die formation classifies as a right-angled ascending or descending broaden-
ing formation. When the two trendlines slope in the same direction, die formation is a broadening wedge.There should be at least two minor highs and two minor lows before diechart pattern becomes a broadening top. A minor high is another name for adistinct price peak. A minor low refers to the valley pattern as prices descendto a low then turn back up. Again, die minor low should be a distinct troughdiat is easily recognizable. Figure 4.1 shows diree minor highs touching dietop trendline and four minor lows either nearing or touching die bottomtrendline. The minor highs and minor lows need not alternate as prices crisscross die formation.
60
ASA Ltd (Investment Co. (Domestic), NYSE, ASA)
Broadening Tops
6
Linear regression on the volume trend shows it splitting evenly betweentrending up and trending down. If you look closely at most broadening topchart patterns, you will see that volume typically follows price. When pricesrise, so does volume; when prices fall, volume recedes. In Figure 4.1, volumerises as prices climb into the beginning of the formation and round over at thepeak. Then volume declines, following prices lower. However, I attach no realsignificance to volume in a broadening top formation.A breakout happens when prices move outside the trendline boundariesor follow a trendline for an extended time. In Figure 4.1, if you extend the toptrendline upward, it will intersect prices at about 58. Prices push through thislevel and move higher. When a breakout occurs, I consider the actual breakoutprice to be the value of the highest peak in the formation. In Figure 4.1, forexample, the breakout price is 55'/2, or the high at the early December peak.For an example of how to apply the various guidelines, consider thebroadening top shown in Figure 4.2. At first glance, it looks like a large megaphone with price trends that generally follow two sloping trendlines. The toptrendline slopes upward and the bottom one slopes downward, each intersecting the minor highs or lows at least twice. Prices, over time, form higher highs
Aug91 Sep
Nov
Oct
Dec
Jan 92
Feb
Mar
Apr
May
Jun
Figure 4.2 The broadening top has higher highs and lower lows as the priceaction widens over time.
and lower lows until they breakout of the formation, generally moving beyond
the line of trend before retracing.The volume pattern is irregular but generally rises as prices move up and
recedes as prices move down. Figure 4.2 shows this quite clearly. During the
Albertsons Inc. (Grocery, NYSE, ABS)
rise in mid-November, for example, volume jumped upward as prices peaked,then just as quickly receded as prices declined.Where in the yearly price range does the formation appear? Broadeningtops, as you would expect, appear near the top of a price range or near the top
of an upward trend.The only characteristic not discussed so far is that the formation is usually horizontal and symmetrical. The formation does not appear as an ascending or descending broadening wedge, with both trendlines either sloping up orboth sloping down. In broadening formations one trendline must slope up
while the other must slope down.Orthodox broadening tops and five-point reversals describe the same typeof formation. They are simply broadening tops that have three minor highs
and two minor lows. Figure 4.3, for example, falls into this category. Otherthan the name, I found no substantial difference between broadening tops andorthodox broadening tops or five-point reversals.Some analysts say five-point reversals are bearish indicators, that the formation predicts a downward breakout. My statistics, admittedly on only 3 0 formations, suggest this is untrue. Sixteen break out upward and the others breakout downward. The sample size is too small to make a definitive statement, butthe numbers do reflect the general trend of upside breakouts for all broaden-
|un 95
|ul
Aug
Sep
Oct
Nov
Dec
Jan 96
Feb
Mar
Apr
Figure 4.3 A weak example of a five-point reversal or orthodox broadening top.It has three minor highs and two minor lows composing the five turning points.
ing top formations, that is, slightly more than half (53%) break out upward.
