Horizontal top resistance line. When two (preferably more) minor highs achieve the same, or nearly the same price, you can draw a horizontal trendline connecting them, forming the top of the pattern.
Down‐sloping trendline. The same applies to the down‐sloping trendline: It requires at least two distinct touches before drawing the trendline (more touches are better).
Touches. I prefer to see at least five trendline touches, three on one trendline and two on the other, with all five being minor highs or minor lows (peaks or valleys). Fewer than five touches make correct identification more difficult.
Whitespace. Figure 10.4 shows an identification problem at AB. There are two trendline touches along the top (as minor highs) and four touches as minor lows along the bottom. The pattern looks like a descending broadening pattern.
It's not.
See that chunk of whitespace at B? Price doesn't cross the pattern often enough to qualify it as a valid broadening pattern. The inset at C shows that the pattern is better drawn as a down‐sloping channel. This chart is an example of cutting off a turn and calling it a descending broadening pattern. Do not tell anyone that you found a broadening pattern after you cut off a turn. What you found was a mistake.
Breakout direction. A breakout occurs when price closes outside the trendline boundary. Breakouts can occur in either direction.
Partial rise or decline. A partial rise, as shown in Figure 10.3, or a partial decline (not shown), is often a clue to the ultimate breakout direction. When price curls around on a partial rise or decline and returns to the trendline, the stock will usually break out immediately (that is, without crossing the chart pattern again).
Figure 10.4 AB is not a descending broadening formation.
Volume. Volume tends to rise over the length of the chart pattern, sometimes following the price movement.
Support and resistance. The pattern's trendlines, when extended into the future, can sometimes act as areas of support or resistance. Figures 10.1, 10.3, and 10.7 show examples. Sometimes the support or resistance level is active for months or even years.
Focus on Failures
Since descending broadening formations can break out either up or down, I show both views of failed breakouts. The first one, Figure 10.5, is characterized by the telltale partial decline in late November. From there, the stock climbs and eventually pierces the top trendline, as predicted.
Once price closes above the trendline, you would expect it to throw back to the formation top and resume the upward trend. In this situation, price reverses at 45 and returns to the formation proper—a classic throwback. Unfortunately, instead of rebounding and heading higher like a typical throwback, the stock continues down. It does more work inside the chart pattern before shooting out the other side in a straight‐line run.
Had you bought this stock after the upward breakout, you would have seen the stock decline from a purchase point of about 44.50 to a low of 36.88. A stop‐loss order placed at the bottom of the chart pattern would have gotten you out at 39, still a hefty decline. However, if you'd held onto the stock (not recommended, by the way), it would have been rewarding. The low occurred on 8 April (not shown), and it turned out to be the lowest price reached during the next 2 years. The stock hit its peak in early November 1993 at a price near 60.
Figure 10.5 A descending broadening formation appears with price that fails to continue moving up. The partial decline suggests the ultimate breakout will be upward, but the rise falters and price moves down instead.
Figure 10.6 This descending broadening pattern (left) results in a 5% failure. A broadening top formed in early November.
Figure 10.6 shows a more harrowing tale because it involves a short sale. Investors watching the sharp 2‐day decline beginning 14 October 1994 would be tempted to short the stock the next day. Had they done so, or even waited a few days, they would have opened the trade near the low. From that point on the stock moved higher, back into the formation before ultimately soaring out the top. If you were a novice trader and had not placed a stop on your short sale, your loss would have taken you from a low of 24.38 to 53, where it peaked near the end of the study.
The figure represents a failure type I call a 5% failure. That happens when price breaks out in a given direction and moves no more than 5% before crossing the pattern and breaking out in the new direction. This type of failure can turn a small profit into a large loss if stops are not used.
Statistics
Table 10.2 shows general statistics for right‐angled and descending broadening formations.
Number found. I found 1,150 patterns in 668 stocks from August 1991 to October 2019. However, that included bear market patterns, and there were not enough of those to include in the statistics. Not all of the stocks covered the entire period, and some no longer trade. Notice that the pattern favors upward breakouts, judging only by the numbers.
Table 10.2 General Statistics
| Description |
Up
|
|---|