as a consolidation of the trend, ifprices were moving up, they usually continue moving upafter the breakout. If the price trend was down, pricesusually continue down after a downside breakout.
Partial decline
For a partial decline, prices must touch the top trendlineand move down, turn around, then head higher withoutcoming close to the lower trendline. An upside breakoutusually follows a partial decline.
Partial DeclineFollowed byUpside Breakout
Sep 95
Oct
Figure 6.3 A descending broadening wedge as a consolidation of the risingtrend. Volume moves higher even as prices head down. A partial decline signalsthat an upside breakout is coming.
92
Statistics
Broadening Wedges, DescendingUnited Technology (Diversified Co., NYSE, UTX)
The partial decline, such as that shown in Figure 6.3, often indicates animpending upside breakout. This works quite well for consolidations or reversals. However, the success rate appears much lower for downside breakoutsthat follow partial rises. I discuss statistics in more detail later, but there are toofew samples to really make a definitive statement about partial rises.Why do these formations form? The chart pattern, as do many formations, illustrates the struggle between supply and demand. In Figure 6.3, afterattempting to close the September gap in early December, the stock stalls.Buying enthusiasm dries up and the stock heads lower.Volume sometimes rises as prices near whole dollar amounts and at 40%,50%, or 