61
62
Broadening Tops
Focus on FailuresWhat does a failure look like? Look at Figures 4.3 and 4.4, two examples ofbroadening patterns that fail to continue in the expected direction. Figure 4.3shows a sharp downward thrust that pierces the trendline on high volume.Since this is clearly outside the lower trendline, and coupled with the failure ofprices to attain the upper trendline, a downside breakout is at hand. But thedownward movement stalls on very high volume, turns around, and moveshigher. This is an example of a 5% failure, that is, prices break out then moveless than 5% in the direction of the breakout before heading substantially inthe other direction. In this case, the breakout direction is downward, but pricesrecover before moving lower than 5 % below die breakout point.Contrast the behavior shown in Figure 4.3 with that shown in Figure 4.4.I include this chart because I have noticed that a large number of broadeningformations act this way. Instead of making a clear up or down thrust that
pierces the trendline, prices move horizontally for months on end beforefinally moving above or below the formation highs or lows.In the case of Figure 4.4, prices decline below the low in early July andhalt. They climb for a bit then recede again and reach a new low in earlyAugust. Another recovery sees prices rise no higher than 44 for about half ayear before finally staging an upside breakout.
Even Figure 4.3 shows a conpierce the trendline. Prices do nottially travel sideways for an extenprices finally break out in the genuThe last point I want to makenearly 200 formations. Once a bromoving in the same direction.
Statistics
As I completed my first pass throuwas not finding many broadeningexamined had usable formations. Sdatabase that I use on a day-to-daynearly 300 stocks, but it is only aboyear, 500 stock database used thro
not that many formations, only 18enough to draw valid conclusions.Does the formation perform a
trend? Just over half (100) are con
General Statis
Arco Chemical Co. (Chemical (Basic), NYSE, RCM)
DescriptionNumber of formations: 132 in500 stocks from 1991 to 1996,57 in about 300 stocks from1996 to 1999Reversal or consolidationFailure rateAverage rise/decline ofsuccessful formations
Most likely rise/declineOf those succeeding, numbermeeting or exceeding pricetarget (measure rule)Average formation lengthPartial rise but ended downApr
May
Jun
Dec
Jan 94
Feb
Mar
Figure 4.4 Prices in this broadening top moved horizontally for 6 months beforestaging an upward breakout. This is a common occurrence with broadening tops.
Partial decline but ended upPercentage of time there wasa trend reversal within 3 months
64
Broadening Tops
Statistics
65
the others (89) are reversals. The formation's behavior depends on the direction of the breakout. Formations with upside breakouts act as consolidations ofthe trend because one of the criteria for a broadening top is that the price trendleading to the formation is upward. Thus, they continue the upward trend;
broadening tops with downside breakouts act as reversals.Some analysts say that broadening top formations are inherently bearishreversals, but I found little to support that claim. I prefer to think of them asweakly performing bullish patterns (those with upside breakouts) or mildlystrong bearish patterns (downside breakouts).The failure rate is not easy to determine since the formation has no indication in which direction it will ultimately break out, so I used a 5% pricemovement as the benchmark. This breakout means that if prices decline below(or rise above) the lowest (highest) point in a formation by less than 5%, thenturn around and head in the opposite direction, the formation is a failure.The reasoning for this approach is simple. If you purchased the stock
after an upside breakout but the stock failed to continue rising, then you wouldbe disappointed and may even take a loss. Given such constraints, out of 189formations, only 8 fail to continue moving in the direction of the breakout.That is a good score.
10
15
20
25
30
35
40
>50
Percentage Cain or Loss
LTH Cains
• Losses
Figure 4.5 Frequency distribution of returns for broadening tops. The most likelygain for upside breakouts is 10% to 15%, and the loss is likely to be in the 10% to20% range after a downside breakout.
