shows a failure that's typical for most chart patterns: It's called a 5% failure.
Price bounces between the two trendlines plenty of times, forming a right‐angled and ascending broadening formation, A. Price along the bottom sometimes pierces the horizontal support line (B) and sometimes it falls short. It's close enough, though, to give us enough minor low touches.
Figure 9.4 The broadening formation breaks out downward, but the stock fails to see price drop far.
Depending on how you draw the horizontal line along the bottom of the chart pattern, the breakout happens at C when the stock closes below the line.
Price makes a lower low before recovering. It's like dipping your toe into water (just after the breakout), finding it too cold for a swim, and scurrying back indoors (when price rises). Price busts the downward breakout at D when a breakaway gap sends price soaring.
Unfortunately, these types of failures happen too often in chart patterns. If you own the stock and it fails to drop more than 5%, then you're in good shape. If you sell a long holding expecting a big decline and it fails to provide one, you might be upset. Chill out. You'll never get out of this life alive.
I don't know of many tips to share that limit these types of failures. One tip is to look at the market trend. If the general market is trending higher, that's a plus. If it's moving sideways, I can live with that, too, but know the ride might be bumpy. A downward trend spells trouble. Do I really want to swim against the current and risk being run over by a jet skier?
I do the same check for stocks in the industry. I count how many are rising over the past 6 months. If I follow a dozen stocks in the industry and nine of them are rising, then that's good. Too many trending lower could spell a problem for a bullish trade.
Finally, after checking the general market and checking the industry health, I'll look at the stock. On the weekly or monthly scale, if the stock has been trending lower for years, then I won't buy it. If it's been making new highs, trending upward in a nice 30‐ to 45‐degree slope, then I feel reassured that the uptrend will continue. That's a momentum play.
Ask yourself this: How long will the uptrend continue? Is buying now closer to the start of the trend or the end? Of course, we won't know for sure until much later, but I want to avoid uptrends that end just after I buy. When that happens, it really pisses me off.
On a shorter‐term scale, look for overhead resistance and underlying support to help gauge where the stock might reverse.
Statistics
Table 9.2 shows general statistics for this chart pattern.
Number of formations. I found 1,223 patterns in stock data from July 1991 to October 2019 in 703 stocks. However, after slicing‐and‐dicing the bear market samples, there were too few to present here. So the following tables only show bull market statistics. Not all stocks covered the entire range, and some no longer trade.
Reversal (R), continuation (C) occurrence. Because the inbound price trend can come from any direction, we can't claim this pattern is a bottom or a top. But we can compare the inbound trend with the direction after the breakout. If the two are in the same direction, then the pattern acts as a continuation of the prevailing price trend.
If price enters the pattern from the top and exits out the top, that's a reversal. The same can be said if price enters from the bottom and breaks out downward (it's also a reversal).
Upward breakouts act as continuations most often, so we know the inbound price trend must have been upward, too. Downward breakouts act more often as reversals (suggesting price was trending upward into the pattern).
Reversal/continuation performance. Reversals for both breakout directions show better performance than continuations.
Average rise or decline. The average rise or decline isn't exceptional. As I mentioned, this pattern is a mid‐list performer, so don't expect a standing ovation.
Table 9.2 General Statistics
| Description | Up Breakout | Down Breakout |
|---|---|---|
| Number found | 551 | 455 |
| Reversal (R), continuation (C) occurrence | 25% R, 75% C | 76% R, 24% C |
| Reversal/continuation performance | 47% R, 41% C | –15% R, –14% C |
| Average rise or decline | 43% | –14% |
| Standard & Poor's 500 change | 12% | –2% |
| Days to ultimate high or low | 243 | 51 |
| How many change trend? | 55% | 25% |
Standard & Poor's 500 change. The performance of the chart pattern beats the tar out of the index. I can't think of any pattern that failed to beat the general market results. That suggests the measure favors the chart pattern.
The chart pattern is performing at its best, from the breakout to the ultimate high or low. But the index, using the same dates, may fall well short of what it's capable of. However, the numbers also show how the general market assists individual stocks to perform. The market rises during upward breakouts and falls during downward ones.
Days to ultimate high or low. How long will your trade last? It lasts as long as you do not close out your position. However, I measured the average hold time from the breakout to the ultimate high or low.
Pop quiz: If it takes 243 days for price to rise 43% after an upward breakout, how long should it take price to drop 14% after a downward breakout, assuming the same velocity? Answer: 79 days. However, the table shows that it completes the trip in just 51 days. Thus, price drops much faster after a downward breakout than it rises in an uptrend. Often, price drops twice as fast.
How many change trend? In a gauge of how well price moves more than 20% from the breakout, this pattern does well. However, it's still a mid‐list performer. Have I mentioned that?
Table 9.3 shows failure rates for the broadening pattern. For example, I found that 15% of the patterns with upward breakouts failed to see price rise more than 5% after the breakout. Downward breakouts failed almost twice as often. Yuck.
Notice as you scan down the list how failure rates increase. Half of all upward breakouts will see price fail to rise 25%. Downward breakouts see half the patterns failing to rise more than 10%.
If you want to average 50% on your trades, 72% of them will fail to meet the threshold after an upward breakout. And that's if you trade it often and perfectly. You could make more or less, depending on your skill and the situation (such as just after a bear market ends when even the losers are winning). Sprinkle in some losing trades and your winners will have to make even more to reach your 50% target.
Table 9.4 shows breakout‐related statistics.
Breakout direction. The breakout direction is almost random with a slight advantage going to upward breakouts.