Average drop
The right‐angled and descending broadening formation's name is a mouthful, but it describes a pattern with a flat top and price following a down‐sloping trend along the bottom.
The performance rank places it in the middle of the chart patterns I studied. The pattern favors an upward breakout almost twice as often as a downward one.
The above Results Snapshot shows performance about what you would expect from a mid‐list performer. Nothing appears that would blow the roof off the house. Volume trends upward throughout the pattern and that is unusual.
Let's take a scenic tour of the pattern.
Tour
What do descending broadening patterns look like, and why do they form? Figure 10.1 shows an example of the chart pattern I caught back in the 1990s. There are the two key ingredients to this broadening pattern. First, price at the top of the pattern reaches the same level (or nearly the same) for several weeks. A trendline drawn atop the pattern's peaks forms a horizontal line.
Second, the minor lows touch and follow a down‐sloping trendline as price drops. Eventually, price breaks out of the pattern by closing either above the top trendline or below the bottom one.
Figure 10.1 A horizontal trendline drawn along the tops, and a down‐sloping trendline connecting the minor lows, is characteristic of this chart pattern. The extended, down‐sloping trendline shows future support and resistance areas. A one‐day reversal appears on 3 November when price pushed above the formation top on high volume but closed at the low for the day.
In this example, the breakout is downward (which happens in mid‐November, the day when the second down‐sloping line begins) because price closes below the lower trendline there. I require price to close outside the trendline, so that's why the one‐day reversal on 3 November at the pattern's top doesn't qualify as an upward breakout. On that day, price closed at 19, the low for the day, and below the top trendline value of about 19.50.
Figure 10.2 shows an example of the broadening pattern with an upward breakout. The top of the pattern is well formed with several minor peaks reaching the same price level. However, two one‐day touches compose the lower trendline. A trendline touch is a trendline touch regardless of whether it is composed of one‐day spikes or many days of consecutive touches, but they need to be minor lows (or minor highs), which these two are. If price cuts through a trendline, such as at the start or end of the pattern, it doesn't count as a trendline touch because it's not at a minor high or low.
The figure shows a broadening pattern with an upward breakout providing a tasty 10% rise in just over 2 weeks. A throwback to the top of the broadening pattern occurs almost 4 weeks after the breakout. I consider throwbacks or pullbacks that happen later than 30 days to be just normal price action, and not a throwback or pullback. This one just makes the cut at 27 days. Often, a throwback or pullback will return to the breakout price in an average of 12 days.
Why do these chart patterns form? Look at Figure 10.3. During 1993, the stock entered the left pattern in early April and moved higher on moderate volume until it reached about 35. There, investors selling the stock matched buyers eager to own the security, and the rise stalled. The stock traveled sideways until 10 May when it moved below the prior minor low. As the stock approached $31, it entered a support zone set up by the retracement in mid‐March. The decline stalled and moved sideways for several days. Due to the support level, many investors believed that the decline was at an end and the stock would move higher. It did. As volume climbed, price gapped up (breakaway gap) and quickly soared back to the old high.
Figure 10.2 Another descending broadening formation, but this one has an upward breakout. Almost 4 weeks after the breakout, price throws back to the formation before ultimately moving higher.
Figure 10.3 The left descending broadening pattern shows a trendline rebound resulting from earlier support. The right formation shows a partial rise that can predict a downward breakout. Shown are two resistance areas that follow the pattern's trendlines.
The stock ran into selling pressure from institutions and others trying to sell blocks of shares at a fixed price. The available supply of shares halted the advance. Price hung on for a few days, moved a bit lower, and paused before beginning a rapid decline to a new minor low.
As volume climbed, the stock declined until it touched the lower trendline, a region of support. Suspecting an oversold stock, investors bought and forced it higher again. When the stock reached the old high, there were fewer shares available for purchase. Investors and institutions who were trying to get 35 a share for their stock sold most of their shares in the preceding months. Soaking up the available supply, the stock gapped upward and closed above the old high. An upward breakout was at hand.
The stock moved higher but soon formed another descending broadening pattern (the right one, in August). This one was compact and tight but had bearish implications.
When the stock tried to reach the top trendline but could not, the partial rise foretold the coming decline. The stock plunged through the lower trending in late September and continued lower.
If you look at both chart patterns, their stories are nearly the same. There is a supply of stock available at a fixed price. After exhausting the supply, price either rises above the top trendline or declines below the bottom one. The determination on which way price will go is not clear. Sometimes supply overwhelms buying demand and the stock declines, unable to recover as the stock pierces the lower trendline. At other times, the supply tightens and enthusiastic buyers jump in and push the price higher.
Identification Guidelines
Are there some guidelines that can assist in identifying descending broadening formations? Yes, and Table 10.1 outlines them.
Appearance. The shape of the broadening chart pattern looks like a megaphone with the top held horizontal. Price climbs until it touches the top trendline, and then reverses direction. On the pattern's bottom, price declines, making a series of lower lows, following a trendline downward.
Table 10.1 Identification Guidelines
| Characteristic | Discussion |
|---|---|
| Appearance |
Looks like a megaphone, tilted down, with the top of the chart pattern horizontal and bounded on the bottom by a down‐sloping trendline.
|