Once a breakout occurs, what is the average move? For formations with
upside breakouts, the average rise is 34%, whereas formations with downsidebreakouts decline by 23%. The average gain is a bit under the 40% that bullish formations exhibit, but the average decline is above the 20% loss for bearish chart patterns.Large percentage moves can skew the overall average, so I computed themost likely rise and decline using a frequency distribution. Figure 4.5 shows agraph of the results. Large gains are the case with upside breakouts as you can
types at 72 and 67 days. The formation is long enough to show up on theweekly charts.Partial rises and declines are a reliable way to determine the breakout
see in the figure. Twenty-one percent of the formations with upside breakouts
direction and they allow an investor to take a position in the stock early. Fig-
have gains over 50%. If you ignore this column, then the next highest one is forreturns in the 10% to 15% range. I consider this range to be the most likely
ure 4.3 shows a partial rise that correctly predicts a downside breakout. Forbroadening tops that show a partial rise, where prices leave the lower trend and
return that investors can expect. If you are lucky, you will have a formation that
rise up but do not come close to the top trendline, a downside breakout follows
does considerably better, just do not bet that farm that it will happen.For downside breakouts, the most likely loss ranges between 10% and20%, which includes the three tallest columns in the graph; they are nearenough to one another that I lump them together. Over half the formations(56%, or the sum of die first three columns) with downside breakouts havereturns less than 20%.The measure rule applies just as it does for most formations. Find theformation height and add the result to the highest point in the formation forthe upside target and subtract the result from the formation low for the downside target.You can see in Table 4.2 that 75% of the upside breakouts reach the target price. However, downside breakouts fare much worse, with 64% reachingor exceeding their targets. I consider values above 80% to be reliable, so the
65% of the time. The results are even better with partial declines, which aredips from the top trendline that move downward without coming close to thelower trendline. Partial declines correctly predict an upside breakout 86% ofthe time.
broadening top does not quite make the grade. I explain the measure rule further in the Trading Tactics section.The average formation length is nearly the same for both of the breakout
Some analysts suggest that broadening formations are bearish formations.Even when they do not work, analysts maintain, a trend reversal soon appears.I scanned my database and looked at all formations to see if this is true. Only
41% of die formations widi upside breakouts reach their ultimate high in lessthan 3 months. This means tJiat less dian half suffer a trend reversal in under3 months. Downside breakouts perform marginally better, at 47%, but still not
high enough to support other analysts' premise. It is my belief, supported bythe statistics, that even when things do not work out as expected, a broadeningtop does not presage the end of the trend.
66
Broadening Tops
Table 4.3 shows breakout statistics. Figure 4.4 is a good example of thedistance between where the formation ends and where the breakout occurs.For both breakout types, it takes over a month to reach the breakout point, onaverage. I consider the breakout to be where prices either rise above the highest high in the formation or drop below the lowest low.In the 100 formations I examined with upside breakouts, it takes nearlyhalf a year (166 days) to reach the ultimate high. Downside breakouts, on theother hand, reach their ultimate low much more quickly, in about 4 months
(129 days). This makes sense because it takes longer to rise 34% than to fall by23% (the average gain or loss from Table 4.2). Both durations measure fromthe breakout point to the ultimate high or low point (a point where a significant trend change occurs).Where in the prior 12-month price range do breakouts occur? Most(94%) upside breakouts happen in die upper third of the price range. Althoughthis may sound suspicious, it is reasonable. Consider that upside breakoutsoccur along the top of the formation placing them closer to the top of theyearly price range. Since broadening tops occur near the end of an upwardtrend, it should come as little surprise that most (49%) downside breakoutsfrom broadening tops appear in the center third of the yearly price range. The
Table 4.4 shows statistics forif there is a relationship betweenbreakout. A frequency distributireveals that most formations havebreakout (either upward or downwmation several more times before uHow did I count the number o4.2. The numbers represent the atouch on the side opposite the entrbottom, but it almost makes its waalternating touch on the bottom. Fiing alternative touches.Returning to Table 4.4, turniinvestor a better feel for how likelya formation with the first touch
touches, then the likelihood of a doon the top) is 95% should prices cr
but it does not mean that the forma
are already at the top, they could do
highest third follows with 40%.
out upward.
Substituting the gains or losses for prices shows interesting results.Upside breakouts from broadening tops climb 35% on average when theyoccur in the upper third of the yearly price range. Downside breakouts splitevenly with about 22% in each category (with a slight edge, 24%, going to the
There is also the belief amongwill occur opposite the side with(which have three touches on top an
center third).
be downward. Of the 30 five-pointout downward.
What about inverted five-pominor highs and three minor lows. Tbreak out upward twice as often asTable 4.3Breakout Statistics for Broadening TopsUpside Breakouts
Downside Breakouts
Number of breakouts
100 or 5 3%
89 or 47%
Formation end to breakout
46 days
34 days
For successful formations,days to ultimate high/low
5.5 months (1 66 days)
4 months (129 days)
Description
Percentage of breakoutsoccurring near 12-monthlow (L), center (C), orhigh (H)Percentage gain/loss foreach 1 2-month lookbackperiod
TFrequency Distribution of SuccesTouches with CumuNumber ofAlternatingTouches
Nu
B
3L0%, C6%, H94%
L0%, C24%, H35%
L10%, C49%, H40%
L22%, C24%, H22%
Note: The best performing broadening tops with upside breakouts are those that appearin the upper third of the price range.
4
4
5
3
6
1
7
Note: The table indicates that most succetouches before breaking out.
68
Broadening Tops
hasten to add that there are 36 additional formations that have more than 5touches. Some five-point reversals, inverted or not, go on to bounce off theopposite side several more times. Once that happens, of course, they are nolonger five-point reversals. My conclusion is that there is nothing magic aboutfive-point reversals or their inverted brethren. They are all broadening formations and there is really nothing special about them that I have been able todetermine.
highest high in the chart patternshown in the figure.
How do you make use of the
sidering purchasing the stock. Sinformation will ultimately break oentry point. The easiest way to inv
the stock turns at the bottom trend
Since a broadening formation
and two along the bottom before t
Trading TacticsTable 4.5 outlines trading tactics for broadening top formations. The first
shows one likely investment locatithe target price using the measuremine if the potential gain is worth t
thing to consider about trading tactics is the measure rule. The measure rule
the purchase price is about 103/8 an
predicts the price to which the stock will move. For many formations, one simply computes the height of the formation and adds the result to the breakoutprice. Broadening formations are not much different. Consider Figure 4.6.The height of the formation is the difference between the highest high (12H)and the lowest low (10), or 2l/s. For upside breakouts, add the height to the
stop loss should be 97/8, for a poten
ratio of 7 to 1, more than enough tOn an upside breakout, priceage. This means you need not fee
wind its way upward while you wa
Buy the stock as soon after
higher. Place a stop-loss order %Should prices drop, your position wTable 4.5Trading Tactics for Broadening TopsTrading Tactic
Explanation
Measure rule
Compute the height between the highest high and thelowest low in the formation. Add or subtract the heightfrom the highest high or lowest low, respectively. Theresults are the target prices for upside and downsidebreakouts.Once a broadening top appears, buy after the stockmakes its turn at the low.Place a stop-loss order \ below the minor low. Shouldthe stock reverse course, you will be protected.
Co long at the lowLong stop
Go short at the high
Sell short after prices start heading down at the top.
Short stop
Place a stop \ above the minor high to protect againstan adverse breakout. Cover the short when it turns atthe bottom trendline and starts moving up. For adownside breakout, cover as it nears the target price orany support level.
Move stops
Raise the stop to the next lowest minor low (for pricesmoving up) or next highest minor high (for pricesmoving down) as prices cross the formation.
Other
Go long if a broadening top shows a partial decline.Consider adding to your position once it makes anupside breakout.
Esterline Technologies
Jul 91
Aug
Sep
Oct
N
Figure 4.6 Use the measure rule toformation height from the highest hi
height from the highest high or lowes
out direction, the result is the expect
70
Broadening Tops
"
If the stock fails to break out upward, perhaps you can capture the ride upto the upper trendline for a 20% rise. Buy when prices turn upward at thelower trendline, then be ready to sell once prices reach the old high. Prices maypause for a bit before moving higher and tagging the top trendline or they may
reverse at this point. Make sure your stops have been raised to protect some ofyour profits.
What about the measure rule for downside breakouts? Again, the formation height is 2'/s. Subtract 2'/g from the lowest low (10) to arrive at the targetprice of 77/8. If prices break out downward, they should reach 77/8. However,the reliability of the target price for downside breakouts is just 62%—not veryreassuring.
For short positions in broadening tops, open the short after the pricetouches point B and begins heading down. Place a stop Vs above the highesthigh (12'A in this case) to limit your losses. Lower your stop to the next minorhigh or apex of the broadening top (either 1 l7/s or 11 l/s in this case) once thestock nears point A. Sometimes the stock will not make it down to the trendline before beginning to move up. At other times, there is a lengthy pausebefore prices turn around or continue down. A lower stop-loss point helps you
achieve at least some measure of profit.The last trading tactic is to look out for partial rises or declines, whichoccur when prices begin to cross the formation but do not come close to theopposite side. Instead, prices reverse course and break out soon after. Whenyou see a partial rise or decline, place a trade once the stock reverses course. If
a breakout happens, then consider adding to your position.
Sample TradeSandra has always taken a liking to the stock market but never had enoughmoney to jump into the game. Still, she paper traded stocks just to get a feel for
the markets and dreamed of one day trading for real. Then her parents died ina tragic car accident with a drunk driver.The year that followed was tough for Sandra because she was close tothem and missed them dearly. She bought a dog to help fill the void in her life,but it was not the same. Fortunately, her parents had insurance and a few savings, all of which she inherited. After paying taxes to the government, she suddenly realized there was no need to continue working. "Why wait till I'm olderwhen my health might be gone or I might die young like my parents?" Sheretired at 2 9.
Sandra knew that if she cut her expenses to the bone she could live off thesavings. She paid off the mortgage, the car loan, credit card balances, andstopped going out to eat in restaurants. Her lifestyle changed to accommodatethe limited income but one thing she would not compromise: her paper trading.
Sample Trade
71
After opening a brokerage account, she waited for the perfect trade andfinally found it; the one shown in Figure 4.6. She saw the broadening top formation early enough to buy into the stock before the breakout. Two days afterthe stock reached point A, she placed her order and received a fill at lO'/j.Immediately, she placed a stop '/s below the lowest low, or 97/s for a potentialloss of 6%.Sandra applied the measure rule and was looking at an upside target of
14'/4. If everything worked as expected, that would give her a return of over35%. After she placed the trade, she sat back and waited but kept an eye on theprice action. When prices paused at the high of the formation, she wonderedif the trend was going to reverse course. She considered taking her profits and
running but decided against it. After a few days, she recognized a flag formation and hoped that it represented a half-mast move (the flag being a halfwaypoint in the upward move). If that was true, she could expect a climb to 13%
(that is the distance from the top of the flag (12%) to the start of the move at10 projected upward using the lowest low in the flag at llH).A few days later, the stock not only fulfilled the measure rule for the flagformation, but for the broadening top as well. Did Sandra sell? No. Since thestock was moving up, she wisely decided to let her profits ride. However, shedid raise her stop to Il 7 /s, or H below the formation high. She viewed thispoint as a support zone and hoped that should the stock retreat to that level, it
would rebound before taking her out.In mid-February, just after the second peak around 1 7 appeared, she recognized a double top formation. She moved her stop to Vg below the confirmation point, or 14'/4. About two weeks after raising her stop, her position soldwhen the stock plunged from the prior close at 1 5s/8 to 1 2 Vs. After commissioncosts, she made 3 3 % in less than 4 months
Tour
5Broadening Wedges,Ascending
73
I call this formation an ascending broadening wedge because it resembles a rising wedge formation with a broadening price pattern. I first noticed it whensearching for the symmetrical variety of broadening formations. Symmetrical
broadening formations have a price pattern that revolves about the horizontalaxis—prices form higher highs and lower lows and two sloping trendlines outline the formation; one trendline slopes up and the other slopes down.The ascending broadening wedge is different from a rising wedge. Bothascending broadening wedge and rising wedge trendlines encompass price
action that slopes upward. However, that is where the similarity ends. The toptrendline of ascending broadening wedges slopes upward at a higher rate thanthe bottom one, giving the appearance of a broadening price series.
Volume of ascending broadening wedges is also opposite that of risingwedges: Volume for the ascending broadening wedge is slightly higher as thebreakout nears, but in a rising wedge volume typically recedes.
The Results Snapshot shows some statistics for ascending broadeningwedges. This chart pattern sports a relatively high, 24%, failure rate thatreduces to 6% if one waits for a downside breakout. Failure rates below 20% Iconsider to be acceptable, so the rule is, wait for a downside breakout beforeselling this one short.
Fullbacks (21%) and throwbacks (7%) are rare, which is somewhatunusual for broadening formations. The numbers suggest that once a breakoutoccurs, there is no looking back; prices break down cleanly and continue down.
R E S U L T S SNAPSHOTAppearance
This is not strictly true as the chart patterns accompanying this entry attest.Price action follows two up-sloping trendlines that
There is some hesitancy when the stock nears the lower trendline.
broaden out.
The 61 % result for meeting die predicted price target is lower than I liketo see in a formation (which is at least 80%). It is even weaker after revealingthe computation. The computation is not based on the formation height as youwould expect. Rather, the target is the lowest point in the formation. The measure rule is similar to the wedge family. Prices decline to, or below, the start ofthe formation about two-thirds of the time.
Reversal orconsolidation
Short-term (up to 3 months) bearish reversal
Failure rate
24%
Failure rate if waitedfor downsidebreakout
6%
Average decline
20%, with most likely decline being 10%
Volume trend
Slight tendency to increase over time
Fullbacks
21%
Throwbacks
7%
Percentage meetingpredicted pricetarget
61%
Surprising finding
72
A downside breakout follows a partial rise 84% of thetime.
A surprising finding for ascending broadening wedges is the partial rise.
A partial rise is when prices lift off the lower trendline but curl around andhead down before coming near the top trendline. When a partial rise occurs, adownside breakout follows 84% of the time.
TourWhat does an ascending broadening wedge look like? Consider the chart pattern in Figure 5.1. The first thing you will notice is the two sloping trendlines;the top one has a slightly steeper slope than the bottom one. Together, the twotrendlines spread out over time but both slope upward. Once prices pierce the
74
Broadening Wedges, AscendingAir Express Intl. Corp. (Air Transport, NASDAQ, AEIQ
Barrick Cold (Cold/Silv
|an 92
Sep 91
Figure 5.1 An ascending broadening wedge. Two up-sloping trendlines containprices that broaden over time.
Figure 5.2 An ascending broadening wethis chart. The partial rise and failure to timpending trend change.
bottom trendline, they drop rapidly. The chart looks like a pie-shaped wedgethat slopes uphill. That is why it is called an ascending broadening wedge. Theprice action alternates and is contained by the two trendlines. The two trendlines are not parallel. If they were parallel, you would have a channel or rectangle (when both trendlines are horizontal).Figure 5.2 shows a better example of a broadening wedge, with two upsloping trendlines where the slope of the top trendline is much steeper than thebottom one.Figures 5.1 and 5.2 both show a similar situation. The formation appearsat the end of a rising price trend and signals a reversal. Although a reversal isnot always the case, nor is the formation required to be at the end of a risingprice trend, both situations occur more often than not.Figure 5.2 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 achange in trend. We further explore partial rises later.
Oct
Dec
Jul92
Why does a broadening wedge forthe head of an investment conglomerateto buy shares in another company. Whtrading department to begin its buyinforces 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 shtors as a share-buyback program annouis nearing the expiration date and the coto complete their promise to shareholdeThe stock makes a new high. Whpressure overwhelms the buying deman
74
Broadening Wedges, AscendingAir Express Intl. Corp. (Air Transport, NASDAQ, AEIC)
Jul 92
Aug
Figure 5.1 An ascending broadening wedge. Two up-sloping trendlines containprices that broaden over time.
Barrick Gold (Cold/Silv
Sep 91
Oct
Nov
Dec
Jan 92
Figure 5.2 An ascending broadening wethis chart. The partial rise and failure to toimpending trend change.
bottom trendline, they drop rapidly. The chart looks like a pie-shaped wedgethat slopes uphill. That is why it is called an ascending broadening wedge. The
price action alternates and is contained by the two trendlines. The two trendlines are not parallel. If they were parallel, you would have a channel or rectangle (when both trendlines are horizontal).Figure 5.2 shows a better example of a broadening wedge, witii two upsloping trendlines where the slope of die top trendline is much steeper than thebottom one.Figures 5.1 and 5.2 both show a similar situation. The formation appearsat the end of a rising price trend and signals a reversal. Although a reversal is
not always the case, nor is the formation required to be at the end of a risingprice trend, both situations occur more often than not.Figure 5.2